Capital Markets Outlook: 3Q 2023

What You Need to Know

Markets posted a strong first quarter, though it was a rollercoaster ride. The path forward will likely stay turbulent, with bank turmoil likely tightening credit conditions and the Fed still wrestling with inflation. Markets, the economy and investment strategies will be unsettled, making research and sound portfolio design keys to avoid overreacting to minutiae and staying focused on navigating the landscape.

Key Takeaways

  • In the second half of 2023, investors will likely face a theme of “resistance,” with equity valuations elevated, earnings facing headwinds and the Fed trying to cool off the job market. By 2024, we think resistance will give way to “normalization.”
  • Equity markets have been largely driven by the 10 biggest stocks; looking beyond the biggest equity names has been a sound strategy after prior market peaks. In our view, quality should be a key emphasis, with low-volatility stocks potentially versatile equity exposure for risk-averse investors.
  • Bond yields are high, setting up returns that could bolster many investors’ portfolios—high yield is a particularly powerful example. In municipal bonds, higher yields and credit spreads, combined with favorable technical conditions, create an attractive entry point.

For Investors, the Market Theme Is “Resistance”

The second quarter was a strong one for risk assets, following a similar pattern as the first quarter: “known unknowns” were resolved, fueling late rallies. This time, the known unknown was the debt-ceiling crisis—once it was worked out, a strong June pushed the S&P 500 into bull market territory.

What comes next? As we see it, investors face the second of three themes—resolution, resistance and normalization—through the end of 2023. The resistance stems from S&P 500 valuations that are at the very high end of their historical range (Display, left) and earnings will likely face pressure as economic growth recedes. Inflation should continue to fall but is still well above the Fed’s target.

Then there’s the job market. The Federal Reserve’s primary emphasis has been getting it under control, but it remains very strong. As a result, markets have priced in expectations that interest rates will stay higher for longer (Display, right) and—if anything—that the Fed will likely hike rates one or two more times before they’re finished with this cycle.

Greater Resistance Is Likely Ahead