Market Overview Q2 2023

Market Recap

Mega-cap technology stocks dominated the first half of the year fueled by an AI (Artificial Intelligence) boom. The darlings of the tech sector rocketed the S&P 500 up +8.74% for the quarter and an eye-popping +16.89% for the first half of the year, while the tech sector rose +43% for the first half.[1] The first half proved to be the second-best in this century and 12th-best since 1926 for the S&P 500.[2] As the quarter progressed, a perceived quick resolution to the regional banking crisis and the US debt ceiling brought further calm to markets. Global stocks as measured by the MSCI ACWI rose a solid +6.18% for the quarter and +13.93% for the first half.[3]

In contrast, the equally weighted S&P 500 lagged, up only +7.03% for the first half, highlighting the dominance of the largest market-caps.[4] The chart below further shows the degree to which mega-cap growth stocks outperformed as investors placed a premium on earnings growth during the first half.

After ten consecutive rate hikes, the Fed finally paused during the quarter, and there appears to be light at the end of the tunnel as Chairman Powell has telegraphed that two more hikes are likely on the horizon. It also appears that peak inflation is in the rearview mirror, and the worst of the tightening cycle may already be discounted, which could be perceived as positive for markets.

Despite nearly a year of leading indicators warning about a recession, and signs still pointing to a sluggish second half of the year, a recession does not appear on the immediate horizon. Overall, economic data remains positive. As of June, economic growth continued for a fifth straight month, according to the latest PMI (Purchasing Managers’ Index), which measures the prevailing direction of the manufacturing and service sectors. Credit conditions remain favorable as falling credit spreads imply reduced economic risks. The labor market has remained resilient and has held recession risks at bay. Furthermore, the stock market rally has seen improved breadth in recent weeks with most sub-industries in uptrends.

However, risks persist as the Fed has suggested it is not yet done with rate hikes, and corporate profits are expected to weaken further. The second quarter earnings picture remains bleak while employment trends are moderating. According to FactSet, the consensus second quarter earnings for the S&P 500 are estimated to decline -7.2%, which would mark the steepest earnings decline since the second quarter of 2020’s pandemic. As we have noted recently, the extent to which earnings results meet or beat consensus expectations will materially influence the near-term prospects for stocks.

We enter the second half of the year with our asset allocation framework continuing to register a moderately defensive posture. While a bit of a cliché, the upcoming earnings season may be the most important in recent quarters. The reality of a challenging corporate earnings environment, as well as the impact on forward guidance, will heavily influence the broader economic growth picture. As we continue to work through an environment of conflicting information, we remain disciplined as new data is released and will adhere to our process while we await the opportunity to increase equity exposure.

What does a strong first half mean for the second half?
As the Ned Davis Research chart below highlights, more often than not, positive momentum continues.

Proving doubters wrong, the record performance year-to-date may not be surprising given the protracted pessimism that existed at the start of the year. As we noted before, investor sentiment is historically a contrarian indicator, particularly during pervasive and prolonged periods.

While every environment is different, the table above indicates when the S&P 500 rose by more than 10% in the first half; 75% of the time, this resulted in a second half in which the index increased by a median of 9.7%. Time will tell if history is a good barometer, or if the market has come too far too fast in the current environment.

[1] Morningstar Direct

[2] Ned Davis Research

[3] Morningstar Direct

[4] Morningstar Direct

Disclosures:

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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Q2 2023 Market Commentary