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August 2023

Market Update: Maintaining a Defensive Positioning

Key Points

  • Maintaining defensive positioning with modest underweight to equities
  • Market rally likely to come under pressure as recessionary pressures build
  • Continue to see better risk-reward opportunities in fixed income

As we cross the midway point of the year, it’s hard to say which has been hotter, the stock market or the weather. While the mercury has been busy breaking records across the country this summer, the rally in US equity prices has continued its sizzling pace with the S&P 500 edging closer to a new all-time high. Fear of missing out on a new bull market has replaced caution among investors despite a large number of historically reliable recession indicators still flashing warning signs.

During the first six months of the year, the powerful performance of the S&P 500 was driven by a handful of growth sectors and, in particular, a few large-cap technology stocks supported by enthusiasm over developments in artificial intelligence.  However, in recent weeks rising optimism about the potential for a goldilocks scenario, in which economic conditions are neither too hot to prevent inflation from falling further nor too cold to fall into recession, has led to a broadening out of positive performance in economically sensitive parts of the market, including small-cap stocks and cyclical sectors, and pushed overall market valuations higher.

Chart 1: Valuations 12 Month Forward P/E Multiples


Sources: FactSet, CNR Research, as of July 2023.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

This isn’t the first time a soft landing has been expected.  It almost always happens at this cycle stage, when the imbalances of the economy are responding to the Fed’s actions and moving back toward equilibrium.  But, changes in interest rates act like a slow-release medicine given to a patient.  They take time for their full impact to work their way through the economy, and they can have some nasty and unpredictable side effects.  The unusual nature of the pandemic shock and associated government interventions likely have lengthened the lags of traditional recession indicators this cycle, but they have not been suspended, and we still believe a mild recession is in the cards later this year or early 2024 as the cumulative effect of Fed tightening takes its toll on economic activity.

Similar to our concerns about the sustainability of market strength in Asia and Europe earlier this year, overoptimistic investor sentiment on US growth prospects have us questioning the sustainability of the current rally in US equities.  Market gains since last October’s lows have been driven almost entirely by multiple expansions, and while higher valuations alone are not an impediment to future market gains, they do create a higher perch from which to fall should earnings results fail to meet expectations.  Indeed, with consensus estimates still projecting a reacceleration of corporate profit growth in Q4, earnings misses could be a key source of market weakness and volatility in the months ahead.  

Given this, we believe it remains too early to raise equity exposure, especially when we continue to see plenty of opportunities in fixed income.  It’s been a decade since bond yields have been this attractive and, even though inflation is trending down, various yields have remained elevated, increasing the real rate of return.  Short term T-Bills and cash-like alternatives have garnered the most attention, but short to intermediate yields in both municipal bonds and corporates offer additional opportunities. Bond allocations not only lower overall portfolio volatility, but they also historically perform better than stocks in recessionary periods.

Chart 2: Yield Comparison
Source: Bloomberg, as of July 2023. Investment Grade Corporate Bond Yield Index: Bloomberg US Aggregate Index.
Indices are unmanaged, and one cannot invest directly in an index. Information is subject to change and is not a guarantee of future results.


While it may be tempting to chase stock market momentum, it is crucial to stay focused on longer term trends and not to forget that equity prices seldom bottom before recession begins.  Just as the summer heat wave will eventually break, we think the stock market is set to cool as recessionary pressures build in the coming months and corporate profits come under renewed downgrades. Our mildly defensive portfolio positioning is a smart way to stay fully invested as clearer signs of the economy’s direction develop, while our focus on holding high quality and income producing US stocks and bonds can help provide client portfolios with relative stability as the investment environment grows more challenging.

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