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Stembrook Market Review - Third Quarter 2023 Thumbnail

Stembrook Market Review - Third Quarter 2023

Market Updates

After a strong first half, equity markets took a breather in the third quarter, down -3.4%.1 Concerns around the narrowly averted government shutdown weighed on both fixed income and equity investors during the quarter. Concerns of a shutdown will likely persist into the final quarter of 2023 as we approach the end of the 45-day extension on November 17th. In addition, investors continue to monitor the Federal Reserve and the path of interest rates. Thus far, the Fed has been able to balance the tight rope of taming inflation while avoiding a recession, commonly referred to as a "soft landing." Despite higher prices and parts of the economy falling into recession-like states, the overall economy has not slowed to the point where the NBER has declared a recession. It is also worth noting that there are other issues that we would expect to keep investors cautious, most notably, the recent conflict in Israel and concerns of a slowing Chinese economy. As mentioned in previous notes, we do not claim to know when the next recession will hit, and it is important to recognize that markets, especially over the short- to medium-term, do not necessarily correlate with the overall economy.

In an effort to combat inflation, the Federal Reserve has kept interest rates elevated. The Fed has two main goals, price stability and maximum sustainable employment, this is known as the "dual mandate." Monetary policy is the central bank's tool for maintaining these goals. When inflation is moving up and the economy is expanding too rapidly, as measured by GDP, the Fed can slow down the pace by raising interest rates or increasing the amount of money that banks are required to hold in reserves. When the economy needs a boost, they tend to do the opposite, lower rates and decrease reserve requirements as a way to increase the amount of dollars circulating in the economy. Higher rates make it more expensive for companies to finance projects and for consumers to make large purchases (homes, autos, etc.). In addition, higher interest rates tend to put downward pressure on both stock and bond prices. Bond returns had their worst year in history in 2022 and fell by -3.2% in the third quarter.2 The good news for bond investors now is that market interest rates are higher, so newly issued bonds are paying higher yields to investors. While not wildly attractive versus stocks, bonds are the most attractively valued they have been in 14 years. The following chart compares the earnings yield - or earnings divided by price - of equities and the the yield on a ten-year treasury bond. When the blue line is lower, bonds look relatively attractive compared to stocks and vise versa.    

Bonds Look Better

On a relative value basis, bonds are the most attractive they have been since September 2009.

Our proprietary models forecast long-term, pre-tax returns ranging from 4% to 6% for fixed income-like asset classes and 9% to 11% for equity-like asset classes (see Expected Market Returns and Risks table). We maintain target weight allocations to equities and fixed income. Our more detailed observations and current portfolio positioning are outlined in the following comments. 

Expected Market Returns and Risks 7-10 Year Horizon

A sampling of return expectations produced by our models. Expected returns are projections and are not guaranteed.  

Historical Market Returns

Historical market returns as of September 30th, 2023. Note that looking backwards at recent returns is not a reliable method of predicting future returns. 

Yields Across Asset Classes

Yields are an indicator of future returns. Orange dots show current yields, blue bars show historical ranges.

 Economic Backdrop

  • In their most recent October release, the IMF projected that global economies would grow at a 3% annualized pace in 2023, adjusted for inflation, which is expected to dip slightly to 2.9% in 2024. The current and expected growth levels are significantly lower than the historical average growth rate of 3.8% since the year 2000.3
  • Slow economic growth is expected to continue in Emerging Markets, as well. The IMF expects these economies to to continue to grow by 4% in both 2023 and 2024, down slightly from 4.1% growth in 2022. Economic growth in China is expected to modestly rebound from a 3% level in 2022 to 5% in 2023 and 4.2% in 2024, still below trend.3
  • Inflation is beginning to cool on a global level as most central banks have enacted tighter monetary policies. While remaining high by recent standards, global inflation is expected to fall to 6.9% in 2024 and 5.8% in 2024 after reaching 8.7% in 2022.3
  • Inflation in the U.S. has begun to to cool. The year-over-year change in inflation dropped to 3.7% at the end of the most recent quarter from a high of 9.1% 18 months ago.4 
  • Per their most recent release, the Federal Reserve is committed to keeping inflation low and announced that they will keep the target federal funds rate of 5.25% - 5.5% in order to get back to their 2% inflation target to which they are "strongly committed" and maintaining their goal of maximum employment. 
  • Improving economic indicators have led the New York Fed to predict a 56% chance of recession within the next 12 months, continuing the trend of a more positive outlook on the economy. 


  • The U.S. Dollar remains little changed this year, up 3.2% this quarter.5


  • For the most part, stocks fell in the third quarter.
  • Small cap stocks in the United States fell the most, down -4.9% in the quarter.6
  • Large cap stocks in the U.S fell by -3.3%7 in the quarter, while non-U.S developed stocks fell by -4.11%.8
  • Emerging Markets stocks performed slightly better, down -2.9% in the third quarter.9
  • Rising oil prices helped buoy energy producers, which ended the quarter up 4.3%.10

Fixed Income

  • As we mentioned earlier, bonds have continued to struggle this year as investors mull over the idea of higher interest rates for longer. Interest rate sensitive, longer duration treasuries felt the most pressure, falling by -11.9%.11
  • Not immune to higher interest rates, municipal bonds fell by -2.6% during the quarter.12
  • High yield bonds continued to deliver positive returns in the third quarter, up 0.5%.13
  • Bank loans had the strongest returns in the fixed income space, up 3.5% in the quarter.14

Global Asset Class Returns

Returns are arranged in columns, by year. Each color represents a different asset class. Each year, the leaders and laggards tend to shift. Diversification across a range of asset classes can smooth returns and enhance growth.

Current Positioning

  • Out of an abundance of caution, we shifted our cash in traded money market funds from a prime fund (holds a combination of commercial paper, repurchase agreements, CDs and Treasuries) to one that holds Treasuries, backed by the full faith and credit of the U.S. government. We sacrificed very little in yield by making this transition. 
  • We have sold our inflation-linked bond positions for taxable and tax-deferred investors as the yields have become less attractive than nominal treasuries on a relative basis.
  • We maintain our neutral duration position in the fixed income portfolio as interest rates have risen to levels that are closer to historical averages.
  • We maintain our overweight to developed non-U.S. and emerging market equities, where valuations and long-term return potential remain attractive. 
  • We also maintain our underweight to large cap U.S. equities, which helped over the trailing twelve months.
  • We favor lower priced, value-oriented equities, both in the U.S. and abroad, which tend to outperform the broad market over time, with less volatility. These investments outperformed in 2022. A number of our international and emerging markets managers outperformed their specific benchmarks by wide margins in 2022 and are enthusiastic about their current positioning.

We continue to focus our efforts on helping you meet your financial objectives by following our disciplined investment approach. Our approach uses return and risk models, incorporating fundamental valuations and tax-efficient strategies. This investment discipline is tailored to your individual situation in our continuing effort to craft and implement your customized investment solution. 

As we approach the end of the year, please keep tax planning and gifting strategies in mind. If you would like to discuss your specific tax situation or plans for year-end gifting, please let us know and we can schedule a time to speak.

As always, we thank you for placing your trust in our investment management and advice and welcome your questions and comments at any time.

Peter & Tom


Endnotes and Sources:


  1. Morningstar: MSCI ACWI All Cap NR USD. 6/30/23-9/30/23.
  2. Morningstar: Bloomberg US Aggregate TR USD. 6/30/23-9/30/23.
  3. IMF World Economic Outlook: October 2023.
  4.  Bureau of Labor Statistics: CPI For All Urban Consumers. 9/30/23.
  5. Barchart: $DXY—U.S. Dollar Index. 6/30/23-9/30/23
  6. Morningstar: S&P 600 Total Return. 6/30/23-9/30/23.
  7. Morningstar: S&P 500 Total Return. 6/30/23-9/30/23.
  8. Morningstar: MSCIE EAFE NR USD. 6/30/23-9/30/23.
  9. Morningstar: MSCI EM NR USD. 6/30/23-9/30/23.
  10. Morningstar:: S&P 500 Energy Total Return. 6/30/23-9/30/23.
  11. Morningstar: Morningstar US 10+ Year Treasury Bond Total Return. 6/30/23-9/30/23.
  12. Morningstar: S&P Intermediate Term National AMT Free Municipal Bond Index Total Return. 6/30/23-9/30/23.
  13. Morningstar: Bloomberg US Corporate High Yield TR USD. 6/30/23-9/30/23.
  14. Morningstar: Morningstar LLSTA US Leveraged Loan Index Total Return. 6/30/23-9/30/23.


Bonds Look Better: As of 9/30/23. 

Source: Federal Reserve, Standard & Poor's,  Stembrook Research. 

Expected Market Returns and Risks, 7-10 Year Horizon: As of 9/30/23.

Source: Stembrook Research.

(1)  Volatility is measured in terms of Standard Deviation. Standard deviation is the statistical measurement of dispersion about an average, which depicts how widely a stock or portfolio’s returns varied over a certain period of time. Investors use the standard deviation of historical performance to try to predict the range of returns that is most likely for a given investment. When an investment has a high standard deviation, the predicted range of performance is wide, implying greater volatility. If an investment’s returns follow a normal distribution, then approximately 68 percent of the time they will fall within one standard deviation of the mean return of the investment, and 95 percent of the time within two standard deviations. For example, for a portfolio with a mean annual return of 10 percent and a standard deviation of two percent, you would expect the return to be between 8 and 12 percent about 68 percent of the time, and between 6 and 14 percent about 95 percent of the time. Source: Morningstar.

Historical Market Returns: As 9/30/23.

Source: Morningstar, Stembrook Research.

Indices: Bloomberg Barclays U.S Treasury Bills 1-3 Month Total Return, Bloomberg Barclays Municipal Bond 5 Year (4-6) Total Return, Bloomberg Barclays U.S. Aggregate Bond Total Return, Bloomberg Barclays U.S. Corporate High Yield Total Return, FTSE All Equity REIT Total Return, S&P 500 Composite Total Return, S&P SmallCap 600 Total Return, MSCI EAFE Total Return, MSCI EM (Emerging Markets) Total Return, Consumer Price Index – U.S., S&P 10 Year U.S. TIPS Total Return, Bloomberg Commodity (Total Return) Index.

Yields Across Asset Classes: As of 9/30/23.

Sources: Cash Equivalents Yields since March 1976. Ibbotson, Federal Reserve Bank, Thomson Reuters, Municipal Bond Yields since March 1988. Barclays Capital, Charles Schwab, BofA Merrill Lynch, Standard & Poor's/Investortools Municipal Bond Indices, Investment Grade Bond Yields since March 1976. Barclays Capital, High Yield since December 1984. BofA Merrill Lynch, Barclays Capital, Real Estate (Public) Earnings Yield since March 1976. NAREIT all Equity, Large Cap U.S. Equity Earnings Yield since March 1976. Standard & Poor's, BARRA, Mid Cap U.S. Equity Earnings Yield since June 1991. Standard & Poor's, BARRA, Small Cap U.S. Equity Earnings Yield since December 1993. Standard & Poor’s, BARRA, Developed Europe Equity Earnings Yield since March 1976. MSCI Europe, Standard & Poor's Europe 350, Developed Pacific Equity Earnings Yield since March 1976. MSCI Pacific, S&P/Citi PMI Asia Pacific, S&P Asia 50, Emerging Market Equity Earnings Yield since December 1998, Inflation-Linked Bond Real Yield to Maturity since March 1997. Citi Yield Book, Federal Reserve Bank. Note: Yields are not perfect predictors of future returns and should not be used in isolation.

Global Asset Class Returns: As of 12/31/22.

Source: Thomson Reuters, Bloomberg, Morningstar, Stembrook Research.

Indices: Consumer Price Index – US, U.S. 30-Day Treasury Bills, Bloomberg Barclays U.S. Treasury Bills: 1-3 Month Index, Citigroup Inflation-Linked Index, S&P 10 Year US TIPS Index, Bloomberg Barclays U.S. Aggregate Bond Index, BofA Merrill Lynch U.S. High Yield Cash Pay, Bloomberg Barclays U.S. Corporate High Yield Index, Dow Jones Wilshire REIT Index, FTSE All Equity REIT Index, S&P 500 Composite Total Return, S&P SmallCap 600 Total Return, MSCI EAFE Index, MSCI EM (Emerging Markets) Index, Dow Jones AIG Commodity (Totl Ret) Index, Bloomberg Commodity Index.


This material is intended to inform you of products and services offered by Stembrook Asset Management, LLC (“Stembrook”). Stembrook is a New Jersey Registered Investment Advisor.

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. The opinions, estimates, and investment strategies and views expressed in this document constitute the judgment of Stembrook, based on current market conditions and are subject to change without notice. The investment strategies stated here may differ from those expressed for other purposes or in other context.

 Past performance is not indicative of future results.

The obligations and securities sold, offered, or recommended are not deposits and are not insured by the FDIC, the Federal Reserve Bank, or any governmental agency.

The views and strategies described herein may not be suitable for all investors. This material is presented with the understanding that it is not rendering accounting, legal or tax advice. Please consult your legal or tax adviser concerning such matters. 

Important note regarding Stembrook’s capital market expectations.

The capital market expectations developed by Stembrook Asset Management are estimates of both a central tendency of asset class behavior and a probable range of asset class behavior over a long-term horizon. These estimates are one of many inputs used in the portfolio construction process, and should not be used independently. These expectations should not be construed as the returns that will be achieved, but merely those that may be achieved if certain assumptions hold true. Also note that each client's portfolio may differ given specific goals and constraints applied to the portfolio construction process. 

Additional information is available upon request.