The bullish sentiment that lifted stocks in the first half of 2023 has faded. The third quarter offered something of a reality check and after strong gains for shares in the first half of 2023, global equities posted a negative return in Q3. Global Government bonds also de-clined in the quarter, with yields rising to their highest levels in over 15 years. Commodities were a notable outperformer with energy gaining amid oil production cuts from Saudi Arabia and Russia.
The optimism that drove the markets in the first half of the year was misplaced, particular-ly expectations that the Federal Reserve would soon be pivoting to lower rates. The reali-ty is that interest rates are going to remain higher for longer.
This has led to a pullback among the “Magnificent Seven” stocks that had provided the market with most of its gains. Instead, value stocks outperformed, including dividend pay-ers. Energy stocks were the best performers, thanks to a higher oil price.
In the US, the labour market remains extraordinarily strong. However, according to the Bureau of Labor Statistics the unemployment rate rose by 0.3% to 3.8% in August. The US purchasing manager’s index (PMI) fell marginally to 50.1 in September, down from 50.2 in August, emphasising the US economy is cooling. (The PMI indices are based on survey data from companies in the manufacturing and services sectors. A reading below 50 in-dicates contraction, while above 50 signals expansion.)
Inflation, while ticking up in August, remains on a downward trend. Comments from Fed policymakers suggest a further rate hike is to come before the end of the year, while the dot plot now illustrates a higher median rate for 2024 (5.1% vs 4.6%).
The best performing major equity market in local currency terms was Japan, returning 2.5% over the quarter to continue a strong run year to date. Yen weakness remained a tailwind, despite comments from Japanese officials that the extent of currency deprecia-tion seen in 2023 was starting to become uncomfortable.
Headwinds to the global economy posed by tight oil markets also caught investors’ at-tention, with Brent crude oil prices rising by 28% over the quarter. The announcement that Saudi Arabia and Russia will extend voluntary oil output cuts through to the end of the year was the major catalyst behind the move. Higher oil prices not only threaten to pres-sure consumer spending but could also prove problematic for central banks if headline inflation begins to reaccelerate. This is a risk that will warrant careful monitoring over the coming months.
In summary, the smooth sailing for risk assets in the first half of the year was unlikely to con-tinue indefinitely in the face of a slowing global economy. Despite the resilience wit-nessed in economic activity year to date, recession risks remain elevated and not all parts of the market appear appropriately priced for such a scenario.
This article first appeared in the Platinum Portfolios Q3 of 2023 newsletter.
