Economic Flash: Is This Rebound Too Far, Too Fast?

This article is brought to you in collaboration with our colleagues at Laird Norton Wealth Management from their post, Economic Flash: Too Far, Too Fast for 2023 Rebound?

U.S. Economy: Inflation Slips

While U.S. inflation is still above the Fed’s 2% target, price increases as measured by the Personal Consumption Expenditures Price Index (PCE) are down to levels not seen since 2021: 3.8% annualized; 4.6% minus food and energy. With national average gas prices down to $3.50/gallon recently vs. $4.80 a year ago, core inflation’s stickiness is likely driven by consumer demand as the unemployment rate remains a meager 3.7%.

U.S. Stocks: Small Caps Join Party

Equity markets surged globally in June, capping off one of the best first halves in the last 25 years. U.S. equities most sensitive to the economy fared best. Among these, small-cap stocks were top performers, as headwinds from rising interest rates, banking system tumult and economic uncertainty seemed less ominous. Technology was outpaced by the consumer discretionary, industrials and materials sectors – up more than 10% each.

Foreign Stocks: Concerning Inflation

Foreign equity returns were generally positive in June, boosted by U.S. dollar weakness, although lagging U.S. markets for a variety of reasons. Inflation in Europe remains stubbornly high, especially in the U.K. (nearly 8% year-over-year), leading investors to price in a continuation of aggressive interest rate hikes. Emerging markets also underperformed the U.S. as China’s economic rebound has so far not been as strong as expected.

Fixed Income: High-Yield Bucks Trend

Interest rates rose quickly at the end of June, with the 10-year U.S. Treasury yield just below 4% in early July vs. around 3.5% in March. Bonds generally performed poorly in anticipation of the Fed resuming interest rate hikes in the months ahead to further curb inflation, as the U.S. economy remains resilient. High-yield bonds gained 1.6% on spillover enthusiasm from the equity markets and accelerated new issuance.

Real Assets: Almost All Up

Real assets have struggled through much of 2023, facing distinct headwinds from lower inflation and economic weakness. Signs of better-than-expected U.S. economic growth contributed to a June rally in real assets (3% to 6%), falling just short of the returns in the greater equity markets. Commodities contributed to that tally but remain the weakest performer year-to-date (-7.8%), with a 20% decline in the energy subsector the greatest detractor.

Alternatives: More of the Same

Hedge funds posted slightly positive results in June and in general have outpaced high-quality bond markets over the last year. Long equity-biased hedging strategies fared the best overall (+1.3%) but still sharply trailed straightforward equity holdings. Convertible bonds (+5.6%) were distinctly positive and may offer a uniquely attractive risk-return tradeoff as many of these hybrid securities are currently trading at attractive valuations.

Source of data: Bloomberg

Equities Total Returns

Fixed Income Total Returns

Economic Indicators

Our Take

Given strong returns in stocks and modest performance in bonds, 2023 seems to fit the mold of market behavior in the years after the 2008 financial crisis. However, the economic circumstances today are markedly different, with interest rates and inflation much higher and unemployment lower than in the recent past. Moreover, we’ve had three of the largest bank failures in history so far in 2023 and ongoing geopolitical conflict, both factors that can sink market sentiment. And yet, here we are with consumer confidence on the rise and markets following suit.

Have we escaped recession to find ourselves in the midst of another economic upswing? Probably not. The probability of recession remains elevated, with more interest rate increases expected by the Fed and signs of economic deterioration finally starting to take hold. Among them: U.S. manufacturing expectations that have fallen to a post-COVID low (46 on the key ISM PMI Index); tighter bank lending; lower personal savings and higher delinquencies in both credit card and auto loans.

While 80% of U.S. homeowners have locked in long-term mortgage rates under 5%, somewhat blunting the effects of higher interest rates, businesses are typically funded with shorter-term loans that will be resetting at much higher rates in the coming years. The outcome, especially in sectors that are cash strapped already, is hard to predict. Our Q3 2023 Market and Economic Commentary, out later this month, will focus on the economic tug-of-war currently playing out.

What We Are Doing

In the near term, the reduction in credit available from banks and the corporate debt markets may lead to singular opportunities in private lending or distressed real estate debt for investors willing to establish strategic, likely less-liquid positions. Separately, we remain committed to infrastructure investments, which are supported by long-term societal needs and require both public and private funding.

Given the results we’ve seen so far in 2023, it’s easy to think the coast is clear. However, one of the hard learned lessons of investing is that the only certainty is uncertainty. The best strategy is almost always to remain focused on the long-term objectives of each portfolio and consider changes in that light. Along those lines, higher interest rates mean that some clients may no longer need to take on as much risk to get the returns required to attain their goals. Others can benefit from the premium paid for illiquid investments when credit is tight. As the new market regime we are likely in unfolds, many new opportunities are arising that we are evaluating in light of each client’s circumstances.

Glossary of Indices


U.S. Large Capitalization = S&P 500 Index

Tracks the performance of a representative sample of 500 leading companies in the major industries of the U.S. economy.

U.S. Small Capitalization = Russell 2000 Index

Tracks performance of the 2,000 smallest companies in the Russell 3000 Index, representative of the U.S. small capitalization equity market.

U.S. Growth Equities = Russell 3000 Growth Index

Tracks the performance of those Russell 3000 companies that have higher price-to-book ratios and higher forecasted growth values.

U.S. Value Equities = Russell 3000 Value Index

Tracks performance of those Russell 3000 companies that have lower price-to-book ratios and lower forecasted growth values.


International Equities (Developed Countries) = MSCI EAFE Index

A float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. Consists of the stock market indices of these 20 developed countries: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

Emerging Market Equities = MSCI Emerging Markets Index

A float-adjusted market capitalization index designed to measure equity performance in the major emerging markets. Consists of the following 25 emerging-market -country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.


U.S. Aggregate Bond = Barclays Capital U.S. Aggregate Bond Index

Covers U.S. dollar-denominated, investment-grade, fixed-rate, taxable bond market consisting of SEC-registered securities. Includes U.S. Treasuries, U.S. agency bonds, U.S. corporates, mortgage-based securities (MBS, CMBS) and asset-backed securities (ABS).

TIPS (Treasury Inflation-Protected Securities) = Barclays U.S. Treasury Tips Index

Measures the performance of TIPS of various maturities issued by U.S. Treasury.


International Developed Bonds = BofA Merrill Lynch Global Government Bond II ex U.S.

Measures the performance of non-U.S. developed-market government bonds on an unhedged currency basis.

Emerging Market Bonds = BofA Merrill Lynch Emerging Markets Sovereign

Bond Index Measures the performance of emerging markets government bonds on an unhedged currency basis.


Intermediate Municipal Bonds = Merrill Lynch Municipals, 3-7 Yrs Index

A subset of The Merrill Lynch U.S. Municipal Securities Index, including all securities with a remaining term to final maturity of between 3 and 7 years.

Municipals, Broad Market = Merrill Lynch Municipal Master Index

Tracks the performance of U.S. dollar denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions.


Absolute Return Funds = HFRX Absolute Return Index

Tracks the performance of hedge funds aiming to provide stable performance regardless of market conditions. Such funds tend to be less volatile and less correlated to market benchmarks. Data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month and is subject to revision.

Market Directional Funds = HFRX Market Directional Index

Tracks the performance of hedge funds that add value by participating in the direction of various financial markets. Such funds characteristically have higher expected volatility than Absolute Return strategies (see above). Performance data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month, and is subject to revision.


Equity Volatility = CBOE VIX Index

Aims to measure investor expectations for near-term stock-market volatility as conveyed by the pricing of stock options on the S&P 500 index that mature within 30 days.

Implied Inflation = 10-Yr TIPS Implied Inflation

Gauges investor expectations for future U.S. inflation based on the difference between the yield on a 10-year TIPS (Treasury Inflation Protected Security) and the yield on a nominal 10-year Treasury.

Gold Spot $/oz.

An index intended to measure the current price of gold, based on futures contracts deliverable in the following month priced in U.S. dollars per Troy ounce.

Oil = Brent Crude Oil Spot Price $/bbl

Brent Crude Oil refers to a particular grade of crude oil often quoted in financial reports as the global benchmark for the price of oil. It typically trades at a premium to the West Texas Intermediate price.

U.S. Dollar = Trade-Weighted U.S. Dollar Index

Value of the U.S. dollar relative to a composite of 26 currencies of major U.S. trade partners, weighted based on trade data.


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