Summer 2023 Market Commentary
Amid investor concerns of recession, bank failures, the debt ceiling, rising interest rates, and a hawkish Federal Reserve, the stock market indexes have powered higher in the second quarter and first half of 2023. The S&P 500 index jumped by 8.7% and the all-cap world index (ACWI) gained 6.3% during the second quarter. For the first half of 2023, the S&P 500 was up 16.8% and ACWI was up 14.2%. Clearly, a welcome result after the dismal returns in 2022. Bonds have continued to lag with year-to-date returns of -1% as unexpected economic strength has increased the prospects of higher interest rates for longer.
The big story is the small group of about five stocks generating nearly all of the S&P 500 index returns this year – Apple (49.6%), Microsoft (42.7%), Alphabet (35.7%), Amazon (55.2%), and Nvidia (189.4%). The large-cap technology rally has been fueled largely by investors chasing the prospects for artificial intelligence or “AI” led by ChatGPT and Microsoft. As a result, the tech-heavy Nasdaq 100 index is up a startling 39.1% year-to-date. The market rally is the narrowest since the dot.com boom of 1999.
Generally, broad market participation is more characteristic of a healthy and sustainable stock market rally. The obvious implication is that small- and mid-cap stocks have dramatically underperformed the largest stocks. For example, the equal weighted S&P 500 index has gained only 6.9% this year or a -9.9% difference from the cap weighted index. The less obvious implication is that prices, and P/E ratios, have shot up without material increases in analyst earnings estimates for 2024, meaning the business model for AI remains elusive and quantification is mostly just a guess at this time.
International markets have also had a good year with the EAFE index up 12.5%, but the emerging markets have lagged, gaining a still respectable 5.2%. Hopes for an early 2023 rebound in China, after finally reopening from Covid, have been dashed as their economy has failed to respond as expected. The Chinese central bank has resorted to cutting interest rates to buoy economic activity and to support the beleaguered real estate sector.
Returns to diversified global portfolios have lagged the benchmark indexes by a wide margin this year as the only way to keep up with the indexes is to own them in their cap-weighted allocations. Active managers have largely lagged the benchmarks as well because most try not to replicate indexes on purpose. Style rotation has, once again, provided another example of how trying to time markets is impossible and costly. The value stocks outperformance of 2022 has been replaced by growth stocks outperformance in 2023 – the Russell 1000 growth index is up 29% this year while the value index is up only 5%. Dramatic rotation has also been seen among sectors with last year’s top returning energy sector down -7% this year after gaining 58% in 2022.
As we enter the second half of 2023, we would note that the majority of economic indicators still point to a recession later in the year – falling leading economic indicators, unemployment rate increases, the inverted yield curve, tighter/reduced bank lending, and manufacturing PMI below 50. The Fed also remains hawkish and poised to fight inflation with interest rate increases and quantitative tightening. The lags associated with the indicators and recessions can be long and varied but average 16 months, meaning we may expect a recession sometime between Thanksgiving and year-end.
While the data is of interest, we know we can’t predict the timing, magnitude, or market impact of a slowdown. We also recognize that maintaining discipline in a narrow market can be difficult but is critical to long-term investing success. Therefore, as part of our ongoing investment planning service, we will avoid the fear of missing out (FOMO), there is no alternative (TINA), chasing returns, and other dangerous shiny objects. We remain focused on our disciplined investment processes to provide well-designed, tax-efficient, globally diversified portfolios that suit our clients’ investment planning needs.
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The views represented in this commentary are not meant to be construed as advice, testimonial or condemnation of any specific sector or holding. Investors cannot invest directly in an index. Unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Past performance is no guarantee of future results. To discuss any matters in more detail, please contact your financial advisor.