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.
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 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.
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®
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