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In a much-appreciated breath of fresh air after a difficult 2022 and first quarter of 2023, markets have swung upward. After clinching significant gains, markets locked in a strong six months for the start of the year.
The S&P 500 Index ended the quarter on a high note and is now less than 10% from its all-time high set in January 2022 (Source: Morningstar). Technology was the champion behind the recent rally, fueled by the growth and excitement of artificial intelligence (A.I.), and a new era of computing. As a result, investors have found renewed enthusiasm for technology companies, which include not only computers and handheld devices but semiconductors and self-driving cars as well. Strikingly, the Nasdaq, a tech-centric index, had its best first half in 40 years, soaring 31.7% (Source: Nasdaq.com).
The economy is proving resilient, demonstrated by the largest drop in US weekly jobless claims in 20 months (Source: Reuters) and a willingness by consumers to continue spending – all despite the COVID pandemic, a 500-basis point increase in interest rates, and turbulence in foreign affairs.
In further attempts to fight inflation, the Federal Reserve has continued to raise interest rates. The short-term rate now stands at 5.25% (Source: Blue River) with indications of future potential hikes, though the end of rate increases may be near. The current rate is the highest in 15 years and welcome news for our short-term bond and money market accounts, which are finally earning a long-overdue positive spread on our savings versus inflation, as discussed further in this edition.
We have spoken with many of you who have recession concerns. The threat of a widely anticipated 2023 recession has dimmed for now, due mainly to the relatively strong job market and disposable spending. First quarter GDP registered growth of 2% and the second quarter is currently expected to come in at 1.9% (Source: Federal Reserve Bank of Atlanta), well above prior estimates.
Roehl & Yi believes, barring any significant economic or world event, a recession in 2023 is unlikely. However, should the markets adjust, triggering a recession, we think it would be shallow in nature rather than prolonged.
The S&P 500 Index ended the first half of 2023 with a gain of nearly 17%. These returns leapfrogged smaller gains for the average stock of 8% in what we see as a narrow market, at least at present. The difference lies in the outsized performance experienced by large market technology stocks such as Apple (+50%), Microsoft (+42%), Tesla (+112%), and Nvidia (+189%). See below for more analysis. The Russell 1000 Large-Cap Growth Index gained 29.02% while the Russell 1000 Large-Cap Value Index returned +5.12% (Source: Morningstar).
The table below shows an overview of market performance for the period ending June 2023, with all 13 equity and fixed income markets seeing positive gains, including international stocks up 11.67%. After a challenging 2022, though bonds were down slightly in the second quarter (-0.84%), they have largely returned to their role of providing income and stability in the portfolio with modestly positive returns for the first six months of the year.
Growth Stocks Make Huge Gains
Representing over 24% of the S&P 500 Index by weight, Mega-Cap Growth stocks have continued to recover from their extreme lows in 2022 and now appear to be benefiting from the A.I. frenzy as well. Meanwhile, the remainder have experienced a more modest recovery year to date (Source: Dana Investment Advisors).
Cash and Bonds Finally Competitive with Equity
For the first time in 15 years, cash and bonds are offering earnings yields on par with equities (Source: Bloomberg). For investors looking to reduce risk and preserve returns, cash and bonds make sense. Notwithstanding more attractive fixed-income yields, stocks still offer long-term investors growth opportunities as company earnings can swell over time. Another consideration is that investors can find higher yields outside the S&P 500 through dividend-paying stocks or foreign equities.
Top 10 Stocks Carry Market’s Weight
As of June 30, the 10 most valuable stocks in the US are close to an all-time high as a share of the overall S&P 500 Index and are primarily responsible for the positive returns relative to the other 490 stocks in the S&P (Source: Ned Davis Research). In caution, markets are understood to be strongest and most sustainable when participation is broad.
There is another story to be told, however. These results obscure what ultimately became a broader rally late in the second quarter. For the second quarter, the Russell 2000 Small-Cap Index rose 5.2%, the S&P Value Index was up 6.6%, and the S&P 400 Mid-Cap Index was up 4.9% – none of those indexes include mega-cap technology stocks.
Inflation Relief on the Horizon, But Still Sticky
As of May 30, CPI inflation has fallen to 4%, half as much as one year ago (Source: Bureau of Labor Statistics). Energy prices have fallen while increases in housing, rents, and the cost of food have stabilized. Europe and most of the developed world are seeing similar trends in a global inflation dynamic that has taken hold for the first time in 20 years (Source: Blue River). Time will tell if we can reach the Federal Reserve’s historic target of 2% inflation or if 4% will become our new normal.
Housing Market Whipsawed
The big fall in mortgage rates has been a primary driver of the cost of housing for many years.
In the chart below on the left, the rate of interest being paid is now less than half that of 45 years ago. With a majority of owners now paying a mortgage interest rate of less than 4% they’re “locked in” and less willing to sell and move. The resulting shortage of homes for sale just adds to the upward pressure on house prices.
While existing homeowners are locked in at lower mortgage rates, new home buyers are feeling the effects of higher rates. The chart below on the right side is for a new home buyer, assuming the median home price and median household income at the national level. This assumes a 20% down payment and an interest rate of 6.67%. The takeaway is that new housing payments are consuming over 40% of household income versus under 30% a few years ago. It remains to be seen how this will impact consumer finances and the economy going forward, as more home buyers become locked into higher rates. (Source: Bureau of Economic Analysis).
Roehl & Yi’s Final Thoughts
While there are bright spots, we recommend that you stay vigilant through market fluctuations.
Consider these suggestions:
- Continue the move toward diversification and review asset allocation.
- Expect some turbulence and stay disciplined.
- Be strategic with cash and take advantage of higher-yielding financial instruments.
- Remain protective of your assets and reduce risk where possible.
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This client newsletter is provided for informational purposes only. Nothing herein should be construed as the provision of personalized investment advice, nor should it be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change without prior notice. Third-party data sources contained herein are for illustrative purposes only and are believed to be reliable, but we take no responsibility as to their accuracy. The newsletter contains certain forward-looking statements that indicate future possibilities. Due to known and unknown risks, other uncertainties, and factors, actual results may differ materially. As such, there is no guarantee that any views and opinions expressed herein will come to pass. Investing involves risk of loss including loss of principal. Past investment performance is not a guarantee or predictor of future investment performance. Any reference to the performance of securities of markets, indexes or specific investments is for illustrative purposes only and does not represent any of R&Y’s recommendations or performance. Any reference to a market index is included for illustrative purposes only as it is not possible to directly invest in an index. The figures for each index reflect the reinvestment of dividends, as applicable, but do not reflect the deduction of any fees or expenses, or the deduction of an investment management fee, the incurrence of which would reduce returns. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark index.