Saxo Morningstar Moat USD Q3 2023 commentary

Market overview

Quarter at a glance

• Stocks and bonds fell by 3.2% and 3.6% for the quarter, respectively, giving up some earlier gains.

• Inflation and interest rates continue to dominate the market narrative, with “higher for longer” now the consensus.

• Longer-term performance is still healthy, demonstrating the value of patience and not responding to every twist and turn

Important Perspective

The third quarter of 2023 was a setback for investors, with stocks and bonds both experiencing declines, offsetting some of the gains from earlier in the year.

The Morningstar Global Markets index ended the third quarter down 3.2% but has returned 9.9% over the year to date and is up 21.0% over the last 12 months. The losses for the quarter were wide but shallow, with the U.S., Europe and emerging markets all experiencing low single-digit declines.

Bonds experienced a strikingly similar decline for the quarter, with the Bloomberg Global Aggregate Bond index down 3.6%. This puts it in modestly negative territory for the year, although bond yields are now gaining in attraction at much healthier rates.

In sporting parlance, it is the equivalent of a soft-tissue injury following a strong run. It is not ideal and requires a careful eye, but it has been a period void of serious trouble.  

There are six noteworthy developments shaping markets: 1) the slowing inflation rate is at risk of rising again, following 25%+ energy price rises, 2) central banks would prefer to keep rates higher for longer, 3) company earnings are trending sideways and expected to fall slightly in the coming reporting season, 4) a recession is still considered a plausible outcome despite the resilient consumer, 5) political uncertainty is mounting as we enter another election cycle, and 6) artificial intelligence continues to grow rapidly with speculation and excitement.

The “higher for longer” (as it’s being called) landscape is perhaps the biggest change.

Pointedly, stocks and bonds took a leg lower following the Federal Reserve’s September meeting. While the Fed left interest rates unchanged, the market interpreted Chair Jerome Powell’s remarks to mean that the central bank intends to keep interest rates higher for longer. This followed a similar tune at the European Central Bank September meeting.

Given the above, it is no surprise that value stocks held up better than growth stocks in the quarter. However, it was energy and materials stocks that performed best, while utilities came in at the bottom.

Among bonds, it was the shorter duration segment that held up best in the quarter, although few areas etched out positive returns. Against the grain, it was high-yield debt that topped the leaderboard, while inflation-linked bonds lost ground, given the shift in inflation expectations.

In such an environment, cash acted as a ballast for the quarter, with U.S. dollar strength also notable.  

Portfolio performance (net of fees)

Top Performers

• Boston Beer Co Inc Class A, Global Payments Inc, The Western Union Co, Lyft Inc Class A, Altice USA Inc Class A

Worst Performers

• Just Eat Takeaway.com NV, Nexi SpA, Equifax Inc, Worldline SA, GN Store Nord A/S

Outlook

Taking a longer-term view, global stocks have experienced an annual gain of 7.2% over the past three years and 6.6% over five years. This would have been a bold forecast for someone who knew we’d experience a pandemic, a war in Europe, and the highest inflation in at least 30 years. More importantly, at this rate, the market would still double every 11 years or so, demonstrating the value of patience and not responding to every twist and turn.

While stocks have certainly not tumbled off a cliff, households continue to feel nervous, with consumer sentiment scores still well below normal levels. In this type of environment, we continue to identify opportunities for investors.

That said, we do acknowledge risks. One longer-term risk is the lack of earnings growth. This is a challenge because investors have been driving prices higher relative to earnings—a dynamic known as multiple expansion. One potential reason for the expansion of multiples this year was a belief that central banks would quickly and aggressively pivot to cut rates. This leaves two important (yet incredibly difficult to forecast) variables for markets: the outlook for interest rates and the direction for corporate earnings.

To show how hard it can be, let’s remember that earlier this year many investors were looking for an economic slowdown by the third quarter (if not a slide into recession) and bond markets were pricing for rate cuts during 2023. Even when it became clearer that a recession was not in the cards for the U.S. this year, bond markets were pricing in as many as five rate cuts in 2024. Investors now appear to believe those scenarios are off the table. 

Meanwhile, the outlook for corporate profits remains muddy. In response, a record number of S&P 500 companies (116) have issued earnings guidance ahead of the end of the quarter, according to FactSet. Currently, earnings are expected to be flat (-0.1%) year-on-year. This increased clarity makes sense at a time when investors are nervous, potentially decreasing the emotional reaction to disappointments. 

At the portfolio level, we must expect further surprises. This is a feature, not a bug, of investing. Moreover, it reinforces the need for robustness and judicious diversification. Specifically, we continue to seek exposure to assets that offer strong forward-looking prospects, while balancing risks with defensive exposures. 

Much like in sports, a well-rounded team that can defend and attack simultaneously is the most likely to repeatedly win.