Key takeaways

  • Stocks recovered much of the ground lost in 2022’s bear market during the first half of 2023.

  • The environment turned more volatile in August as stocks gave back some ground.

  • The bond investors face significant changes, with interest rates today at more attractive levels.

The stock market generated a solid recovery in the first seven months of 2023, as the benchmark S&P 500 gained more than 20%. However, stocks gave back some ground in August and September. By the end of September, the index stood just 13% higher than where it was at the start of 2023.1 Nevertheless, it represented a turnaround from 2022’s bear market (representing a drop in value of more than 20%).

The same could not be said for bond markets. Interest rates, which moved significantly higher over the course of 2022, continued to trend higher in 2023. When interest rates rise, bond prices fall. While bond investors earned higher yields in 2023, total returns have been flat or modestly negative.

Last year’s broad-based downturn affected both stocks and bonds, even leading to negative returns for investors with well-diversified portfolios. The market’s tumult appeared to be in large part a reaction to a substantive policy shift by the Federal Reserve (Fed). The Fed rapidly raised short-term interest rates and began, for the first time since 2019, reducing its bond holdings. Many feared that in its quest to lower inflation, the Fed’s actions could tip the economy into a recession.

Notably, a recession has, to this point, been avoided. “The economy today can best be described as resilient,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. Freedman attributes the economy’s ongoing modest expansion to persistent consumer activity. “Consumers have been spending more than most thought they would, and that has boosted corporate profits.”


Positive economic signals

The U.S. economy demonstrated steady growth in the first half of 2023. The primary measure of economic activity, Gross Domestic Product (GDP), grew at a 2.2% annualized rate in the first quarter, and 2.1% in the second quarter. It was a similar pace to 2022’s 1.9% annualized rate.2 Investors and economists anticipated a slowdown given the Fed’s determined effort to temper rising inflation by slowing the economy. “The economy’s held up reasonably well to this point because of the strong labor market (unemployment below 4%), and consumers' fairly strong financial position,” says Freedman. “Our U.S. Bank economics teams believes these factors continue to help us narrowly avoid a recession in the near term.”

“We’ve seen very narrow leadership from technology, communication services and consumer discretionary stocks. Those three categories generated double-digit gains through the first half of the year, with much of the rest of the S&P 500 lagging behind.”

Eric Freedman, chief investment officer for U.S. Bank Wealth Management

The Fed could claim a degree of success in managing the inflation challenge. After peaking at a rate of 9.1% in June 2022, inflation (based on the Consumer Price Index, or CPI, measured over the previous 12-month period), fell to 3.0% in June, its lowest level since March 2021.3 However inflation rose modestly after that, to 3.7% for the 12-month period ending in September 2023. One key tool the Fed has used to combat inflation is raising its target federal funds rate from near 0% to 5.25% - 5.50%. The Fed has indicated it will hold the line on rates well into 2024, with additional rate hikes possible.


Assessing recession risks

The Fed’s rate hikes are designed to slow the pace of economic growth. It leads to higher borrowing costs for consumers and businesses. That may dissuade some from adding debt to their balance sheets or make it more expensive for those who choose to borrow, particularly compared to conditions that existed prior to 2022. Yet consumer spending remained solid. “Some factors are at play that could hinder consumer activity, like higher borrowing costs and dwindling savings remaining from previous government funding programs,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “The strong labor market and solid wage gains give consumers the wherewithal to maintain enough spending activity to keep the economy on track.”

The extent to which consumers and businesses maintain current spending levels may also impact inflation’s path in 2023. “Labor costs are a critical consideration,” says Freedman. “Job openings exceed available workers, which can push elevated wage gains even higher.” That could partially offset the Fed’s inflation-reduction strategy.

Freedman notes the interdependent relationship between consumers and businesses. “Businesses are confronting higher costs, particularly for wages and borrowing. That can have a cascading effect on business expenditures. If business spending slows, that can ultimately impact consumer spending, and the interdependence persists.”


Equities prove resilient, bonds face rising rates

Stocks regained considerable ground after reaching a bear market low in October 2022. Following a brief rally in late 2022, S&P 500 stocks were largely rangebound between 3800 and 4200 during the opening months of 2023. In June and July, equities performed particularly well before giving back some of those gains in August and September.

Source: U.S. Bank Asset Management Group. Chart depicts daily changing values of the Standard & Poor’s 500 Index, an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.

Freedman notes that three industry sectors drove the U.S. stock market’s positive results in early 2023. “We’ve seen very narrow leadership from technology, communication services and consumer discretionary stocks.” Those three categories generated gains in the 25% to 40% range through the first nine months of the year, with the rest of the S&P 500 lagging far behind.1 Broader participation among other sectors is required to sustain an upward trend for stocks, Freedman says. “When leadership is narrow, it’s less healthy than a more balanced type of rally.”

As for the fixed income market, many types of bonds traded in a consistent range between October 2022 and July 2023. Then rates began to shift higher. The result is flat-to-negative total returns in bonds as bond values decline in a rising rate environment. “The recent runup in interest rates may change how investors view their portfolio options,” says Haworth. “It potentially opens opportunities to capitalize on more attractive interest rates available in today’s bond market to take some equity risk out of a portfolio.”

Source: U.S. Department of the Treasury, Daily Treasury Par Yield Curve Rates.


How to invest today

Freedman says that even with the economy holding its ground so far in 2023, uncertainty persists and that could result in possible additional asset repricing. If consumers and businesses cut back on spending, it would likely result in reduced corporate profit growth, and consequently, lower stock prices. Freedman says the likelihood of this scenario is uncertain but deserves investor consideration.

In such an environment of uncertainty, dollar-cost averaging may be an effective way to invest in equities. “By making regular investments over a period of time, you aren’t anchored to an investment at a single price; you stretch your investment out at different price points over time,” says Haworth. By doing so, you protect against investing as a market high just before a negative turn in the market. Given that the direction of markets is difficult to predict in the short run, this is a strategy that can help overcome concerns about investing just prior to a market dip.

“Be prepared to take what the capital markets offer given the current environment’s realities,” says Freedman. He recommends that long-term investors position their portfolios with a neutral mix of equities, fixed income and real assets, relative to their investment plan. Freedman adds, “It’s critical to have a financial plan that’s tied to the specific goals you hope to achieve.”

Once that plan is in place, says Freedman, it’s important to regularly review your plan with your wealth management professional. Determine whether there are opportunities to rebalance your portfolio in ways that more appropriately reflect your investment objectives, time horizon, risk appetite and the current market environment.

Have questions about the economy, markets or your finances? Your U.S. Bank Wealth Management team is here to help.

Note: The Standard & Poor’s 500 Index (S&P 500) consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The S&P 500 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.

Related articles

Is the economy at risk of a recession?

The Federal Reserve is focused on fighting inflation with ongoing policy moves intended to slow consumer demand. Does this put the economy at risk of a recession?

Analysis: How persistent might inflation be?

While the pace of rising inflation is slowing, persistently higher prices continue to weigh on consumers and policymakers alike.


Start of disclosure content
  1. Source: S&P Dow Jones Indices LLC, performance as of Sep. 30, 2023.

  2. Source: U.S. Bureau of Economic Analysis, Gross Domestic Product.

  3. Source: US. Bureau of Labor Statistics.

Start of disclosure content

Investment and insurance products and services including annuities are:
Not a deposit ● Not FDIC insured ● May lose value ● Not bank guaranteed ● Not insured by any federal government agency.

U.S. Wealth Management – U.S. Bank is a marketing logo for U.S. Bank.

Start of disclosure content

U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

The information provided represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific investment advice and should not be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation.

U.S. Bank does not offer insurance products but may refer you to an affiliated or third party insurance provider.

U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments, Inc.

Equal Housing Lender. Deposit products are offered by U.S. Bank National Association. Member FDIC. Mortgage, Home Equity and Credit products are offered by U.S. Bank National Association. Loan approval is subject to credit approval and program guidelines. Not all loan programs are available in all states for all loan amounts. Interest rates and program terms are subject to change without notice.