What’s New

As we moved deeper into fall, investors were once again forced to grapple with the consequences of an increasingly tense geopolitical backdrop.

The horrific terrorist attacks in Israel on October 7th helped to spark a short-term flight to safety in markets, with the war overall having limited impact on markets so far.

Attention was quickly diverted back toward the economy and inflation, the strong move higher in gold despite the modest strength in the dollar and the rise in real rates is a subtle reminder that investors may be keen to protect themselves from rising tensions globally.

From an economic perspective, October brought a blow-out GDP print in the US. The consumer continues to remain resilient, as the lagged impact of unprecedented fiscal support and elevated asset prices continues to support spending. However, we would caution that savings continue to be run down, and data shows that all but the upper 20% of households by income have run through their savings. It was also noteworthy that private investment ground to a halt in the third quarter, as higher rates are likely weighing on the decision to borrow and invest in the current environment.

Against this backdrop, the US 10-year yield continued to grind higher, closing the month up 36 basis points at 4.93%. The 2-year treasury was largely unchanged, having increased 4 basis points to close the month at 5.08%. This meant that the yield curve continued to steepen, a key data point to monitor as the last 4 recessions have occurred after the curve moved back into positive territory. Meanwhile, the S&P 500 (-2.20%), Dow Jones Industrial Average (-1.36%), and Nasdaq 100 (-2.08%) all finished the month lower as investors dealt with geopolitical risks, the idea long-term rates being higher for longer, and the potential for the US economy to slow meaningfully from here.

Outside of the US, the major economies continue to struggle to gain traction. Flash estimates of GDP in Europe suggested that the bloc’s economy contracted modestly quarter-over-quarter and barely grew at all on a year-over-year basis. In China, we continue to see policy efforts stepped up to put a floor under growth, and while we have seen signs of stabilization, we have little reason to think that the world’s second largest economy will be coming to the rescue like it has several times since the onset of the Great Financial Crisis.

Our Perspective

We have been adamant that a soft-landing is unlikely as we progress through the economic cycle. Historical evidence suggests that the Fed has never brought inflation down from the levels we’ve seen without causing significant economic hardship. Should the Fed begin cutting rates next year, we believe it is more likely than not that it will be in response to an adverse economic outcome, and therefore, we would anticipate the Fed would have to cut more aggressively than the market is currently pricing.

Given this, the market is likely going to have to reprice its outlook with higher yields, rising uncertainties, and weaker earnings. While the market is typically forward-looking, recessions tend not to be priced into the market until their arrival is imminent.

With that in mind, we are placing an emphasis on risk management and have adopted a defensive position strategy in our core portfolios.

You Ask, We Answer

Markets and the economy never take a day off, especially given the current environment. We’re answering questions that are top of mind for investors. Hear our thoughts and answers on:

1. I understand not buying growth stocks at high valuations, but why are you not buying stocks when they drop to bargain prices? 
2. In 100 words or less, can you share a takeaway on the current environment?
3. How much of the asset allocation for stocks is based upon P/E ratio?
4. What is a credit spread? Why is it important?

Find our views and answers in the full article: You Ask, We Answer.

Our View
Economic Cycle		The economy is late cycle. The Fed has hiked aggressively and while the economy has remained resilient to date, the manufacturing industry is showing serious pain and we anticipate that the lagged effect of monetary policy will start to be felt in other parts of the economy in the coming quarters.
Stock Market		The US stock market has rebounded strongly off its October 2022 lows. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansions. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		Interest rates remain well off of their lows, as the economy has remained resilient and the market weighing the dynamics of still-elevated core inflation and the potential for interest rates to remain higher for longer. Corporate spreads remain well contained, particularly in light of the risks we see to the economy.
Important Issues on the Radar		Inflation: Factors including a resilient demand environment and wage increases threaten to keep core inflation elevated. Should this be the case, the Fed may remain tighter for longer.
		China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the policy response in the coming months.

Indicates change Indicates no change

Source: Wall Street Journal, Bloomberg.

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