Quarterly Economic Review: Second Quarter 2023

During the second quarter, U.S. economic growth continued near a 2% pace, the Fed raised rates once and promised to deliver another two hikes prior to year-end, U.S. equities were strong performers led by mega cap Nasdaq names, fixed income returns were negative as long rates rose, real assets were mixed with gold and real estate rising while energy fell. Alternative assets remained well positioned, especially as certain segments continue to rerate lower in price given the change in rates.

U.S. growth estimates, as forecast by Blue Chip Financial Forecasts rose above 1% from an initial estimate near 0%. Real time nowcasts, as measured by GDPNow, suggest the economy may be growing at a rate above 2%. Key indicators such as non-farm payrolls, retail sales, ISM manufacturing, housing starts, and consumer confidence all showed growth or improvement during the quarter.

Globally, growth is mixed to negative. Europe is experiencing stagnant growth with the Eurozone reporting -0.1% in Q2 2023, largely driven by the recession in Germany. Its normally resilient, export-driven economy has suffered due to rising energy costs, which hurt margins and reduced output. Demand from China has also accelerated at a slower pace than in past downturns. The UK reported +0.1% growth, China 2.2% and Japan registered 0.7% - versus the U.S. which reported 2% for 2023 Q2.

Equity markets continued their upward trajectory over the second quarter of 2023. While nearly all major global equity markets posted gains, U.S. stocks retook the lead from developed international stocks over the quarter. Despite the impressive nearly 17% gain for the S&P 500 Index so far this year, an extremely narrow handful of mega-cap technology and consumer names drove nearly all of that performance.

There has been a wide level of dispersion between S&P 500 sectors so far this year, with a nearly 50% gap between the top (IT) and bottom (utilities) performing sectors. The IT, communication services, and consumer discretionary sectors were standouts for the quarter and year-to-date, rising double digits over both periods. Positive performance paired with stalling earnings growth has raised valuations across most global equity markets. Compared to the start of the year, current valuations have risen to be either expensive (U.S.) or closer to long-term averages (international).

Fed raised rates once during the quarter and made clear that it will maintain a restrictive stance until there is additional progress on inflation or signs of meaningful weakness in the labor market. Chair Powell’s most recent comments indicate that “a strong majority of Committee participants expect to raise interest rates two or more times by the end of the year”.

Most fixed income sectors performed poorly as intermediate and long-term rates rose during the quarter. Credit spreads across corporate bonds are priced for continuing economic growth, not recession.

During the quarter, Real Assets continued the pattern of mixed performance seen in Q1. Energy drifted moderately lower with West Texas Intermediate (WTI) falling from $72 towards $70, largely trading in a tight range between $66 and $70 while Brent crude fell from $80 towards $75. Gold rose towards a 13-month high, closing near $2,060, but could not hold that level and ended the quarter approximately 3% lower. Public Real Estate markets continued to display very choppy performance in Q2 with returns near 2% for the Dow Jones U.S. Real Estate Index.

For most alternative strategies, fundraising levels are down significantly this year versus recent years. Despite the recent slowdown in deals, many managers feel the current market environment should setup ample opportunities to select investments with a high potential for excess returns. As a broad global rerating of pricing continues across many alternative asset classes, timing, setup and opportunistic entry points will be key to successfully capturing structural or cyclical excess returns. Arguably, this rerating process may take between six to eighteen months to play out. If the Fed retains a higher for longer policy stance, it could push the process towards the longer end of that time horizon. The implication for alternative investments vary greatly by strategy and style.