Mid-Year Market Review—Better than feared, and the “Magnificent Seven”
Stocks have climbed a formidable wall of worry as the collateral damage from banking turmoil was not as severe as feared. The first half of 2023 turned out to be a good period for investors: global equities have returned about 17%i. “AI” has become a household name, and “AI” related companies like NVIDIA have lifted the markets single handedly. The “magnificent seven” is the latest term to be given to the small number of stocks driving the surge in this year’s stock markets. This list includes Apple, Microsoft, Amazon, Meta, NVIDIA, Tesla, and Alphabet. Bond yields have remained quite stable since early 2023, thereby creating positive nominal returns for investors. The U.S. economy continues to show resilient growth as upturns in both residential construction and in robust consumer travel have been notable positives. Although stronger growth has meant sticker inflation, we continue to see progress on inflation decelerating.
Market Outlook—Resilience, Diversification & Diamonds in the Rough
At this point in time, we are in the camp that the US economy will continue to show a healthy degree of resilience. The second half investment returns may not be as punchy as the first half, but we expect the S&P 500 to remain positive through the end of the year. The S&P 500 positive returns were driven by a small number of technology companies. We believe that there will be a broadening out of the market. We see opportunity in the industrial sector, REITs, technology, and smaller to mid- size companies. We continue to view the bond market constructively, with great opportunities to lock in attractive yields and total return.
Where’s the Recession we were promised?
The 2023 recession that economist predicted is missing in action. Now the forecasters are suggesting that a soft landing is probable. There are a few factors at work that include demographic changes that impact employment, and interest rate de-sensitivity in the housing market.
BETTER THAN FEARED
Despite turmoil, stocks enjoyed positive returns across the spectrum. Regional banks failing, debt limit jeopardy, and interest rate hikes are a few of the issues that the market has taken in stride. U.S. equities climbed in the second quarter with the S&P 500 advancing a solid 8.74%, bringing the first half of the year return up to 16.89%.
Large-capitalization growth stocks, as measured by the Russell 1000 Growth Index, have been the best performers by far, advancing 12.81% for the quarter and 29.02% for the year-to-date. Market breadth continued to be mediocre with the Russell 1000 Value Index up 4.07% for the quarter and 5.12% through June 30.
Small-capitalization stocks continue to lag the S&P 500, as measured by the Russell 2000 Index, advanced 5.21% in the quarter and 8.09%i year to-date. International equities, as measured by the MSCI EAFE Index, only advanced 2.95% in the quarter but they have returned 11.67% year-to-date with Japan remaining a bright spot as its economy continues to recover from pandemic restrictions. The MSCI Emerging Markets Index was a laggard advancing 0.90% for the quarter and 4.89% for the year-to-date.
During the quarter, the 10-year U.S. Treasury yield rose slightly from 3.49% to 3.81%. This resulted in the U.S. Aggregate Bond Index declining -0.84% for the quarter, although it is still positive year-to-date returning 2.09%. High-yield bonds, as measured by the ICE BofA U.S. High Yield Index, fared better advancing 1.63% for the quarter, bringing the year-to-date return to 5.42%. Municipal bonds, as measured by the Bloomberg U.S. Municipal Bond Index, were down slightly for the quarter declining -0.10%, but positive year-to-date returning 2.67%.
We remain cautiously optimistic about broadly embracing risk assets while equity market performance is led by a narrow segment of companies amid a protracted Fed tightening campaign. The probability of a recession in 2023 has significantly decreased.
FORGET FAANG, MEET THE ‘MAGNIFICENT SEVEN’
Last decade the acronym ‘FAANG’ was popularized as it represented the strongest tech stocks at the time, many of which continue to outperform to this day. The “magnificent seven” is the latest term to be given to the small number of stocks driving the surge in this year’s stock markets. This list includes Apple, Microsoft, Amazon, Meta, NVIDIA, Tesla, and Alphabet. These companies were hit hard in last year’s bear market and had been cost cutting late last year to right-size their businesses. In addition, these stocks have been driven by the Artificial Intelligence boom. The combined value of these seven stocks is $11 trillion –nearly triple Germany’s GDPii. The other 493 stocks of the S&P 500 and smaller companies have been relative laggards since the market bottomed out last October. We have seen some improvement in breadth over the last half of Q2, but not robust enough to call it a trend. If breadth expands, this would be a positive sign for the overall stock market and health of the economy.
MARKET OUTLOOK – EQUITIES
Resilience, Diversification & Diamonds in the Rough.
We believe the S&P 500 should stay positive for the rest of the year, albeit with more volatility than the first half of 2023. Historically the market has seen solid returns during a Fed interest rate “pause”. In addition, the odds have improved that the economy will hold up through the end of the year. This could imply that there will be broader participation by companies besides the big technology names.
Our approach is to carefully rebalance some of those high-flying technology names and look to diversify into some of the sectors that appear relatively undervalued such as Financials and REITs. International markets started the year full of optimism, but that sentiment has since faded due to a deceleration in China’s growth prospects and global inflation remains stubborn. We retain a neutral position on global equities, with a bias towards the U.S. market.
We are selectively re-balancing portfolios away from some of the large technology names that have done so well, into undervalued parts of the market like financials and REITs that are benefitting from an interest rate “pause”.
MARKET OUTLOOK – FIXED INCOME
Locking in yields, and adding duration
With regards to the bond markets, we believe that bond yields are unlikely to rise much further as inflation cools. This should allow the Fed to move towards the end of the tightening cycle. We remain confident that this is a great time to be a bond investor due to attractive current yields and the prospect that interest rates will fall over the next year which will make currently issued bonds more valuable.
We prefer high quality investment grade credit ratings; however we believe it’s a good time to start buying bonds with a bit longer maturities to lock in today’s attractive yields.
MARKETS IN REVIEW
(Market Data as of July 14, 2023)
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