Market & Economic Commentary: Q2 2023
Quarter in Review
As the second quarter of 2023 came to a close, investors’ persistent optimism dominated the equity markets. Despite the first half of the year that witnessed interest rate increases, turmoil in the banking sector, and geopolitical uncertainty, markets spent the second quarter gaining back some of the value lost in 2022. After a somewhat lackluster April and May, equity markets recorded one of the best first halves of the year in quite some time by the end of June. The Nasdaq, S&P 500, and the Dow were up 32.3%, 16.9%, and 4.9% for the year. It was the Nasdaq’s best first half of a year since 1983, primarily due to growth in tech stocks driven by the surge in Artificial Intelligence (AI)[1].
With the concerns that roiled the banking sector in March in the rear-view mirror, investors looked ahead with optimism to the potential monetization of AI. A select few large capitalization tech stocks dominated performance early in the quarter because of their connection to either the AI supply chain or its direct utilization. However, as signs of moderating inflation and continued economic strength persisted through the quarter, the market enthusiasm expanded beyond the largest tech stocks and became a more broad-based phenomenon.
Meanwhile, the concern about March’s bank failures fueled turbulent swings in short-term Treasury yields and reverberated across bond markets in early Q2. The debt-ceiling standoff temporarily distorted the short-term bond market as investors positioned their holdings to avoid getting caught up in the drama. However, bonds settled back into recent patterns, with higher short-term and lower-long term yields – a dynamic called Inversion that represents a view that interest rates will have to be lowered in the future. This turbulence impacted the bond performance for the quarter, with the Bloomberg US Aggregate Bond Index and the Bloomberg Global Aggregate Bond Index posting -0.84% and -1.53% returns, respectively. Despite this, both indexes remained in positive territory for the year due to their strong performance in the first quarter[2].
The Economy, Inflation and the Fed
Stronger than anticipated economic growth, coupled with consistently low unemployment, has reignited talk that the US economy can slow inflation while avoiding recession. Indeed, headline inflation continues to moderate, although core prices, which exclude food and energy, have remained sticky. The Fed’s preferred inflation gauge, the Core Personal Consumption Index (PCE), increased in May by 4.6% from a year earlier. A remarkable slowdown from the 9% inflation experienced at one point in 2022.
Source: Bloomberg, Bureau of Economic Analysis, data as of 6/30/23
After ten consecutive interest rate increases since March 2022, the Fed paused in June and held its benchmark Federal Funds rate steady between 5% and 5.25%. While there may be one or two more rate increases on the horizon, part of the market’s recent recovery has been pricing in the fact that the Fed has signaled that it is close to the end of the rate-increasing cycle.
Tech Companies Reverse 2022 Losses
The launch of ChatGPT ignited exuberance over the potentially transformational technology of AI and fueled investors’ appetites for companies like Alphabet (Google), Amazon, Apple, Meta, Microsoft, and Nvidia. All experienced a significant surge in their share prices during the second quarter. By the end of May, these stocks were responsible for most of the market’s 2023 gains[3]. This was a mirror image to 2022 when it was these same companies, and the large tech sector more generally, that led the markets down.
However, by the end of the quarter, the equity market rally broadened out. Indeed, 454 out of the 500 stocks in the S&P were up in June, compared with only 124 in May. As of the end of May, the S&P 500 would have been negative year-to-date without the top performing eight stocks. By June, the number of stocks contributing to the positive return had broadened to 44[4]. Still, the inverse of the 44 stocks in positive territory means that, despite broad strength in June, 456 of the S&P 500 stocks remained in negative territory at month’s end; though broadening, the rally was still fairly concentrated.
The important takeaway from this narrow leadership is that markets are comprised of many unique sectors and geographies, and the performance of each can not only diverge significantly but can turn rapidly. Attempting to “time the market” by identifying the next sector to outperform can seriously backfire if the timing is off by just a month or a week. The table below shows the extreme variation in performance of various sectors from 2022 compared with the first half of 2023. Each color box represents a unique sector or asset class. Clearly, with the rapid potential reversal of fortunes, keeping a portfolio diversified across security types and geographies helps to capture market performance over the long term[5].
Source: Morningstar Direct and www.hedgefundresearch.com
Final Thoughts
Over the short-term, markets tend to be sentiment driven because they are influenced by people embracing compelling narratives. Recent themes from pandemic lockdowns to constrained natural resources to the frenzy of the AI boom, geopolitical events, and investing themes have both motivated and then, often, disappointed or frightened investors.
Over the long term, however, markets are driven by secular growth and company earnings. Unfortunately, we don’t possess a crystal ball that can tell us in advance which specific companies, industries, sectors, or geographies will benefit.
The good news is that decades of research have shown that investors can reap rewards by being broadly diversified and remaining patient.
As always, we will monitor the movements of the markets over the short-term while continuing to focus on your long-term goals, encouraging you to remain patient in order to be able to harvest the potential rewards over time.
Index Disclosure and Definitions
Investors cannot invest directly in an index. Indexes have no fees. Historical performance results for investment indexes do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the occurrence of which would have the effect of decreasing historical performance results. Actual performance for client accounts will differ from index performance.
S&P 500 Index represents the 500 leading U.S. companies, approximately 80% of the total U.S. market capitalization.
Dow Jones Industrial Average (DJIA) Is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
The Nasdaq Composite Index (NASDAQ) measures all Nasdaq domestic and international based common type stocks listed on The Nasdaq Stock Market and includes over 2,500 companies.
MSCI World Ex USA GR USD Index captures large and mid-cap representation across 22 of 23 developed markets countries, excluding the US. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets (as defined by MSCI). The index consists of the 25 emerging market country indexes. Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.
Bloomberg Barclays Global Aggregate (USD Hedged) Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging market issuers. Index is USD hedged.
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Diversification seeks to improve performance by spreading your investment dollars into various asset classes to add balance to your portfolio. Using this methodology, however, does not guarantee a profit or protection from loss in a declining market. Past performance does not guarantee future results.
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[1] Source: Morningstar Direct as of June 30, 2023
[2] Source: Morningstar Direct as of June 30, 2023
[3] Phillips, M. (June 1 2023) The S&P 500 gains are almost entirely from just five companies. Axios.
[4] S&P 500 Dow Jones Performance Report US Equities 2023
[5] Morningstar Direct and www.hedgefundresearch.com Using this methodology does not guarantee a profit or protection from loss in a declining market. Past performance is not a guarantee of future results. Investors cannot invest directly in an index. Actual performance for client accounts will differ.
