Quarterly Market Review: Q2 2023

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Global stocks continued to recover from last year’s drawdown, with the MSCI All Country World IMI Index returning 6% over the quarter and outperforming global bonds, as measured by the Bloomberg Global Aggregate Bond Index, for the third consecutive quarter. In the US, inflation expectations remained moderate, as 5-year breakeven rates stayed under 2.5% during the quarter. Market volatility continued a downward trend in 2023, as the Cboe Volatility Index hit year-to-date lows in June.

Globally, information technology was the best performing sector, lifting the returns of large growth stocks, while value-oriented sectors such as energy and financials lagged the overall market. Large growth stocks with low profitability did particularly well, as names like NVIDIA returned over 50% while Tesla and Netflix returned over 25%.

In the US, size, value, and profitability premiums were all negative as large growth stocks with low profitability outperformed. Other developed markets saw positive value premiums yet faced negative size and profitability premiums. Equity returns in emerging markets lagged developed markets but the premium environment was slightly more favorable, as the size and value premiums were positive and the profitability premium—while negative overall—was positive within small caps.

U.S. Economic Review

Although many economists have predicted a recession for 2023, the economy is proving resilient. Several factors are keeping the economy in expansion mode — the strong labor market, strong corporate and consumer balance sheets and the stabilizing housing market — despite signiﬁcant headwinds. The Federal Reserve paused its rate hike in June as inﬂation continued to show signs of steady decline, yet it remains well above the central bank’s 2% target.

While the trajectory of inflation remains the top story for the economy, one risk that has taken over the spotlight in recent months is the stability of the office sector. With occupancy rates hovering at about 50% on average, this segment of commercial real estate is under considerable stress. In response to the heightened risks, as well as spillover from the banking turmoil in March, banks have tightened credit standards, making lending less available and more expensive.

Fiscal policy is still stimulative. Many corporations extended the maturity of their loans during the low-rate environment of the pandemic, making them less vulnerable to higher interest rates. Households still have significant savings built up to support spending. Since the pandemic, consumers have ramped up spending on services while cutting spending on goods. However, the services sector is now the sole driver of growth for U.S. business activity.

Where do markets go from here?

Corporate profits could fall in a recession. In 2022, the S&P 500 earned just over $219 in aggregate¹, and forecasts for 2023 have earnings growing by roughly 1%.² Recent earnings growth has been negative, meaning that markets believe the worst is behind and that conditions should improve rapidly. A contraction in the economy could lead to lower sales, and a tighter labor market could lead to wage pressures – both of which could squeeze corporate profits, in turn putting downward pressure on stock prices.

Bond markets have stabilized. High-quality, short- to intermediate-term bonds have been more stable than lower-quality and longer-dated bonds, but bonds across the board have largely stabilized following the significant price swings during the first quarter.

Limited access to capital means an increased chance of defaults in certain sectors. The problems in the banking system earlier this year mean that credit conditions are likely to remain tight for an extended period. Companies that are forced to roll over existing debt and industries more susceptible to interest rate increases could see an uptick in defaults.

What are the investment planning implications?

Don’t buy hype. Finance author Morgan Housel aptly stated that “expectations are like a debt that must be repaid before you get any joy out of what you’re doing.”³ Certain companies in the U.S. have high expectations embedded in their current prices. Continued high returns will require the companies to exceed the current expectations. In markets, it doesn’t matter whether the news is good or bad, only whether it is better or worse than expected.

Bond yields continue to look attractive. With short-term, high-quality bonds yielding well north of 4%, fixed income looks attractive for both income and portfolio protection. If the risks in the economy – and their potential impact on the value of your stock holdings – are concerning, consider discussing a reduction in your stock allocation with your advisor.

Don’t try to time the market. The banking crisis is leading banks to tighten lending standards, which slows company investment and increases the likelihood of a recession. However, research shows that recessions are not a reliable way to time the stock market. Rather, stay focused on your goals and remember that your plan is built to anticipate market declines.

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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Certain information is based upon third party data, which may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article.

Market segment (index representation) as follows: US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index [net dividends]), Emerging Markets (MSCI Emerging Markets Index [net dividends]), Global Real Estate (S&P Global REIT Index [net dividends]), US Bond Market (Bloomberg US Aggregate Bond Index), and Global Bond Market ex US (Bloomberg Global Aggregate ex-USD Bond Index [hedged to USD]). S&P data © 2023 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2023, all rights reserved. Bloomberg data provided by Bloomberg.

Key Economic Indicators: Sources: Bureau of Economic Analysis (BEA) for real GDP growth. Real GDP is the annual rate of change of real gross domestic product, seasonally adjusted. Bureau of Labor Statistics (BLS) for core CPI. The core consumer price index (CPI) is the annual rate of change, seasonally adjusted, and excludes food and energy. Consumer sentiment is from the University of Michigan’s consumer sentiment index. Unemployment rate is reported by the BLS, and jobs added is based on nonfarm payroll employment reported by the BLS. Retrieved from FRED, Federal Reserve Bank of St. Louis. For all indicators, the boxed number reflects the latest reading, and the line above the box shows the change since the last update. The shaded areas reflect normal readings compared to history (based on the 25th-75th percentile of historical measures), while areas outside the dark blue reflect more extreme readings compared to history. The ranges are based on the percentile values of historical readings for each economic figure. The lowest number reflects the 5th percentile value, the bottom of the blue range reflects the 25th percentile, the top of the blue range is the 75th percentile, and the highest value reflects the 95th percentile. All ranges are based on the full period available. To account for population and employment, the ranges presented for jobs added are based on the percent change in employment numbers, using December 2022 as the base year.

1. New York University. “Historical Returns on Stocks, Bonds and Bills: 1928-2022.” January 2023.
2. FactSet. Earnings Insight. June 23, 2023.
3. Collab Fund. “Expectations Debt.” May 25, 2023.