Investment Insights

As we enter the final quarter of 2023, we review the year-to-date performance and provide our thoughts on what to expect for the remainder of the year. For 3Q23, the S&P 500 declined by -3.3%, with the tech-heavy Nasdaq (down -3.9%) underperforming the broader index. Equity returns were lower globally, with the MSCI World also lower for the quarter (-3.4%). Unfortunately, the promise of asset class diversification was also of little help in 3Q23 as fixed income index returns were also negative (Agg, -3.2%) for 3Q23, as longer duration Treasury rates impacted returns further out the curve. Only high yield corporates (+0.5%) and Treasury bills posted positive total returns (+1.3%) for 3Q23. Looking at other indicators, for 3Q23, the US dollar index (DXY) rose (+3.5%), while WTI oil was higher (+28.5%). Yields rose on the benchmark 10-year US Treasury rate (UST10) rose sharply to 4.57% (up 73 bps).

The key driver for the third quarter was continued economic strength despite the Fed’s most aggressive rate campaign in a generation. The latest GDPNow estimate for 3Q23 real GDP is 5.4%, compared to a 2.1% pace in 2Q23. In July, the Fed raised rates by +25 bps to a range of 5.25% to 5.5%, and has held rates steady since. While headline inflation (CPI YoY) continues to decline, core PCE remains in the high 3% range, well above the Fed’s 2% target. Rates are in restrictive territory and the economy is expected to lose steam, but there’s still work to be done. We expect the preferred method for the Fed to slow the economy from here forward will be to keep rates higher for longer, rather than continue to raise rates. We believe the acute phase of interest rate pain is now over. While we acknowledge that the shift to higher rates has undoubtedly been painful, now that we are here, we believe it is a great environment to buy bonds. In our view, we are set up a picture of very attractive returns for fixed income over the longer term.

For equities, the picture is more nuanced. We continue to see stretched valuations for mega-cap tech, and a higher-for-longer rate environment makes the present value of those future cash flows even less valuable. Once again, we highlight that the return on the equal-weight S&P 500 through the first nine months of 2023 was only 1.8%, compared to the market-cap weighted S&P 500 return of 12.6% over the same period. The concentration in the biggest names means that well diversified equity portfolios continue to lag the broader market since the rally in the largest constituents drove the almost all market gains. We therefore maintain a cautious view on large cap growth. Nevertheless, we see large cap value equities as cheap and we introduce a slightly overweight positioning on this asset class.

Elsewhere in the world, European equities (using the Euro STOXX 50, -4.8%) also declined for the 3Q23, as did Japanese and emerging markets equities. We see the policy tightening in Europe, the war in Ukraine, the trade ties with China, and the recent unrest in the Middle East all contribute to the downside economic risks for the continent. That said, we note that valuation remains much more attractive for European equities than U.S. large cap peers. Ultimately, we believe that valuations matter, especially in an environment where U.S. Treasury yields are higher than they have been in 2+ decades. For that reason, we stay neutral on developed market equities ex-U.S.

As we look ahead into 2024, the chances of a U.S. recession have receded, but not totally dissipated, in our view. In our previous quarterly letter, we stated our view that there was an “over 50% chance” of recession in the next 12 months. We based that view on indicators such as the inverted yield curve and tighter lending conditions from the bank loan officers’ survey. Now, we sense that recession risk is roughly even odds. But in some sense, the issue of whether the U.S. enters a “technical” recession is only semantics. Whether or not growth slowly sufficiently to tip the country into a recession, we expect growth to slow down noticeably in the next few quarters, as the cumulative impact of higher rates continues to exert pressure on financial conditions. Our investment thesis is the same for either scenario: favor fixed income over equities, focus on valuations, and stop hiding out in Treasury bills and cash.

In the table below, we update our Amerant View, which we first introduced in our 2Q23 newsletter. The views represent our investment team’s tactical views for the next twelve months, based on investment valuations and macro trends. As a reminder, these are not client-specific recommendations, and clients should consider their financial goals and long-term objectives when determining their asset allocations. We update our views with stronger overweights on investment grade and high yield fixed income. We refine our equity views to include a recommendation for both U.S. large cap growth equities (underweight) and U.S. large cap value (overweight). We maintain U.S. small caps and developed markets equities ex. U.S at neutral.

Importantly, we are downgrading cash to underweight, as we believe strongly that today’s rates are unlikely to persist over the intermediate term. Even if they do, it’s not too soon to lock in duration with the Fed likely on hold for now, and possibly done altogether. We would frame this investment decision as follows: It’s not whether 5.5% on six months bills is good. Rather, the question you should ask is whether you will be able to roll 6-month bills twenty times over the next 10 years and still maintain an average 4.8%+ yield over that time? We acknowledge the bond math for the duration decision is not as simple as our question implies (it ignores the impact of receiving higher cash flows upfront, and there is also a risk of locking in principal loss if forced to sell a Treasury bond before maturity). Still, the rhetorical question is meant to isolate the compelling logic behind adding duration now: will U.S. Treasury rates be higher or lower than today’s rates over the longer term? And if you think, as we do, that rates will eventually settle at a lower level, then extending fixed income maturities now becomes an easy call.

Despite our view of a slightly better chance to avoid a recession, we have maintained our dynamic positioning in the conservative stance we adopted late last year. Although recession risks appear to have declined somewhat, we continue to believe that the global economy will continue to slow. We will be ready to change our positioning to take into account the possibility of achieving a soft landing, but for now we maintain that increasing exposure to equities just as economic growth slows noticeably could be exactly the wrong time to add risk. As always, we continually review our positioning and will communicate any changes in our views going forward.

Notes: Asset class performance is in USD and refers to the following indices: Equities: US Large Caps (S&P 500), Emerging Markets (MSCI EM), Europe (MSCI Europe), Japan (MSCI Japan). Fixed Income: 10-Yr. US Treasuries (BofAML US Treasury Current 10-Yr.), Emerging Markets Sovereign (USD) (JPM EMBI Global), Emerging Markets Sovereign (LCL) (JPM GBI EM Global Diversified), US High Yield (BofAML US HY Master II), US Investment Grade (BarCap US Aggregate Bond), and Developed Markets Sovereign (excl. US) (JPM GBI Global Ex US). Source: Morningstar. (1) Strategy returns net of mutual fund expenses and Amerant Investments standard management fees.

On this table, you can see the returns for the first three quarters of 2023 and the year-to-date.

The third quarter of 2023 saw mostly negative returns across asset classes, with equities negative across all geographies. In fixed income, only High Yield was slightly positive, while 10Y Treasuries and emerging markets debt were both lower for 3Q23. For the year-to-date, index returns positive across equities and mixed for fixed income. We note that, once again, higher rates drove losses in longer duration fixed income categories for the YTD 2023.

In our view, the Fed’s rate hiking cycle is over. Nevertheless, we have maintained our dynamic positioning, which we had adopted last fall to maintain a conservative stance. We continue to believe that the global economy will continue to slow, although we do believe that recession risks have declined somewhat. We have considered shifting dynamic portfolios back to neutral, but we feel that scaling into risk as growth deteriorates does not make sense. We will consider adding risk once our “traffic lights” signal more attractive equity valuations on offer. As always, we continually review our positioning and will communicate any changes in our views going forward.

⁽¹⁾ Strategy returns based on the total return of the underlying mutual funds, including reinvestment of dividends and change in NAV. Net of mutual fund expenses and Amerant Investments standard management fees. Returns may vary. Past returns are no indication of future performance.

⁽²⁾ Monthly returns before February 2010 are those of the offshore corresponding strategies. For the Dynamic portfolio, monthly returns before November 2009 are those of the Income & Growth portfolio, which is the neutral positioning of the Dynamic portfolio. Dynamic portfolio started in November 2009.

During 3Q23, the Income Portfolio returned -3.0%, the Income & Growth Portfolio returned -4.4%, the Growth Portfolio returned -4.9%. The Dynamic Portfolio, positioned in Income, returned -3.0% during the quarter.

Year-to-date, the Income Portfolio returned 0.4%, the Income & Growth Portfolio returned 1.6%, the Growth Portfolio returned 4.8%, and the Dynamic Portfolio returned 0.3%.

In late 2022, we positioned portfolios more defensively to be better prepared to withstand an environment of increased volatility due to continued fears of recession and geopolitical risk. In hindsight, we were too cautious with this positioning as the U.S. economy has stayed relatively healthy to date. Although signs of slowing are abundant, we have lowered our estimated chance of recession. Still, we have decided against shifting our dynamic positioning back to its neutral stance. We remain somewhat wary of downside market risks, and we await evidence of widespread deterioration in economic conditions. If equity markets reprice as expected, this will prompt us to shift into a more aggressive posture for the dynamic portfolios.

As always, we take the trust you have placed in us very seriously. In our day-to-day operations, we continue to follow current events and the reactions of the markets closely, and we stand ready to adjust your portfolios accordingly.

To obtain more detailed information on our market views or the performance of your advisory portfolio, please contact your investment consultant at Amerant Investments by calling (305) 460-8599.

Sincerely,

Amerant Investments, Inc.

amerantbank.com