13 Oct 2023
02-10-2023 | Hugh Gimber
Review of markets over the third quarter of 2023
Following a robust rally for stocks in the first half of 2023, the third quarter offered something of a reality check. Developed market equities fell by -3.4% over the quarter, taking year-to-date returns down to a still strong 11.6%. Value stocks proved relatively resilient vs. their more expensive growth counterparts, returning -1.7% over the quarter in comparison to -4.9% for growth stocks. The gap between the two styles remains wide year to date, however, with growth stocks having outperformed by more than 18% so far in 2023.
A sell-off in global bond markets was partly to blame for the pressure on risk assets, with the global aggregate bond benchmark falling by -3.6% in the third quarter. The US Treasury market was a notable laggard, while in credit, the lower interest rate sensitivity of high yield bond benchmarks helped both the US and European high yield bond markets to eke out positive returns, returning 0.5% and 1.5% respectively. As bonds and stocks fell simultaneously, commodities were the notable outperformer, returning 4.7% over the quarter, echoing the market dynamics of 2022.
Exhibit 1: Asset class and style returns
Source: Bloomberg Barclays, FTSE, LSEG Datastream, MSCI, J.P. Morgan Asset Management. DM Equities: MSCI World; REITs: FTSE NAREIT Global Real Estate Investment Trusts; Cmdty: Bloomberg Commodity Index; Global Agg: Bloomberg Global Aggregate; Growth: MSCI World Growth; Value: MSCI World Value; Small cap: MSCI World Small Cap. All indices are total return in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2023.
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 depreciation seen in 2023 was starting to become uncomfortable.
The UK market was the next strongest performer regionally, returning 1.9% in part thanks to its relatively large tilt towards the energy sector, which was supported by a sharp rise in oil prices. Returns were negative in all other regions, taking year-to-date returns in the US and Europe ex-UK to 13.1% and 10.0% respectively. In emerging markets, renewed concerns about the state of the property sector in China weighed on sentiment, despite a number of new stimulus measures announced over the quarter that were aimed at stabilising housing activity.
Exhibit 2: World stock market returns
Source: FTSE, LSEG Datastream, MSCI, S&P Global, TOPIX, J.P. Morgan Asset Management. All indices are total return in local currency, except for MSCI Asia ex-Japan and MSCI EM, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2023.
In fixed income markets, government bond returns were negative across developed markets as yields rose over the quarter. UK Gilts remain the major laggard year to date, but did enjoy a relatively better few months, returning -0.7% over the quarter as weaker growth data forced investors to dial down their expectations for where interest rates will peak in this hiking cycle.
High yield bond markets remain the top performing sector this year, with the US and European benchmarks returning 6.0% and 6.1% respectively so far in 2023. In a rising yield environment, the shorter-dated profile of high yield bond benchmarks has been a source of resilience, with spreads broadly flat over the quarter.
Exhibit 3: Fixed income sector returns
Source: Bloomberg Barclays, BofA/Merrill Lynch, J.P. Morgan Economic Research, LSEG Datastream, J.P. Morgan Asset Management. Global IL: Bloomberg Global Inflation-Linked; Euro Gov.: Bloomberg Euro Aggregate - Government; US Treas: Bloomberg US Aggregate Government - Treasury; Global IG: Bloomberg Global Aggregate - Corporate; US HY: BofA/Merrill Lynch US HY Constrained; Euro HY: BofA/Merrill Lynch Euro Non-Financial HY Constrained; EM Debt: J.P. Morgan EMBIG. All indices are total return in local currency, except for EM and global indices, which are in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2023.
While the simultaneous fall in stocks and bonds over the third quarter will remind many investors of 2022, there were some important differences in the drivers behind these moves. Economic data over the quarter pointed to a deterioration in the growth outlook, with services activity starting to show signs of “catching down” to the already weak manufacturing sector. Coupled with a continued moderation in inflationary pressures, investors are increasingly confident that we are approaching a peak in the global hiking cycle. We discuss this more in our recent publication “Beyond the pause: What happens after peak rates”.
The focus has therefore shifted from the level of peak rates, to how long central banks will hold rates at restrictive levels, with “higher for longer” increasingly viewed as the necessary scenario to tame stubborn price pressures. Fiscal sustainability was another area of concern for bond investors, with the US Treasury market in particular being hit by concerns over the amount of issuance that will be required to sustain a large fiscal deficit.
Exhibit 4: Fixed income government bond returns
Source: Bloomberg Barclays, LSEG Datastream, J.P. Morgan Asset Management. All indices are Bloomberg Barclays benchmark government indices. All indices are total return in local currency, except for global, which is in US dollars. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2023.
Headwinds to the global economy posed by tight oil markets also caught investors’ attention, 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 pressure 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 sum, the smooth sailing for risk assets in the first half of the year was unlikely to continue indefinitely in the face of a slowing global economy. Despite the resilience witnessed in economic activity year to date, recession risks remain elevated and not all parts of the market appear appropriately priced for such a scenario. The reset in fixed income yields suggests that core bonds should perform their job as a diversifier if weaker growth helps to break the back of inflationary pressures, but the positive correlation between stocks and bonds in the third quarter is a timely reminder of the importance of alternative assets that can diversify against different risks.
Exhibit 5: Index returns for September 2023
Source: Bloomberg Barclays, LSEG Datastream, MSCI, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 30 September 2023.
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