Quarterly Perspectives

July 1, 2023

Equity markets continued to advance in the second quarter led by a narrow group of very large companies. Interest rates drifted higher as economic data remained stronger than expected. The Federal Reserve paused its tightening cycle in June and will monitor incoming data to determine if more actions will be required. Economies around the world are experiencing widely varying levels of growth and inflation, which has led to diverging global central bank policies. While the U.S. economy remained resilient, some leading indicators point to headwinds on the horizon.

Economic Backdrop

U.S. economic growth persisted in the second quarter, driven by a strong labor market and healthy consumer expenditures. Households continued to spend freely on travel and hospitality to satiate pent-up demand for experiences. Impacted by a structural supply shortage, the housing market remained firm despite reduced affordability. Federal incentives boosted demand for business investment in areas such as infrastructure, semiconductors and batteries for electric vehicles. Hiring activity remained healthy, but the historically tight job market that characterized the post-pandemic period showed signs of normalizing. Demand for labor continued to exceed the supply of available workers, though the gap has narrowed. Employers curtailed worker hours and job openings declined well below their record highs. In June, unemployment claims hit their highest level since 2021. Hiring appears poised to moderate just as more workers have joined the workforce, which should further moderate wage growth and temper inflation overall. The U.S. Consumer Price Index increased 4.0% year-over-year in May, down from its peak of 9.1% last June. The cost of goods and commodities have fallen significantly though the cost of labor and many services is still growing above an optimal rate. In contrast to the resilient economy and reduced price pressures in the U.S., Europe is suffering a recession and entrenched inflation. Consequently, the European Central Bank hiked rates again in June despite the weak economy. The U.K. has so far avoided a contraction but continued to tighten policy aggressively to combat its 8.7% inflation rate, among the highest across developed economies. Even Japan, mired in deflation for decades, has seen inflation exceed 3.0%. China has experienced growth concerns as its economic reopening failed to ignite a sustained resurgence in consumer spending. Business and consumer confidence in China remains anemic, reflecting mounting debt burdens, high youth unemployment, low birth rates and a shift in government priorities from high economic growth to more restrictive industrial policy. On balance, inflation remains problematic around the world, compelling many central banks to tighten policy further which is likely to slow the global economy.

Excess Savings

Consumer spending in the U.S. is being supported to an extraordinary degree this business cycle by the unprecedented excess savings that were amassed during the pandemic. The Federal Government injected approximately $5 trillion into the U.S. economy in the form of stimulus checks, child tax credits, expanded health care coverage and increased unemployment benefits. Simultaneously, accommodative monetary policy drove interest rates lower, which reduced financing costs and contributed to a wealth effect as prices appreciated across real estate, stocks and bonds. With many discretionary spending options limited by social distancing measures, the personal savings rate surged to a historic 33.8% early in the pandemic and remained abnormally high for over a year. The Bureau of Economic Analysis estimates that accumulated excess savings reached $2.1 trillion by the summer of 2021. Since then, consumers have been drawing down their coffers but as of March of this year an estimated $500 billion of excess savings remained. The peculiar nature of this business cycle cannot be understated. In the aftermath of most recessions, it takes consumers years of working and spending judiciously to replenish the wealth that was destroyed through lost incomes and lower asset prices. In stark contrast, the aggressive government intervention during the pandemic created, rather than destroyed, wealth that continues to percolate through the economy. At the current rate of spending, consumers will deplete these excess savings sometime around yearend which will introduce another headwind to an economy already poised to encounter the lagged effects of monetary policy and tighter bank lending standards. Excess savings have buttressed economic growth, but as liquidity begins to dwindle in the months ahead, the expansion will be challenged.

Fixed Income

Bond returns were generally flat in the second quarter and slightly positive for the year-to-date. Improved inflation readings provided reason for the Fed to leave overnight policy rates unchanged at a range of 5 to 5.25 percent in June. This allows the Fed time to evaluate how the economy adapts to the lagged effects of policy and the tighter lending standards implemented in the wake of banking distress. Monetary officials expect further rate hikes will be required given still stubbornly elevated inflation levels. The Fed also projected higher rates for longer than it previously forecasted which postponed investor expectations for interest rate cuts from 2023 into 2024. These are important reasons the benchmark ten-year U.S. Treasury climbed from 3.5% at the start of the quarter to 3.8% in June. Short-term rates have increased as well, keeping the yield curve inverted to a historic degree. The unusual condition, in which the rate on short maturity notes exceeds that of longer issues, has now persisted for more than a year. Yield curve inversion is often a harbinger of recession with lead times ranging from months to years. In the interim it is not unusual for economic data to remain firm, causing market participants to question the validity of such leading indicators as they grow weary of anticipating a slowdown. With substantial tightening in the pipeline, it is likely that inflation will subside further in coming quarters and long-term bond yields should follow. We continued to extend the average duration of bond portfolios to lock in higher yields at longer maturities while remaining focused on high-quality holdings.


Stock indices rose in the second quarter propelled by large capitalization, technology-oriented issues. The market capitalization-weighted S&P 500 returned 16.9% year-to-date through June, though the seven largest stocks accounted for some 75% of the total gain. Such thin leadership is considered by many investors to be an unhealthy market characteristic. The Dow Jones Industrial Average returned just 4.9% year-to-date, highlighting the disparate nature of the market. Stocks have cheered a string of encouraging news, including cooling inflation, a debt ceiling resolution, strong consumer spending, excitement over artificial intelligence, perceived stabilization in the banking industry, a line of sight to the end of the Fed tightening cycle and better than expected corporate earnings. However, leading economic indicators, such as the inverted yield curve and diminishing credit availability, suggest a less rosy outlook.

Given the long lag associated with monetary policy, Fed tightening is yet to be fully absorbed by the economy. Money supply is contracting, a highly restrictive force, as the liquidity that was responsible for generating excess savings and inflation is receding. CEO and consumer confidence are at depressed levels and real wages are in decline. The New York Fed’s economic model recently assigned a 70% probability of recession over the next twelve months, a level not reached since 1982. We remain cognizant that the unique circumstances of the pandemic have complicated this business cycle by creating an asynchronous recovery across industries and bolstering consumer spending through excess savings. In client portfolios, we have maintained balanced equity exposure across sectors. While the recent market rise has led to excessive price-to-earnings multiples in some sectors, the average stock does not appear overvalued. We continue to selectively emphasize reasonably priced, high-quality growth companies with durable business models that we expect to perform favorably over the full course of a business cycle.