The economic outlook is not always definitive and easy to interpret. That’s reality, and it certainly seems to be the case today as we look toward year-end and into 2024. The recent mixed bag of data highlights both upside and downside risks to the economy ahead. As such, we are structuring portfolios with a balance of defensive and economically sensitive exposures, given the uncertainty and where we believe we are in this cycle.

The good, the bad, the unknown

Through the first 10 months of the 2023, the domestic economy has shown remarkable resiliency.  The broader stock market has also rallied for much of the year and remains in positive territory, despite a pullback since July. That’s the good news. In our view, consumers continue to power the economy, and labor markets remain relatively healthy with headline employment gains.

On the other hand, we see various risks to both income and spending ahead. For example, the resumption of student loan payments threatens to eat into many consumers’ spending power, just as savings cushions that were accumulated during the pandemic are nearly depleted and oil prices are rising again. The Leading Economic Index continued to decline on a year-over-year and six-month basis during the third quarter, and the Bureau of Economic Analysis’ various measures of corporate profits appear to have stalled. In general, we still believe the most severe impacts of the Fed’s rate-hike cycle, tighter lending standards, and a rollover in corporate profits have yet to be fully felt.

In terms of recent sector performance in the U.S., the third quarter was a mixed bag as the market rallied in July and then pulled back. In the first four weeks of the fourth quarter, as the S&P 500® continued to decline, early-phase defensive sectors like Utilities and Consumer Staples outperformed alongside Information Technology and Communication Services, which we see as mid-phase sectors with moderate economic sensitivity. Over the same period, the most economically sensitive, late-phase sectors have all lagged, including Energy, Financials, and Industrials.

Looking ahead, our broad view of the macroeconomic and market backdrop remains largely consistent with earlier in the year, which we believe warrants a balance of exposures to defensive areas of the market and areas that should benefit if growth persists. The near-term risk of recession may have been pushed out somewhat, but multiple indicators still signal heightened risks for the economy and corporate profitability. And even if the Fed succeeds in engineering a so-called “soft landing,” we still see little fuel for a sustained reacceleration of economic activity in the near-to-intermediate term. All of this is consistent with a late-cycle environment, and we continue to avoid or underweight the most economically sensitive areas of the market, which tend to benefit from more dynamic early-cycle economic conditions.

Stay balanced—Stay in the game

Despite the risks ahead, it’s worth emphasizing that even when we skew to the defensive, we do not advocate exiting the market. We understand that many investors have remained on the sidelines, reticent to re-enter equities given the volatility and poor returns of 2022.  

Although that’s understandable, it’s important to remember that timing the market with any consistency is a virtual impossibility, and this says nothing about the potential for negative tax ramifications. Rather, we believe investors may be better served by focusing on why they allocate to equities in the first place—presumably for their long-term return potential.

After all, despite recent downside volatility, the broad stock market has still roughly doubled the return on cash and cash equivalents thus far in 2023 (the S&P 500® returned 10.0% YTD through October 30th), even in the face of elevated and rising interest rates. Thus, investors who are seeking equity returns over time but who have been waiting on the sidelines in money market funds may have enjoyed some increase in yields, but they may also find themselves behind where they should be on the path to their investment goals. We believe that dynamically aligning portfolio exposures to the macroeconomic backdrop throughout the economic cycle is a better approach to managing risk and capturing returns than attempting to time in and out of the market based on uncertain risks and sentiment.

This report should not be relied upon as investment advice or recommendations and is not intended to predict the performance of any investment.  The information contained herein is not intended to be an offer to provide investment advisory services.  Such an offer may only be made if accompanied by WestEnd Advisors’ SEC Form ADV Part 2. These opinions may change at any time without prior notice. All investments carry a certain degree of risk including the possible loss of principal, and an investment should be made with an understanding of the risks involved with owning a particular security or asset class. Portfolio characteristics and/or allocations are generally averages and are for illustrative purposes only and do not reflect the investments of an actual portfolio unless otherwise noted.  Portfolios that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than a portfolio whose investments are more diversified.  While every effort has been made to verify the information contained herein, we make no representation as to its accuracy.