Altair Insight: Climbing the Wall(s) (3Q23) – Quarterly Market Review


Markets’ proverbial wall of worry tends to loom menacingly higher in the fall, and 2023 is proving no exception. Spooking investors this October is a lengthy list of Halloween-level scary developments: A new war in the Middle East, dysfunction in Congress, a looming government shutdown, surging longer-term Treasury yields, still-high inflation, rising oil prices, labor strikes, a $1.7 trillion federal budget deficit and a $33 trillion national debt.

market monitor
Noah Kroese Illustration for Altair Advisers.
Consumers have so far kept the economy growing through high inflation and rising interest rates. They are being forced to navigate these challenges for longer than anticipated, which is resulting in a decline in savings and a housing slowdown.

Temporary or not, that witch’s cauldron of issues has darkened the mood of consumers and markets alike. Consumers’ confidence has waned even as their spending continues to power the economy. The stock market has slumped since a first-half rally powered by technology companies seen as benefiting from an artificial intelligence boom. Bond markets are down amid fears the Federal Reserve will keep rates “higher for longer,” a catchphrase that bodes well for climbers, balloonists and long jumpers – not for investors.

Amid the autumn anxiety, however, are some crucial positives that are not keeping investors up at night.

The economy remains strong, inflation is moderating, and corporate profits are improving. The broad U.S. market’s returns remain above average for the year even after the worst quarter of 2023. That is due to the “Magnificent Seven” stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms) that, cooling or not, have accounted for virtually all of the S&P 500’s gains this year with returns averaging over 90%.

As winter approaches, we are closely watching the American consumer – showing signs of fatigue from high rates, inflation and other pressures. Achieving a soft landing, a moderate economic slowdown followed by growth, hinges on continued strength in spending along with a healthy labor market. A significant weakening of either would make a recession much more likely. The consumer’s performance, representing 70% of the economy, will have a lot to do with how the economy and markets navigate the multiple challenges in the months ahead.

Heightened geopolitical risk also is top of mind amid the outbreak of war between Israel and Hamas – a conflagration that, besides taking a terrible human toll, poses new danger for global stability and the world economy if it significantly broadens.

We recommend clients maintain overall target allocations in the higher-, medium- and lower-risk categories for now. The recent rise in bond yields, however, prompts us to begin changing our recommended positioning within lower-risk investments. We believe medium- to long-term Treasury yields are now nearing their peak and, while they may move higher yet or remain at current levels for some time, we believe the current risk-reward tradeoff is favorable for investors. Thus we recommend clients shift from short-term Treasury bonds to intermediate-term Treasury bonds within their taxable fixed-income allocations.

Please read on for more of our thoughts on the main issues affecting markets.

1. Signs of stress are emerging for consumers who up to now have enabled the economy to avoid a recession with their spending.

Along with the labor market, consumers have been a cornerstone of economic growth since the pandemic began. Now they are undergoing still more tests that may ultimately determine if the Federal Reserve is able to engineer a soft landing – reduce inflation back to its target without causing a recession. The possibility that their spending, while still vigorous, could slow in the face of lingering challenges keeps us cautious about the outlook for next year.

Consumers actually have been carrying the load for a slow-growth economy since before the pandemic. One of the cartoons we commission every quarter to help explain our views in a visual and (hopefully) entertaining way depicted the American consumer in 2019 as Atlas, bearing the weight of the world on his shoulders, assisted by Jerome Powell. The burden got heavier after the emergence of COVID-19.

Today, Powell’s Federal Reserve is no longer flooding the economy with cash to keep it vigorous, nor is Congress. Consumers again must rely on their own income and savings as the Fed effectively works against them by raising interest rates to “unstimulate” their post-pandemic spending habits and curb inflation – without turning them miserly.

So far, so good. Inflation is down and spending growth tailed off in late summer but not by much. Third-quarter spending was enough to help drive a forecast by the Atlanta Fed of 5.4% GDP growth for the July-through-September period.

Some trend lines are cause for concern, however. The persistence of above-average inflation is squeezing households more than earlier in the year, particularly with food and gasoline prices rising at an above-average pace. The cumulative impact of a 5-percentage-point leap in interest rates since March 2022 is taking an increasing toll. Other pressures on consumers, too, are becoming evident.

  • Mortgage rates have soared, bringing housing affordability as measured by the National Association of Realtors to a record low as average mortgage rates climbed to 8%.
  • Delinquencies on credit cards and auto loans are at their highest rates in more than a decade, according to Equifax and Moody’s Analytics.
  • Total credit card debt recently topped $1 trillion for the first time, according to the New York Fed.
  • Student loan payments resumed in October after a three-year pause initiated during the pandemic, adding another obligation for many consumers.
  • The personal saving rate has dwindled to 3.5% of disposable income, down from an 8% average in the pre-pandemic years of 2017-19 – evidence that households are using more of their paychecks on items such as food and energy and have less financial cushion in the post-Covid-aid era.
  • Excess household savings that peaked at $2.1 trillion in August 2021 fell to under $700 billion by summer and will soon return to pre-pandemic norms.

Given the pressures, it is no wonder that consumer confidence as measured by the Conference Board fell to a four-month low in September and a University of Michigan consumer sentiment survey tumbled in October to its lowest since May, showing increased pessimism about business conditions and inflation.

Feeling gloomy, of course, does not necessarily equate to spending less. A maxim in the retail world holds that you should watch what consumers do, not what they say. Retail sales have kept edging higher in each of the past six months.

Consumers remain in good shape for now and are capable of leading the economy into a period of stronger growth with their spending. We are cautiously optimistic that they can ace their next test. However, we are watching spending to see if the economy holds up or slows as job and wage gains moderate and renewed student debt obligations pinch.

2. The economy has outperformed expectations this year. Slower growth lies ahead in 2024.

The U.S. is the star performer of a global economy that shows resilience while just “limping along,” to use the International Monetary Fund’s metaphor, as higher interest rates begin to sting after a lengthier-than-expected lag.

A healthy labor market, improving corporate earnings, solid levels of business investment, low business delinquency rates and steady GDP growth testify to an American economy that is mostly holding firm. The IMF recently upgraded its growth estimate for the U.S. by 0.3 percentage points to 2.1% for 2023, touting its “remarkable strength” amid challenges.

Those plaudits aside, however, some cracks are showing that have the potential to cause trouble if they linger or worsen next year. The IMF’s forecast U.S. growth pace in 2024 – be it a limp or a leisurely jog – is just 1.5%.

Manufacturing as measured by the Institute for Supply Management has contracted for 11 straight months. The Leading Economic Index has declined for even longer at 18 consecutive months. And the housing market is under pressure with mortgage rates at a 23-year high, home sales at their lowest levels since 2010, and would-be buyers crimped by the resumption of federal student loan payments.

The slow pace of improvement in corporate profits reflects the challenging environment that companies are operating in. S&P 500 companies are estimated by FactSet to report essentially flat year-over-year earnings for the third quarter, flirting with a fourth consecutive quarter of lower profits.

As mentioned earlier, the economy next faces a series of obstacles – resumption of mandatory federal student loan repayments, high mortgage rates, depletion of extra savings accumulated during the pandemic, and growing consumer pessimism – just as the critical holiday shopping season approaches.

These are yellow flags, not red ones. We believe the economy remains on pace to avoid a recession, something that many pundits thought improbable at the beginning of this year. Nevertheless, growth will slow as consumption and inflation decline. The economy is more vulnerable to either further deterioration in key areas or an unexpected shock – particularly given that the government is unlikely to come to the rescue as it did with Covid stimulus.

If there is a recession, we strongly believe it will not be severe. Deep recessions do not happen without pain in the labor market and a jump in unemployment. The labor market is cooling but still historically strong, with the September report showing 336,000 jobs added and unemployment staying near a record low at 3.8%.

Still, the evidence tells us to remain cautious and monitor the economic data closely to watch for any material weakening. The longer that rates and inflation remain elevated, the heavier the burden on the economy and the greater the risk of a downturn.

3. Even if the Federal Reserve does not raise interest rates again, keeping them “higher for longer” heightens risk.

After an uncharacteristic three months without a rate hike, Fed officials sent some interesting public signals in October that may presage the central bank’s next action – or inaction. We are not referring to the launch of a Fed account on Instagram, which actually happened. (@federalreserveboard had 121,000 followers after three weeks, leaving Chair Jerome Powell work to do to match Taylor Swift as a social media influencer with her 274 million followers.)

Rather, it was signs of a Fed pivot. Several members of the rate-setting Federal Open Market Committee (FOMC) suggested that the sustained rise in long-term Treasury yields could provide the necessary monetary tightening and spell the end of the historic rate-hike cycle, eliminating the need for the additional increase this year that many had projected. San Francisco Fed President Mary Daly, who will be an FOMC voting member in 2024, said: “If financial conditions, which have tightened considerably in the past 90 days, remain tight, the need for us to take further action is diminished.” Fed Vice Chair Philip Jefferson and Dallas Fed President Lorie Logan, both current voting members, made similar comments, later echoed by Powell himself.

A halt to increases is the needed first step toward normalization of the restrictive monetary policy that is beginning to squeeze borrowers, investors and the economy. Uncertainty about the Fed’s intentions has kept markets on edge since summer. While the central bank is unlikely to declare “We’re done,” preferring to keep its options open in case conditions change by its December meeting, our base case remains the same as when we stated the following in our Altair Insight after the July meeting: “Barring a dramatic change in data, we believe it likely was the final increase in the central bank’s 16-month tightening campaign.”

The all-important second step – cutting rates to take the pressure off – still appears distant. Fed policymakers indicated in their quarterly predictions in September that rates would stay higher for longer than previously anticipated, with fewer cuts in 2024, due in part to a strong labor market.

We anticipate the “higher for longer” mantra to dominate the Fed’s approach for at least the first half of 2024. Markets concur: The FedWatch gauge of market expectations predicts just two quarter-point rate cuts in the next 12 months, one each next summer and fall.

Given the Fed’s determination to keep its policy restrictive for an extended period to curb inflation, it would probably take a severe recession to get the Fed to loosen its policy significantly. We do not anticipate that.

4. Inflation is trending lower at a stubbornly slow pace that is just right for the economy.

The Fed’s protracted campaign to drive inflation lower has delivered impressive results so far. As with any marathon, however, the final miles are the toughest. While it would be premature to say progress is stalling, the mixed takeaways from recent data confirm that the path back to normal rates has gotten bumpy.

Overall inflation as measured by the Consumer Price Index rose more than expected in September on a monthly basis (0.4%), in part due to higher oil and gas prices. The annual inflation rate stayed at 3.7%. Excluding food and energy, core CPI was 4.1% – double the Fed’s 2% target rate. Fed policymakers voiced surprise when they met in September at spending’s continued resilience, the meeting minutes showed. In other words, inflation is proving sticky.

Seen through a longer lens, the trend is more encouraging.

Goods inflation, the main culprit when CPI soared to a peak of 9.1% in June 2022, is now zero. Services inflation is a still-lofty 5.7% but falling. And the core PCE index, the inflation gauge the Fed is said to watch the most closely, has fallen below 4% annualized for the first time in over two years. Better still, it rose only 0.1% in August, even as consumers were wrapping up a summer spending spree.

The biggest remaining factor behind high inflation, housing, epitomizes the mixed nature of recent progress in taming prices.

Shelter – the government’s measure of housing costs, based on rent levels rather than home prices – makes up more than a third of CPI. It accounted for more than half the September increase in inflation due to a surprising uptick in rent prices. But the data also showed the pace of rent costs finally starting to roll over – 7.4% year-over-year compared to the peak of 8.8% in April. Based on Zillow rent prices not yet reflected in the government data, further slowing lies ahead.

All told, the Fed’s 2% inflation target is becoming more realistic but is not imminent. We view that as good news for the economy.

Why is a slow pace of cooling good? A nosedive in spending and inflation could foretell a painful recession, perhaps even deflation. By the same token, a sustained acceleration of spending or even a pause in the past year’s easing would force the Fed to tighten policy again, also spelling trouble for the economy.

Bumpy or not, the halting progress on inflation has been beneficial because it highlights that the economy is hardier than many thought and appears on track to sustain that strength. Some might call it a tortoise’s pace; we would rather compare it to Goldilocks’ porridge: Not too hot, not too cold, but just right.

5. Bonds are on pace for a third consecutive down year, but we believe a turnaround is on the horizon.

Painful times continue for the bond allocations of portfolios – mostly in the form of further mark-to-market (unrealized) losses. A long-awaited recovery earlier this year was cut short by concerns the Fed could extend its interest rate-hike cycle and keep rates high for an extended period. The market then slumped further when longer-term Treasury yields soared this past summer and early fall.

The yield on the benchmark 10-year U.S. Treasury note has climbed by more than a percentage point since June, topping 5% for the first time since 2007 and sending prices of existing bonds in the opposite direction. That leaves our taxable bonds benchmark negative for a third straight year as of late October; our gauge for tax-free municipal bonds also is narrowly in the red year-to-date.

We see positive developments taking shape in this period of unprecedentedly poor performance, however. The surge in yields, which has been detrimental for short-term returns, appears likely to have mostly run its course. And that has created an opportunity for investors that we intend to capitalize on for our clients.

While we felt late 2022 conditions warranted a tactical shift to short-term Treasurys, market conditions have since changed, with longer-term yields recently rising significantly. Intermediate-term government bond yields, as proxied by 7-year Treasurys, also reached a 16-year high of 5.0% this October. We recommend that clients take the opportunity to lock in these attractive yields for a longer period given our belief that rates are near a peak. Data shows that intermediate Treasury yields typically peak around the last Fed rate hike in a cycle.

It is possible that rates creep higher or stay at current levels for months. Timing is difficult, since longer rates will likely move ahead of Fed action. But at some point, they will weigh heavily on the economy and will have to come down. Either they will decline naturally as inflation cools or as a result of the economy slowing significantly. We believe they are unlikely to go materially higher. If our base case of yields staying put or falling holds up, clients will benefit from this move.

We remain staunch advocates of both taxable and tax-exempt municipal bond investments, despite the mark-to-market losses of the 2020s. They currently are generating substantial and reliable income because of the same rising interest rates that sent prices lower. And they still provide valuable diversification to portfolios over the long term, cushioning losses – most of the time – from periodic pullbacks in stocks.

Our Outlook
  • Global tension is high amid war between Israel and Hamas, and with Russia and Ukraine dug into an extended war. Markets have maintained their historical tendency to stay stable during military conflicts. Wide expansion of either war, however, would heighten volatility in stocks and energy prices and pose additional risks for the global economy.
  • Barring a dramatic change in economic data, we believe the Federal Reserve is finished raising interest rates. We do not anticipate a rate cut for at least six months, however.
  • We are cautiously optimistic that inflation will continue slowing, with lower interest rates to ultimately follow. The Fed’s 2% target goal is achievable by late 2024 but is vulnerable to further geopolitical shocks or other exogenous events.
  • The economy has held up well in the face of challenges from high interest rates and inflation. The longer financial conditions remain tight, the greater the odds of economic weakness. If a recession occurs, we do not believe it would be severe.
  • We expect bond investments to bounce back soon after their historically poor performance over the past couple of years. We believe longer-dated U.S. Treasury yields are approaching their upper bounds, particularly with the Fed appearing to be at the end of its interest-rate hikes. Bond prices move inversely from their yields.

Quotes of the Quarter

“Forecasters who’ve long been expecting a hard landing of the economy made a big mistake in betting against American consumers.” – Ed Yardeni, Yardeni Research president

“We see a global economy that is limping along, and it’s not quite sprinting yet.” – Pierre-Olivier Gourinchas, International Monetary Fund chief economist

“There are still large differences between women and men in terms of what they do, how they’re remunerated. … We’re never going to have gender equality until we also have couple equity.” – Claudia Goldin, first woman to win the Nobel Prize in Economics on her own

Market Data

U.S. Stocks

A first-half rally driven by big technology stocks reversed course over the summer as markets pulled back in the face of surging bond yields and the Fed’s threat to keep rates higher for longer than expected. The result was the first quarterly decline for U.S. stocks since the third quarter of 2022.

Just three of the tech giants dubbed the Magnificent Seven for their dramatic runup through the winter and spring posted third-quarter gains, and all were much smaller than in the first six months: Meta 9.1%, Alphabet 9.0% and Nvidia 2.8%. The other four returned to earth with losses: Apple -11.6%, Microsoft -7.1%, Tesla -4.4% and Amazon -2.5%. Nonetheless, their lofty year-to-date returns continued to account for almost the entire 2023 gain of the largest 500 companies: 12.6% for the iShares S&P 500 ETF through nine months, even after a 3.7% quarterly drop.

Only energy stocks prospered, thanks to a 29% gain in West Texas Intermediate crude oil during the quarter. The S&P energy sector jumped 12.2%; all others were negative except for communications services stocks, which rose 1%. Small caps struggled as investors shunned risk; the iShares Russell 2000 ETF fell 5.6% and saw its year-to-date gain trimmed to 2.0%. For the quarter, value stocks had bigger drops than growth stocks at the large-cap level while outperforming among small caps.

International Stocks

Overseas stocks also fell, underperforming their U.S. peers. High energy prices, a 3% rise in the dollar against other leading currencies, and the tight monetary policies of global central banks all weighed on markets.

The iShares MSCI EAFE ETF declined 4.9% to reduce its 2023 gain to 6.9% through September. Translation to U.S. currency was a significant detriment to investments in those international stocks. In local currency, the same index fell just 1.2% and was up 11.2% year-to-date.

Emerging-markets stocks continued to be pressured by the slowing economy in China, which accounts for a third or more of the benchmark. The iShares MSCI Emerging Markets ETF declined 4.1%, leaving it with a slim 0.9% gain for the year.

Only India (+1.9%) managed a third-quarter gain among major global stock markets. Hong Kong was the biggest loser, shedding 11.2% for the quarter and 17.1% through nine months of 2023.

Real Estate

Real estate investment trusts suffered among the largest setbacks in the quarter, pushed sharply lower by the Fed’s higher-for-longer stance and continued concerns about tighter credit. Pressure from elevated rates heightened in September when job growth surged unexpectedly, raising speculation that the Fed could raise rates again before the end of the year.

The Vanguard Real Estate Index Fund, a benchmark index that measures the performance of publicly traded REITs and other real estate-related investments, tumbled 8.5% following a modest first-half gain to go negative for the year at -5.4%. Office REITs, among the biggest losers since the pandemic began, outperformed the S&P 500 and were the best-performing real estate sector, ahead of data centers. Their 1.5% decline still dropped them to their lowest level since 2009, however.

The Vanguard Global ex-US Real Estate ETF, a proxy for international real estate stocks in more than 30 countries, dipped 2.6% and was 6.0% in the red for the year.


Publicly traded senior bank loans and private debt investments (direct lending) were a rare bright spot for investors in the third quarter. Bank loans extended their year-to-date gains on the strength of solid corporate fundamentals and higher short-term interest rates, which have lifted bank loans’ floating-rate coupons. The Invesco Senior Bank Loan ETF rose 2.2% in the quarter and was up 9.1% through nine months.

Private direct lending also produced strong gains. It outperformed publicly traded bank loans because of its yield advantage. The sharp rise in rates boosted demand and prices.

Fixed Income

Bond holdings went negative for the year on a total return basis with a poor quarter caused by the surge in yields, a reflection of the Fed’s tight monetary policy and high rates. Yields, which move inversely to prices, rose nearly a full percentage point to 4.6% on 10-year Treasurys as the economy held firm and the Fed hinted at another rate increase to come.

The Vanguard Total Bond Market ETF, proxy for the taxable bond market, sank 3.2% and was -0.9% for 2023. Our benchmark for tax-exempt municipal bonds declined 1.6% and was down 0.6% year-to-date.

The material shown is for informational purposes only. Past performance is not indicative of future performance, and all investments are subject to the risk of loss. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties, and actual results may differ materially from those anticipated in forward-looking statements. As a practical matter, no entity is able to accurately and consistently predict future market activities. Information presented herein incorporate Altair Advisers’ opinions as of the date of this publication, is subject to change without notice and should not be considered as a solicitation to buy or sell any security. While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented. Material contained in this publication should not be construed as accounting, legal, or tax advice. See Altair Advisers’ Form ADV Part 2A and Form CRS at for additional information about Altair Advisers’ business practices and conflicts identified. All registered investment advisers are subject to the same fiduciary duty as Altair Advisers.

ETFs and mutual funds selected by Altair are intended to approximate the performance of the respective asset class in lieu of an established index. An ETF or mutual fund is generally managed by an adviser and, therefore, can be subject to human judgment while an index is typically comprised of an unmanaged basket of instruments designed to measure the performance attributes of a specific investment category. Unlike indices, the ETFs and mutual funds selected incorporate fees into their performance calculations. There can be no assurance that an ETF or mutual fund will yield the same result as an index. Altair has no relationship with the ETFs and mutual funds selected.

Any blended benchmark referenced is comprised of a collection of indices determined by Altair Advisers. Altair Advisers used its judgement to select the indices and relative weightings to be shown, with the objective of providing the user with a meaningful benchmark against which to compare performance. Despite its best efforts to remain neutral in selecting the indices and their relative weightings, the blended benchmark should not be viewed as bias-free as elements of human nature inherently played a role in selecting the components of the blended benchmark.

The Closed-End Fund Blended Benchmark consists of 60% First Trust Equity Closed-End Fund TR USD Index, 20% Invesco CEF Income Composite ETF, and 20% VanEck Vectors CEF Municipal Income ETF.

The Securitized Credit Benchmark consists of 65% iShares MBS ETF and 35% iShares iBoxx $ High Yield Corporate Bond ETF.

The U.S. Municipal Bonds Benchmark consists of 65% VanEck Short Muni ETF and 35% VanEck Intermediate Muni ETF.

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