The Winners-Take-All Market - 3rd Quarter 2023

Fixed income and equities, both domestic and abroad, declined during the third quarter. Though the Federal Reserve (Fed) announced a much-anticipated rate hike pause last quarter, recent data has members considering additional increases and espousing a “higher rates for longer” mentality. Uncertainty regarding the outlook for global economic growth, inflation and geopolitical disruption has caused investors to flock to a very narrow segment of “safe” U.S. stocks, leading to a winners-take-all market.

As shown in the chart below, seven mega-cap companies have driven nearly 75% of U.S. returns over the last year, while other sectors (Financials, Healthcare, Industrials, Energy, Real Estate, and Utilities), Small Cap U.S. companies, and international companies of all sizes, have lagged significantly. There’s no question that these seven companies (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla) are exceptional enterprises, but we believe this narrow market breadth is recognition of challenging economic conditions for all but those with the most robust balance sheets, a shared characteristic among the seven listed above. As long as economic growth holds up and the labor market remains healthy, the Fed will have little reason to relax its interest rate posturing. Many businesses, both large and small, have low-cost debt financing coming due which will need to be paid down or refinanced in a higher-cost environment. We feel these increased costs will hinder research and development budgets on the margin, slowing the productivity enhancements which have driven returns over the past decade.

   Source: Bloomberg LP

Geopolitical instability (e.g., Russia’s invasion of Ukraine, China’s economic aggression, and now the attacks on Israel) has only added to the confusion. A greater number of political parties around the world are promoting isolationist policies. Businesses continue to rework supply chains and seek redundancies. To a certain extent, there is a dearth of trust and a lack of conviction as to how these challenges will resolve economically.

Our view at EPIQ is that the U.S. economy and inflation will continue to slow. Whether this will cause a recession in the U.S. remains to be seen. For the first time in more than 15 years, we see real value in high-quality fixed income providing strong competition for capital with stocks. Until monetary policy from the Federal Reserve pivots to a more accommodative position (lower rates), broad stock market returns will likely trail historic norms.

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