2023 Quarter 3 Commentary

“The biggest risk of all is not taking one.” - Mellody Hobson

As we reach the midpoint of the year we hope that everyone is enjoying the warm weather, perhaps even supplementing it with your favorite summer food and/or cocktail of choice. We also hope that, between bites of watermelon and sips of your preferred beverage, you have been able to follow along with the mostly positive news posted in some of the recent financial headlines. As we well know, during the past few years, investors have had to weather increased market volatility due to COVID-19, energy crises, supply chain issues and global monetary policy tightening; however, 2023 has finally been a chance for markets to show signs of life.

Economically, there are many reasons to be optimistic for recent developments as we pass the halfway mark in the year. First and foremost, United States GDP increases have continued since 2Q 2022 and have continued to increase as depicted in the graph to the left. We’re also seeing that despite the Federal Reserve’s attempts to tighten monetary policy through interest rate increases, other econometrics that are often watched by policy makers seem to continue to say that the United States economy is remaining resilient.

For instance, payrolls recently beat expectations as seen in the graphic below. Retail sales continue to edge up despite calls for decreases. Demand for housing remains strong given new home sales also beat expectations, even with increased interest rates. All of this good news may signal to the Fed that the interest rate hikes may continue into the future – room to run that many hadn’t thought possible even a year ago.

However, despite all these economic successes, some investors are still waiting for the other shoe to drop in the form of recession. While good and well, data has shown time and time again that investors that try to time the market to this extent often miss out on the rebound. In the chart below from Bloomberg, you can see that the Nasdaq Index is on track for its best first half of the year ever. This is why having defined goals and a sound financial plan that you can stick to, despite times of economic downturn as well as successes, is such an important factor in achieving your goals.

In this quarterly commentary, we’ll discuss some of the market conditions as well as some behavioral finance tips and tricks to help investors stay the course.

Domestic Equity

As mentioned in the introduction, equity markets in the second quarter of the year have also been looking to move past the tumultuous 2022 based on the aforementioned good economic news and finally turn the corner. Below, you’ll find the performance of various domestic equity categories over the past 3-month, 12-month and 3-year periods from Morningstar.

For the first time in quite a few editions of our commentaries, you’ll find it hard not to notice the overwhelming positive returns not just in hot areas, but across the spectrum. Large Growth equities have outperformed their peers in the last three-month period, posting a 12.80% gain since Q1. Given the significant loss in value in the previous year, this aligned with our investment thesis that Growth stocks could be poised for a rebound in the current year.

Small-Cap stocks also have seen some rebound over the past few months but interestingly, Small Value has lagged a little behind over the past year’s return period. Overall, these returns have outpaced Wall Street analyst projections as seen in the graph.

As investment professionals, we assess these predictions qualitatively and take them with a grain of salt. However, it is worth noting that analyst predictions tend to deviate from the actual performance results and by large margins in some cases. In terms of sector performance, it’s no surprise that the sector with the largest concentration of large growth stocks – Technology - has been outperforming its peers over the last year.

However, despite the rally in the initial part of the year, optimists looking over the past month will also realize these returns are spread more generally evenly across sectors, such as Consumer Discretionary, that has joined the Tech rally over the past month. Additionally, some of those joining also include Industrials and Materials. These are remarkable because they are typically more connected to the overall health of the economy. Other notables include the Financials Sector, which, having started the year poorly after the failure of several large regional banks, is now almost flat for the year. Real Estate is another interesting sector, with some industry analysts predicting that because of increased mortgage rates, the sector would struggle.

However, homebuilders have been performing relatively well because many new home buyers must gravitate to new homes, driven by a lack of supply on the market. It's worth noting that, when the S&P has performed well in the first half of the year, the year almost always outperforms the year as a whole. As seen in the graphic below, performance six months later is usually positive rather than negative three to one. Additionally, a negative return hasn’t happened since 1987. This isn’t to say that it couldn’t or won’t happen, but it certainly bodes well for the optimists among us.

Fixed Income

The Equity market isn’t alone in taking advantage of 2023. After a historically poor performance in the past year, fixed income has finally turned a corner and started posting gains year-to-date.

In particular, fixed income instruments with an aggressively long duration suffered the most during 2022. This isn’t too surprising, as in a rising rate environment, these securities are typically forced down. However, it is also worth noting that higher credit-rated securities also outperformed, as treasuries became more attractive given recession concerns. However, similar to the equity performance, last year’s losers were in fact this year’s stars so far. Long duration fixed income has been outperforming. This isn’t to say that short term credit is posting losses, but longer duration had room to run. In addition, and in the same vein, lower rated bonds are seeing some gains as well as credit spreads widen further into the year. This indicates that perhaps investors are seeing some recession concern dissipate as they move into riskier fixed income trying to generate higher yields.

Revisiting Behavioral Finance: Lessons Learned

In previous Quarterly Market Commentaries – as well as in our quarterly webinars – we’ve dug deep into some behavioral biases that influence our investment choices, such as loss aversion. We often revisit these areas from time to time to remind ourselves of our susceptibility to these biases and learn how to avoid them. Here, we present a few new topics for consideration.

Endowment bias is an emotional bias that causes individuals to value an owned object higher, and often irrationally, than its market value. For example, imagine that an investor receives an inheritance from the death of a family member in the form of one company’s stock. The sound financial circumstances would dictate selling the stock and investing in a well-diversified portfolio. However, in some instances, that investor may feel that because the shares meant something to the family member, he wouldn’t want to sell them. Endowing the shares with extra value, even if well intentioned, may lead to incorrect financial decisions.

Another emotional bias cited by educators and researchers is Status Quo bias. Other biases typically result in some sort of action. For example, selling winners and holding onto losers. However, those afflicted with Status Quo bias do the opposite by not changing their strategy after life circumstances change; or perhaps not changing their investments after a regime shift in the marketplace. When these instances occur, make sure to revisit whether your current plan will continue to work or if adjustments can guide you closer to your goal.

Portfolio Strategy

We have been mostly positive on stocks year-to-date and particularly tilted portfolios toward growth for those investors who prefer to invest more aggressively per their Investment Policy Statement (IPS). As noted over the last several Quarterly Market Commentaries, this continues to be an effective strategy in the current environment. That being said, in areas that we believe are overbought – for instance, some Large Growth stocks have seen significant valuation increases in which price-to-earnings (P/E) and other metrics have grown to very large amounts – we will sell down concentrated positions as necessary to maintain diversified portfolios. When purchasing and selling securities, we also always consider tax implications for those positions not in taxable accounts. We continue to maintain our International and Domestic Mid- and Small-Cap equities in accordance with clients’ individual IPS. Our market expectations for these categories are neutral at this point. As these capital market expectations change, so will our target allocations in client portfolios.

As always, our fixed income strategic allocation will vary from client to client based on many different attributes for each client and each account. Factors that we assess include taxability, overall risk tolerance, disbursement needs, etc. In the past year, we’ve increased allocations to lower duration and higher credit rating securities with consideration for higher yields for clients that have allowed these securities in their portfolio.

As stated in our last commentary, “While we continue to believe that short-maturity bonds will continue to be attractive, it’s also a time to reflect on adding longer maturity products as well.” However, we did not substantially add duration to portfolios yet, because internal metrics pointed to markets were overestimating the likelihood of lower interest rates by year end. So far it's seemed prudent to stay long in short-duration securities.

Thank you and stay safe and healthy!