CRA Financial - Mid Year Review and Outlook

2nd Quarter 2023 Review

The market recovery continued in the 2nd quarter with stocks advancing significantly, rewarding investors who remained invested despite challenges existing for the global economy.  However, numerous experts still predict a recession for the back half of the year, though at this point the US stock market is clearly pricing in a soft landing.  The advancement of the stock market has been narrow with large cap technology stocks leading the way, while many stocks have seen significant declines for the year.  

Charles Schwab’s Chief Investment Strategist, Liz Ann Sonders has referred to this economy as a “rolling recession’, where different sectors of the economy are challenged at different times as opposed to simultaneously, as we often see when the market faces broad-based systematic risk.   Her prediction is appearing accurate where at first non-profitable companies and cryptocurrency sold off followed by large technology stocks in 2022. This year the recession has rolled on to regional banking stocks sending this index down around 28% year-to-date.   Predicting which sector the recession may “roll” next is difficult, and perhaps the stock market recovery actually broadens through the second half of the year.  Risk in the market certainly remains as The Fed delicately balances the use of higher rates which could slow the economy down faster than is necessary, ultimately triggering a full recession.  As the year progresses, more eyes will shift to politics, with candidates gearing up for the 2024 presidential election next year.

U.S. Stocks 

Stocks bounced higher particularly in June, as Congress avoided disaster by coming to an agreement to raise the debt ceiling.  Additional tailwinds came from the Federal Reserve Bank who paused their rate hiking at their June meeting signaling at least a slowing to the pace of their rate hiking strategy.

For the quarter, U.S. stocks advanced with the S&P 500 Index returning 8.74%.  The Dow Jones Industrial Average performed considerably worse only returning around 4%.   Mid and Small-cap stocks advanced 4.85% and 5.21%, respectively, as measured through the S&P Mid-cap 400 and Russell 2000 Index.  The tech-heavy NASDAQ Composite Index was the leader returning 13.05% during the 2nd quarter.   

 While the stock market overall has advanced, as mentioned earlier, the recovery has been quite narrow.  Investment manager Blackrock has said that 2023 has been a tale of two markets with certain sectors advancing sharply higher compared to other sectors, which have declined year-to-date.  Mega-cap technology stock returns have been particularly robust.  In fact, if you took seven of these stocks out of the S&P 500 (META, AMZN, AAPL, MSFT, GOOGL, TSLA and NVDA) the index would have provided virtually no return through the beginning of June.  While these stocks have given a nice rebound to the overall market, it is difficult to imagine their outperformance will continue in the way that is has through the first half of the year.  We may need to see more stocks participate for the market recovery to continue.

International and Emerging Markets

 International investments lagged domestic stock performance during the 2nd quarter this year.  The aforementioned tech stocks are all U.S. based and their outsized performance pulled the U.S. stock market considerably higher comparatively.   Still, the EAFE index was positive and returned 2.95% for the quarter, while emerging market stocks advanced 3.96%.   

 Inflation remains elevated in Europe with a May reading of 6.1% for the Euro Area.   This inflation growth rate has declined from its peak, although some worry that the next winter could cause further inflation for Europeans should a colder winter be experienced.  Certain countries specifically are still in a tough battle with inflation.  The United Kingdom, for example, reported an 8.7% inflation rate for the month of May, more than double what we saw here in the U.S.

The Fed 

The Federal Reserve raised rates on May 3rd to rate of 5.00% - 5.25%.   Their commentary hinted that they would pause rate hikes, which proved to be true when the Fed by-passed a rate rise in June.  The pause in rate hikes was celebrated by the stock market and is perhaps one of the key reasons stocks advanced for the quarter; however, the Fed’s tone remained hawkish stating that more rate hikes in the future should be expected.

Keep in mind the reason they have hiked rates is to slow down inflation by slowing down the economy.  Inflation was measured at 4.0% for the 12 trailing months in May, down significantly from the 9.1% reading from June of 2022 (See chart below).  The Fed remains consistent in stating that their goal is to bring inflation down to a rate of 2% and are expected to remain data dependent.   What this means is that if inflation does not continue ticking downward, they will raise rates higher or leave them higher for longer.  However, if inflation continues its downward trend allowing them to reach their goal of 2%, then they may finally be able to say we have made it through their rate hiking cycle.  The Fed also has a history of cutting rates not long after they have raised.  We do not expect them to cut rates any time this year, but would not be shocked if they lowered rates in 2024.

Fixed Income and Interest Rates

 While the Fed controls short-term interest rates through setting their Federal Funds Rate, longer-term interest rates are determined through supply and demand dynamics similar to the stocks market (see the yield curve chart below).   Interest rates declined for the first quarter with Silicon Valley Bank collapsing and a new fear of a banking crisis emerging; however, the bond market seems to be looking past this in Q2 with rates ticking up slightly.  

Investors continue to be paid more on shorter-term bonds due to the moves the Fed has made.   1-year treasuries continue to yield north of 5% for guaranteed government money and CDs. This phenomenon is known as an inverted yield curve.  Clients should take note if you have significant cash holdings at the bank and are not being paid a rate near 5%. The fact that longer-term rates are paying less shows that the bond market is not expecting rates to remain high forever.   The curve below is the bond market saying that rates will be lower in the future…we just do not know when.  In the meantime, taking advantage of higher interest rates is prudent.

The slight increase in interest rates during Q2 led to a decline in bond prices with the Aggregate Bond Index losing (-0.84%) while Bloomberg’s Municipal Bond index lost just (-0.10%).  Bonds as a whole remain much more attractive than they were a year and a half ago now that we have established this higher rate base for bonds to pay.

What's Ahead for the Rest of 2023?

 The stock market has made a significant recovery year-to-date but still needs to advance by 8% to reach its previous high.  If the recovery can broaden, we would see more stocks participating in this rally, which would also signal a healthier expected future economy.   Risk of the Fed overtightening and triggering a recession remains.  Inflation also needs to continue its downtrend and remain low for this new bull market to solidify.  At CRA, we remain cautiously optimistic; however, history is on our side as the last 6 times the CPI (inflation rate) fell more than 5%, the market was higher by an average of 15% a year later.  

We hope that everyone has a safe and enjoyable summer.  We look forward to coaching and partnering with you and, as always, we remain available for you.

As always, let us know if you have any questions.

Best, 

CRA Investment Committee 

Matt Reynolds CPA, CFP®

Tom Reynolds, CPA 

Robert T. Martin, CFA, CFP®

Gordon Shearer Jr., CFP® 

Jeff Hilliard, CFP®, CRPC®

Joe McCaffrey, CFP® 

Phillip Tompkins 

Important Disclosure Information

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by CRA Financial, LLC [“CRA]), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CRA. Please remember to contact CRA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. CRA is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. A copy of CRA’s current written Disclosure Brochure discussing our advisory services and fees continues to remain available upon request or at www.crafinancial.com. Please Note: If you are a CRA client, please advise us if you have not been receiving account statements (at least quarterly) from the account custodian. 

Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your CRA account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your CRA accounts; and, (3) a description of each comparative benchmark/index is available upon request.

Please Note: Limitations: Neither rankings and/or recognitions by unaffiliated rating services, publications, media, or other organizations, nor the achievement of any professional designation, certification, degree, or license, or any amount of prior experience or success, should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if CRA is engaged, or continues to be engaged, to provide investment advisory services. Rankings published by magazines, and others, generally base their selections exclusively on information prepared and/or submitted by the recognized adviser. Rankings are generally limited to participating advisers (to the extent applicable). Unless expressly indicated to the contrary, CRA did not pay a fee to be included on any such ranking. No ranking or recognition should be construed as a current or past endorsement of CRA by any of its clients. ANY QUESTIONS: CRA’s Chief Compliance Officer remains available to address any questions regarding rankings and/or recognitions, including the criteria used for any reflected ranking.