Current market environment performance of dynamic, risk-managed investment solutions.
By Jason Teed
In the third quarter, the U.S. economy demonstrated impressive resilience, fueling optimism for a “soft-landing” scenario (reining in inflation without causing a recession). However, financial markets faced challenges during this time, adjusting to the potential of prolonged higher interest rates.
A notable factor on the horizon is the peak in interest rates. The recent increase in rates has played a central role in shaping the financial landscape, driven by adjusted expectations for future Federal Reserve policy. Investors have responded to Fed commentary, which suggests that monetary policy settings will remain restrictive for longer than previously anticipated.
The prevailing view is that the Fed will take a cautious approach to combating inflation, leaning toward a more gradual tightening process. Although this might lead to more rate hikes, it’s essential to recognize that time could be more vital than further increases in controlling inflation. Hence, the Fed’s bark may turn out to be worse than its bite. Nevertheless, the recent rise in interest rates has pushed stock prices lower, which some see as an opportunity.
Although the rise in rates has induced market volatility and depressed stock prices, history shows that such rate increases often lead to stock market rallies. Importantly, the current inflation backdrop seems more positive. Unlike previous rate surges where inflation was rising, current data indicates a sustainable (though not entirely smooth) decline in inflation.
Commodities outperformed for the quarter, gaining 4.7%—primarily due to a substantial rise in energy prices. This surge was influenced by concerns over oil supply imbalances resulting from production cuts in Russia and Saudi Arabia.
Conversely, the U.S. fixed-income market encountered difficulties, experiencing significant increases in yields. Notably, 10-year yields rose by 74 basis points during the quarter, reaching their highest levels since 2007, sending bond prices still lower. This rise was driven by the Federal Reserve’s continued hawkish stance and bolstered by robust economic data and an influx of bonds into the market. Nevertheless, global high-yield markets fared relatively well during the broader market sell-off, aided by resilient earnings and a decrease in default rates.
In the U.S. equity market, both large-cap and small-cap segments experienced declines. Earlier in the quarter, an AI-driven rally had pushed valuations to unsustainable levels. Moreover, while earnings surpassed expectations, corporate guidance was pessimistic.
As economic tailwinds wane and challenges grow alongside tighter monetary policy, diversification and active management will remain essential for investors. The following chart of monthly changes in the S&P 500 illustrates how quickly the market can change. Note how different the experience is in the various periods shown. Each contains a different perspective. Months are up and down; some quarters are mostly up, but others are mostly down. In the end, for the year, an investment in stocks is profitable. This emphasizes the importance of using active management to seek out undervalued opportunities throughout the year.
Performance trends for the quarter
Amid market volatility, about 56% of our strategies were profitable for the quarter. The top-performing strategies for the quarter tended to be fixed-income strategies, although some tactical equity strategies also performed well.
Equity-based trend-following strategies tended to struggle for the quarter. While such strategies can falter when markets change direction, as was the case this quarter, they often perform well when markets consistently trend up or down (see the first three-quarters of the chart).
Among our strategies that are available in multiple risk profiles, there was a pronounced negative correlation between risk and return. The more aggressive strategies struggled for the quarter, taking longer to transition to defensive positions.