Fear is the best fertilizer for future bull markets.”    Jason Zweig

Third Quarter Summary

Compared to the first half of the year, almost all financial assets pulled back during the third quarter. The correction included domestic and foreign equities and bonds, most commodities, precious metals and currencies.

The US dollar and oil were exceptions that rallied over the summer. Although September has been a traditionally weak month, it was even more so this past decade, with the S&P 500 falling 3.8%, 4.7%, 9.2% and 4.8% from 2020 through this year.

The swoon in financial markets occurred despite the continuing resiliency of the US economy. Real GDP growth, consumer spending and employment continue to be indicative of the expanding economy. These factors weighed on inflation, which drifted lower at a pace too slow for the Federal Reserve. The short-term Federal Funds Rate had increased only once in July from 5.25% to 5.50%, with the US central bank being data dependent on the future course of interest rates.

Meanwhile, longer-term rates increased, with the 10-year US Treasury rising 73 basis points to 4.57% by quarter’s end, as investors finally realized the “higher for longer” rate strategy of the Fed was real, and the economy was showing few signs of an imminent recession.

Economic Struggles Continue Abroad and at Home

Even after the Covid lockdown was lifted in China earlier this year, the country’s economic growth has continued to disappoint market strategists, with its struggling real property sector (comprising 25-30% of the Chinese real GDP) dragging down consumer spending. Note that residential homes and apartments make up the bulk of net worth for the average Chinese household. Moreover, unemployment among young people has risen above 20%.

In addition, debt from an overleveraged property sector, rising unemployment and an unfavorable demographic situation (the Chinese population has been decreasing) has impacted trading partners as well. This applies to European Union countries such as Germany, in particular. The US, which is not as dependent on trade, has largely been spared most of the pain.

However, there is widespread discontent among consumers regarding gasoline prices and inflation in general. West Texas Intermediate petroleum prices spiked over 28% to $90.79/bbl., with Brent prices even higher. The OPEC+ coalition (OPEC plus Russia) has proven durable, with the Saudis extending their 1 million barrel per day cut, thereby restricting supply. Though the rate of inflation is coming down slowly, prices are still rising, and the cost of goods and services remains well above pre-pandemic levels.

At home, wage issues continue with numerous strikes such as the Hollywood actor’s and UAW strikes and large wage hikes for transportation companies posing a dilemma for the Fed in its quest for 2% inflation. Meanwhile, the US dollar has rallied again as relatively stronger economic growth, along with higher interest rates relative to other countries, has bolstered the greenback.

Investment Outlook for the End of the Year

  • The Fed is near the end of its tightening cycle, with one or two rate increases possible. Of greater importance is the length of time that rates will stay elevated.
  • Our belief is that rates will stay high well into 2024. Inflation remains somewhat sticky because higher wages, oil and other factors such as conversion to alternate energy, will not fall quickly.
  • The economy will slow, as consumer spending is crimped by higher prices and borrowing rates. The resumption of student loan payments will be a contributing factor.
  • Taking all of this into account, there is a 50-50 chance of a recession commencing by next spring. Even if one does occur, however, we feel it will be mild, due to better consumer and corporate balance sheets than previous downturns.
  • Also mitigating the decline is a labor market based on a structural shortage of workers, especially skilled laborers.
  • Finally, some sectors will continue to experience rolling recessions while others recover. This will help cushion the overall impact of an economic contraction.

Our portfolios have been positioned for some time to manage a slowdown, investing in companies that are leaders in their industries, with most equities currently slanted toward growth. Fixed income retains a barbell approach, offering the flexibility to pivot when economics conditions cause a change in the yield curve.


“The U. S. government will always do the right thing after it’s exhausted every other option.”  —  Winston Churchill

Second Quarter Summary

Most equity markets continued their rally during spring, with fixed income pulling back after a good first quarter. Precious metals (such as gold) dipped moderately while commodities fell, led by the more cyclical copper and oil. The dollar ended flat.

So far this year, the biggest theme has been the resilience of the U. S. economy despite the rapid increase in interest rates beginning in March 2022. Real Gross Domestic Product (GDP) grew at an annual rate of 2.0% the first quarter, up from earlier estimates of 1.0%.

The second quarter has followed in similar fashion with forecasts close to 2.1%. The job market remained tight with unemployment at 3.6%, up only marginally since its multidecade lows of 3.4%. All this good news is being tempered by the glacial progress to harness inflation. The core rate (excluding energy and food) lingers between 4.5-5.0% and still a long way from the Federal Reserve’s goal of 2.0%.

Concerns Not Realized

In early spring, there were concerns that the failures of SVB Financial and Signature Bank would force regional banks to tighten credit standards. To date, tightening has been rather modest although it is still early.

There was also angst in April and May about a possible failure by Congress and the President to raise the debt ceiling. Fortunately, an agreement was reached before the critical early June deadline. However, many see the two-year deal as kicking the can down the road.

The strength in the economy, concerns that haven’t yet surfaced and rhetoric from the Fed have dashed any hopes for an imminent pivot in the Fed Funds rate. The markets have finally realized that higher interest rates will continue into the near future. This is also occurring globally with central banks in the UK, Eurozone, Canada and Australia reflecting similar narratives.

Liquidity and Other Factors Influencing Stocks and Other Asset Classes

Since the low of last autumn, equities have been helped by the Fed providing extra liquidity to the financial system, even though rates have been rising and the Quantitative Easing (QE) program is being unwound. Chairman Powell has been keen to keep something in the economy from “breaking.” A recent example of this has been the Bank Term Funding Program (BTFP) instituted shortly after the SVB and Signature Bank failures to assist regional banks in meeting deposit drawdowns by customers. This has, however, diluted the overall tightening of monetary policy.

Moreover, due to the prolonged period of extremely low rates following the Great Financial Crisis in 2008, both consumers and corporate borrowers had time to lock in low borrowing rates for extended terms. This has made the sharp rate hikes in Fed Funds less effective than usual.

Housing has also been abnormally affected by higher mortgage rates. While initially limiting the number of home borrowers, the high rates are also freezing existing homeowners with low-rate mortgages in their homes, thereby limiting supply. This has contributed to putting a bottom for home prices

Finally, effects of the pandemic have caused various parts of the economy to grow and contract at separate times. The most obvious has been the goods sector which first boomed then contracted. Conversely, the service sector shrank then picked up as Covid vaccines became available. This has led market strategists to describe the varying performance of distinct parts of the economy as “rolling recessions.” These factors have all extended overall growth and contributed to the equity rally in the first half.

Investment Implications and Outlook for the Second Half

With the economy and corporate earnings coming in better than expected so far in 2023, we have:

  • Selectively added back to some growth stocks that have corrected in price but possess characteristics resistant to an economic slowdown including such areas as AI (Artificial Intelligence), cyber security and EVs (Electric Vehicles)
  • Maintained our overall asset allocations, as we believe that current interest rates make fixed income an attractive alternative to equities for the first time since the GFC

As stated in quarterly commentaries since last fall, we still anticipate a significant slowdown in the economy by year-end and perhaps even a recession, due to the lagged effects of interest rate increases and an inverted yield curve. However, any recession will probably be mild, with both consumer and corporate balance sheets in much better condition than in previous downturns and the mitigating effects of rolling sector recessions. The reduction of the labor force due to Covid will also prevent unemployment from increasing as much as in previous economic cycles.



“When my information changes, I alter my conclusions. What do you do, sir?” — John Maynard Keynes, British Economist (1883-1946)cncartoons029020 965

First Quarter Recap

Financial markets rose in the first three months of 2023 with equities and fixed income improving despite a volatile environment. Most global indices joined the rally although commodities were mixed. Copper rose higher while oil fell for the period. Similarly, gold rose while the U.S. dollar drifted lowe

The first quarter was confronted with shifting narratives.

  • Early January featured a continuation of a soft economy consensus from the old year, with reports showing general weakness. Bond and stock prices rallied, hoping for an imminent Fed pivot where rate hikes would soon end, and the US central bank would begin cutting interest rates.
  • By February, stronger employment and inflation reports changed that narrative to a “no landing” or reheating story, which lasted for another month.
  • In March, fears of a banking crisis were sparked by the sudden failures of SVB Financial (the parent of Silicon Valley Bank) and the closure of Signature Bank. The FDIC had to quell the predicament by promising to insure all depositors of the failed institutions with accounts over the $250,000 limit.
  • In Europe, long-ailing Credit Suisse was taken over by UBS in a merger engineered by the SNB, the Swiss central bank.

Implications of the Regional Banking Crisis

Fortunately, the systemically important money center banks were not involved in this event compared to the Great Financial Crisis of 2008.

However, regional banks do account for 30% of all loans in the US, with their presence in mortgage lending and commercial real estate even larger. By quarter’s end, it is likely that regional banks will begin restricting credit by tightening lending standards for borrowers. It is still too early to quantify the impact of reduced lending to the economy, though most estimate the hit to be around 0.5-1.0% of real GDP (Gross Domestic Product).

The Effect on Fed Policy

The economy is still growing at a moderate rate but slowing pace. Inflation continues to normalize although service inflation, as well as housing costs and wages, remains sticky. Recently, the Fed has shown a slow tightening bias, citing an ongoing shortage of workers. The effects of regional banking problems may also lead the Federal Open Market Committee (FOMC) to pause or even halt the interest rate hiking process.

At this point, it is our belief that a pivot — or the beginning of a rate lowering cycle — is possible sometime in 2024 and not this year. Having lost a lot of public credibility by staying with the theme of “transitory” inflation in 2021, Fed Chair Jerome Powell is determined to bring down inflation much closer to 2%. Perhaps haunting him is the memory of the late 1970s, when then Fed Chair Paul Volcker stopped restrictive monetary policy too soon and had to raise rates sharply after just a few months, causing a deep recession.

Differing Messages from the Stock and Bond Markets

Fixed income markets have displayed unusual volatility this year. Overall, yields have moved lower, with the curve (difference between short and longer maturities) deeply inverted, with three-month and two-year Treasury yields considerably higher than the ten-year yields. This normally indicates a recession or at least a significant slowdown in the economy to a stall-speed pace. Another predictor of future economic growth, the index of Leading Economic Indicators (LEI) has been in negative territory for some time.

On the other hand, equities have rallied on the prospect of an imminent Fed pivot but seem to ignore the main reason for a pivot – significant economic weakness. A steep falloff in GDP growth would also impact corporate earnings, causing stock prices to swoon. The only way to avoid this is a soft-landing scenario. Although possible, we view it as an outside chance at best.

Investment Implications Going Forward

In our view, the Fed is close to ending its interest rate increases. If that occurs, stock market leadership will migrate back to growth after favoring value strategies over the last 18 months. As a result:

  • We have started to add to higher growth equities, especially those that are not too dependent on the economic cycle
  • Our bond market strategy will gradually rotate to longer fixed income bonds from short-term maturities
  • We have added to international equities, focusing on emerging markets which feature positive demographics due to our belief that the US dollar has peaked, at least for the for next year or two

Numerous cross currents due to the pandemic and its aftermath still reverberate throughout the economy manifesting a great deal of the market uncertainty and volatility being experienced. We think that a well-diversified portfolio featuring quality and liquidity will offer the best opportunity to build and preserve wealth over time, especially when the situation improves.