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After three consecutive quarters of positive returns, U.S. equities (as measured by the S&P Composite 1500®) posted a negative quarterly performance (-3.4%), bringing the YTD gain to 12.2%. Notwithstanding supportive Q2 2023 earnings data (link), this negative performance played out across the large-, mid- and small-cap segments of the U.S. equities space.
Q3 2023’s macroenvironment was a mixed bag, without enough positive surprises to continue the market rally seen in the first half of this year. Although the U.S. Fed raised rates only once this quarter, the market perception appears to be skewed toward “higher for longer,” with expectations increasing for another rake hike before the end of the year. The downtrend in inflation still isn’t within the Fed’s acceptable range, and energy prices and housing costs continue to drive inflation. The labor market remained durable, with unemployment levels near historic lows, but this data was countered by falling consumer confidence levels. This weakening sentiment is also seen among corporations, with ISM Manufacturing PMI monthly numbers in contraction territory for the past 10 months.
The popular “magnificent 7” group, which contributed to about 60% of the H1 2023 positive returns within the S&P 500® (-3.3% for the quarter), saw five of its constituents post negative returns. The underperformance of mid-cap (S&P 400®, -4.2%) and small-cap (S&P 600®, -4.9%) segments compared to their large-cap counterpart continued in the third quarter, but at a relatively slower pace. Sectoral performance across S&P 500 sectors also saw a reversal, as Energy (12.2%) was the top performer, while the Information Technology (-5.6%) and Consumer Discretionary (-4.8%) sectors were down this quarter. The rate-sensitive sectors of Real Estate (-8.9%) and Utilities (-9.3%) were the biggest underperformers within S&P 500 sectors.
International equities followed suit, with both the S&P Developed Ex-US BMI (-4.2%) and S&P Emerging BMI (-2.0%) moving lower for the quarter. European equities struggled with relatively higher rates and higher energy costs, along with a lack of the fiscal spending seen in the U.S. The expected boost to the global economy from the reopening of China has become mired in credit concerns surrounding its Real Estate sector.
Returns across the factors space within S&P 500 stocks were mostly negative. High beta (-8.0%) and low volatility (-5.8%) at the opposite ends of the risk spectrum were the biggest underperformers. Growth (-2.6%) outperformed value (-4.1%), aided by Energy’s weight in growth. The top factor performer was momentum, with Energy again driving the outperformance.
U.S. 10-year Treasury yields breached 4.5% in September, the highest level since the 2008 Global Financial Crisis. In addition, the U.S. 2-10-year Treasury slope has remained inverted since June 2022, but the inversion narrowed this quarter, exacerbating losses on the relatively longer tenor bonds. The S&P U.S. Treasury Bond Index was down 1.9% this quarter, along with the broader S&P U.S. Aggregate Bond Index (-2.2%) and the S&P Eurozone Sovereign Bond Index (-2.0%). After hiking the overnight rate twice during this quarter, the European Central Bank has indicated a tilt toward a pause with an eye on inflation (link). U.S. corporate bonds also fell for the quarter, with both the iBoxx USD Liquid Investment Grade (-3.4%) and the comparatively shorter duration iBoxx USD Liquid High Yield (-1.5%) down. The one spot with positive quarterly returns within the fixed income space was the iBoxx USD Liquid Leveraged Loans (0.6%), a segment that primarily covers floating-rate securities.
On the commodities front, the S&P GSCI has been recovering its losses from H1 2023, gaining 4.1% for the quarter and 16.0% YTD. The bulk of these returns has been driven by gains in the S&P GSCI Energy segment (up 7.8% in Q2 2023 and up 28.8% YTD). Despite concerns around a global slowdown, oil prices were up 28.5% for the quarter, driven by tighter supply considerations. A stronger U.S. dollar weighed on the precious metals (-5.1%) segment, as it was the biggest quarterly underperformer within commodities. The industrial metals segment was slightly positive (up 1.5%), as zinc and aluminum price gains more than countered weakness in nickel prices.
