Mid Year 2023 Market Update
We have been pleased to see the positive growth in the markets as compared to the downturn we were experiencing at this time last year.
The most popular prediction headed into 2023 was that markets would suffer through a rough first half but rally by year’s end. However, stocks and bonds have refused to comply with that forecast.
Here is a quick snapshot of of several key markets through the end of July:
As you can see, both the NASDAQ & S&P 500 have bounced back very well, from the oversold levels of last year. One caution and concern we have been communicating is that these gains were made in a very small number of companies - this has not yet been a broad based rally across all sectors and companies.
This is a time when investors are looking for guidance, and a way forward. Recent headlines have included focus on inflation adjustments, and looming Fed decisions regarding additional interest rate hikes. The Debt ceiling negotiations in DC were particularly divisive before resulting in a deal to avoid default, as we expected. US Debt, the impact of artificial intelligence, US-China tensions and the never-ending war in Ukraine, continues to be at the forefront of the news.
Our recommendation is to continue staying diversified, buying quality investments and holding for the long term. Not hold and forget, but hold and rebalance periodically. When is the best time to buy? Always.
The below chart shows that missing the first half of a Bull Market can significantly reduce returns, as we wouldn’t want to be just “sitting on the sidelines” waiting for a recovery or for the markets to turn around, as you just might miss that opportunity waiting to “time the market”.
Today, investor sentiment is poor, and that creates potential opportunities. Bearishness, as measured by short equity interest, is at multi decade highs, while the amount of money in money market funds and treasury Bills is at a record high. Rates for short-term cash are at the highest level since 2007. All these factors suggest that investors are waiting for a decline in market indices before shifting assets into equities. This has been the most telegraphed recession/bear market in history. If everyone is waiting, any decline may be brief, and untradable.
This piling up of cash has been triggered by plenty of bad news this year that could have derailed the first half’s rally in risk assets. Further tightening monetary policy, the Federal Reserve (Fed) has raised interest rates in three of their four meetings this year and ten times overall since last March.
In July the Federal Reserve raised its key interest rate by 0.25%, now set between 5.25% and 5.5%, the highest level in 22 years, as it continues to fight persistent inflation in the U.S. economy. The reality is the Fed is getting a grip on the inflation problem. Both June and July inflation reports confirmed that price pressures are receding. June’s headline measure of inflation slid for the twelfth consecutive month, falling to 3.0% on a year over year basis. This was the longest stretch of declines since the early 1980’s. Economists anticipated a rise for July and expected year over year inflation to rise to 3.3%, while 3.2% was reported. As a reminder in June 2022, this measure was at a whopping 9.1%
Shelter costs still carry a high weight in the inflation index, and are still running at a 7.8% annual pace, other real time indicators, such as Rent.com’s rent trends, are reporting a 0.6% YoY decline in rents.
Given the long lags in which house price trends get captured in the official statistics, it's worth noting that if the shelter component was replaced with Rent.com’s rent trends, the core inflation measure would be below the Fed’s target of 2% at +1.3%!
The uneven economic data means that a further fed rate hike cannot be ruled out. The 500 basis points of tightening so far is enough to bring inflation back to target, and significantly slow the economy. Further Fed tightening, in our view, can increase the risk of a recession.
A later recession should be a milder recession for the simple reason that by 2024 inflation should have fallen by enough to allow the Fed to ease aggressively. A recession that starts in 2023 while inflation is still above the Fed’s target would limit the pace of easing.
The economy is showing some signs of cooling.
Year-over-year earnings have declined for two consecutive quarters on smaller revenues and shrinking profit margins. Several US banks have failed amid the ongoing crisis in the regional banking industry, raising fears of a looming credit crunch. China’s reopening from COVID restrictions has been underwhelming. And, sadly, the Russia-Ukraine war rages on with no clear end in sight. Investors continue to be attracted to high paying money market rates, and short term bonds, making it difficult for corporations to finance long term projects.
As mentioned earlier, mega Cap stocks are once again dominating the performance of the U.S equity market. This time it is driven by excitement around generative artificial intelligence technologies such as ChatGPT. The year to date return of the top seven tech stocks through July has been 84% - Nvidida has posted a 190% return and Apple’s market cap now exceeds that of the entire small cap Rusell 2000 index. Not all stocks in the S&P 500 are equally represented. The index’s components are weighted by their market value, which favors the biggest companies. The magnificent Seven include Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms. These seven companies account for nearly 30% of the index.
The S&P 500 has returned 19.5% through July. However, as the following chart shows, excluding the magnificent seven, the return has been just 4%.
ChatGPT’s release late last year triggered a wave of predictions about how transformative the new generative artificial intelligence technology will be. Goldman Sachs thinks AI could lift U.S. labor productivity growth by 1.5% per annum over the next decade and boost corporate profit margins by 400 basis points.
These forecasts are speculative, but it’s hard not to be excited by the potential of AI. The effects of AI could occur faster than in previous technological revolutions such as the introduction of electricity, roads and the internet. These previous episodes depended on scale and network effects to become transformative. Use of AI, by contrast, is increasing quickly and the effects on growth and productivity may occur in years rather than decades.
Identifying the investment winners and losers from AI is not clear-cut. AI runs on computer processing power and data, so specialized chipmakers are likely to be beneficiaries, as well as companies that have access to large amounts of computing power, cloud storage and data.
There is also the question of whether AI will turn into a speculative mania in the manner of the 1990s tech bubble. The gains for companies such as Nvidia and Meta this year can in part be explained by large increases in their earnings expectations. Aggressive Fed tightening and the risk of recession are likely to keep the lid on AI euphoria for now. The return of low interest rates and easy money in the next cycle could be the trigger for an episode of speculative excess. AI is still in its infancy and will be one of the key investment themes to monitor going forward.
It must be maddening for market prognosticators to watch stocks and bonds continue to climb ignoring the wall of worry. The widening gap between financial assets’ performance and underlying risks underscores the notion that the economy is not the market and vice versa.
This doesn’t mean investors are not on edge. Eager to protect their unexpected gains, while unwilling to exit the markets in fear of missing out on future opportunity. Investors continue to await the highly forecasted recession in history and investors crave clarity regarding its timing and severity. But until the resilient consumer and strong labor market falter, investors will likely have to wait a while longer for the anticipated recession — which might take a few more quarters to unfold.
Historically there has never been a market bottom before a recession began, further fueling investors’ anxiety. Meanwhile, a look beneath the surface of the solid year-to-date performance of the S&P 500 supports investors’ growing skepticism on how long this rally can last.
The index bottomed nine months ago in mid-October and, by this stage of the rally, participation should be meaningfully broader.
Historically, during the monetary policy transition period between the last rate hike and the first rate cut, risk assets perform reasonably well. But be wary of rate cuts, because risk assets typically fall when the Fed starts cutting. Afterall, the Fed is lowering rates for a reason — usually in response to a recession or capital market breakdown.
Many of you already know, there are many more positive years in the stock market than negative years. Going back to 1926, the S&P 500 has had 71 positive years to only 26 negative years. And for 36 of those 71 positive years the S&P 500 was up over 20%.
While we may be entering an economic slowdown which could have a potential mild recession. There is a huge amount of surplus cash waiting to buy the dip. The landscape for investing is improving. Bearish sentiment fading on the back of a resilient economy, decelerating inflation, and better than expected earnings - said Raymond James Chief Investment Officer Larry Adam.
With the Fed near the end of its tightening cycle, a glimmer of hope for the elusive soft-landing led to a broadening of performance beyond just tech.
The Dow Jones Industrial Average reported 13 consecutive days of gains, falling one day shy of a record that dates back to 1897.
We may experience additional bumps in the road, but maintain a diversified portfolio to help mitigate unnecessary risks in your portfolio’s. As the landscape changes, we actively tweak your accounts to make sure you're invested properly based on the goals we have discussed, and your current financial needs.
Just to reiterate our process here at Sterling Fox Financial Services. We meet with many other partner firms throughout the year on an ongoing basis. In both good times and bad we listen to, absorb, and ask questions among their financial experts. Which we can then make sure we are investing your money in the best possible places.
Thank you for your continued trust in us, and our commitment to your goals and your long-term financial well-being. Be patient and remember why you invested in the first place. If you have any questions about this update, your accounts, or anything at all, please reach out at your earliest convenience.
The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal.
The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations.
The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index.
The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
Any opinions are those of Bob Volpe and Phillip Passey and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The information contained in this material does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Past performance may not be indicative of future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.