As we leave 2023 Q2, the economic backdrop shows some trouble spots that continue to strain the capital markets. Inflation is lessening, but still too high and a very low unemployment rate still indicates a good economy that has yet to cool to the Fed’s liking. Add to those points more potential Fed tightening, the global backdrop and the continuing Russia/Ukraine war and you have a recipe for more market doldrums.
Despite these points, it is fascinating that the broad capital markets – but certainly NOT all capital markets - have shown so much resilience. In 2023 Q2, large cap blend stocks represented by the S&P 500 (IVV) (grossly influenced by its 7 largest mega-cap tech stocks) with a 2023 Q2 return of 8.76% once again outperformed the rest of the equity markets (mid- and small-cap equities) by 400 basis points (see table below)! Yet another recent period where diversification didn’t work; almost every other asset class was a detractor to return!
But, it wasn’t just small- and mid-cap equities that underperformed core equities. Diversifying positions in REITs (SCHH), international developed (SCHF) and emerging market equities (SCHE) and high-quality dividend paying stocks (DVY) all have lagged significantly. It sounds like a broken record, for those who remember what a broken record sounds like, since we have seen this scene repeatedly over the recent past. We talk a lot about “reversion to the mean” where markets never persistently outperform other sectors because there is a tendency for markets to return to their long-term relationships – we just have not seen it yet!
My blog post from May 17, 2023 titled Don’t just stand there, Do NOTHING! summarized our philosophy this way:
At D&A we are philosophically inclined to move slowly away from long term strategic positioning unless there is a firm reason to do so. For example, shortening fixed income duration in 2022 was the correct re-positioning that benefited client portfolios and will be reversed when market conditions indicate. Alternatively, we are not ready to move away from diversifying positions in U.S. small- and mid-cap equities, emerging market equities, or other “factor” investments that have lagged and we will continue to hold international developed markets that have recovered a bit YTD in 2023.