Quarterly Market Commentary
2nd Quarter 2023 Market and Economic Commentary
Dear Valued Client:
Although seemingly forgotten now, the second quarter of 2023 was almost derailed by debt ceiling concerns. However, in the 11th hour, a deal was reached, allowing the government to pay its bills for now. From a market perspective, this deal should be viewed as unquestionably positive as it takes the debt ceiling issue off the table until 2025. Outside of the debt ceiling, the US economy has defied expectations and ongoing calls for a recession. The average forecast by analysts tracked by Bloomberg called for a decline of the S&P 500 in 2023, the first time the aggregate prediction of Bloomberg analysts has been negative since 1999. However, the S&P 500 has rallied over 27% from its October 2022 low, and optimism is once again in the air. The market’s resilience is largely due to the continued strength of the labor market, which still boasts an unemployment rate of 3.7% – near multi-decade lows – and healthy wage growth of 4.3%. In fact, US wages outpaced inflation on a year-over-year basis in May by 0.2%, ending the streak of 25 consecutive months of negative real wage growth. There have been some signs of the consumer becoming stretched however, something to keep an eye on moving forward.
The S&P 500 was up +8.74% for the second quarter and is up 16.89% year-to-date through the end of June, which was driven primarily by a small handful of technology stocks. Diving further into the technology sector, it is what Wall Street has dubbed as the “magnificent seven” that have driven much of this year’s stock market gains. If you remove these seven stocks, the S&P 500 would be slightly negative for the year, with a total return of -0.23%. With this in mind, the spread between large-cap growth and value should be no surprise; the Russell 1000 Value index returned 4.07% for the second quarter versus 12.81% for the Russell 1000 Growth index. Lastly, although lagging behind their larger-cap peers, both mid and small-cap stocks were also positive. Small caps returned 5.21% for the second quarter versus 4.76% for mid-cap stocks. As we move into the second half of the year, we expect market gains to broaden and value stocks to perform better on a relative basis to growth once the threat of a recession moves out of investors’ minds.
International developed and emerging market equities returned 2.95% and 0.90% for the second quarter, respectively, lagging the S&P 500. There are two main reasons international developed markets are underperforming domestic markets this year. For one, while the Federal Reserve has paused rate hikes for the time being in the United States, most internationally developed economies continue to raise rates. In June, Switzerland, the UK, and the European Central Bank all hiked rates again between 25 and 50bps. Second, most foreign economies are cyclical in nature, defined by prominent, traditional manufacturing sectors and a few high-tech, growth companies. Amidst the surge in interest in high-flying technology and growth stocks (many commanding hefty weights within U.S. benchmarks), international markets and their more value-oriented composition have moved out of favor. Emerging markets face all of these same headwinds but are also more impacted by the fluctuation of the dollar. The DXY index, which measures the value of the dollar against six major currencies, has moved sideways this year, leading to lackluster returns for the broader emerging markets index.
Similar to the equity market upturn in the first half of 2023, the bond market is now also in positive territory. The Federal Reserve (Fed) kept rates unchanged during its June meeting, moving to the sidelines after a 14-month tightening campaign that lifted the Fed funds rate to a target range of 5.0% to 5.25% — the highest since August 2007. The Fed felt comfortable pausing primarily because of the continued downward trend in inflation. The May CPI report showed a decline in the headline inflation rate to 4.0%. This was the 11th consecutive decline in the year-over-year rate and the lowest level since March 2021. Core inflation (which excludes volatile segments like Food/Energy) moved down to 5.3%, the lowest since November 2021. While inflation is still above the Fed’s target rate of 2.0%, the significant progress warranted a pivot by the Fed. However, despite not raising rates in June, the Fed did indicate that two more rate hikes are likely in the cards before the summer comes to a close. The threat of additional rate hikes, coupled with the volatility that was sparked by a potential debt ceiling-induced default on government bonds, caused yields to push higher during the second quarter. The US 10-year yield increased from 3.41% to 3.84% , with the two-year rising from 4.02%3 to 4.90%. Higher yields push bond prices lower as the two move inversely to one another. As a result, the fixed income market, as measured by the Bloomberg Barclays US Aggregate Bond Index, returned -0.84% in the second quarter but still remains up 2.09% for the year. There is a silver lining in higher rates for both retirees and investors. The more cash you have stashed away in a savings account as interest rates rise, the more you stand to benefit from higher income earned.
Ultimately, we believe markets are showing signs of a rolling recession – implying that some sectors may be heading into a downturn, while others are stabilizing and rebounding. For example, the housing industry was the first to suffer a tailspin after the Fed began sending interest rates sharply higher 15 months ago. As mortgage rates nearly doubled, home sales plunged. Manufacturing soon followed. And while it hasn’t fared as badly as housing, factory production is down -0.3% from a year earlier. However, at the same time, consumers ramped up their spending on travel and entertainment venues, buoying the economy’s vast service sector and offsetting the difficulties in other sectors. Lastly, it is important to remember that the markets are “forward-looking,” and tend to anticipate what might happen in the future, whereas much of the economic data reported in the news (like inflation or GDP) are “backward looking,” meaning that they are outcomes of what’s already happened. This is all to say you can’t predict market performance by looking at economic data alone. For Q2 2023, the estimated earnings decline for the S&P 500 is -6.5%. Should this come to fruition, it would mark the third straight quarter of negative earnings contraction, signaling we are well into an earning recession. However, markets seem to be shaking this off and looking to forward earnings growth, which is estimated at 0.8% for Q3 and 8.2% for Q4. As we turn the page to the second half of the year, we remain cautiously optimistic about the prospects for the market.
As always, we are available if you have any questions about your portfolio, our current views and plans, or if you’d like to schedule a review, please don’t hesitate to contact our office at (858) 550-3960 or (800) 884-5121.
Graydon Coghlan, CRPC – President/CEO
Registered Representative, Securities America, Inc.
Financial Advisor, Securities America Advisors, Inc.
CA Insurance License #0B31440
4370 La Jolla Village Drive, Suite 630
San Diego, CA 92122
(858) 550-3960 (phone)
(858) 550-3969 (fax)
All opinions and estimates included are as of the date listed and are subject to change without notice. This letter is provided for informational purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security or offering of individual investment advice. The S&P 500 Index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928. The Barclays Capital U.S. Aggregate Index is a broad index representing the U.S. bond market. An investor cannot invest directly in an index. Past performance does not guarantee future results. *Sources: Nasdaq; Morningstar; Advisor Group
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