Q2 2023 market color courtesy of finviz.com:
The S&P 500 ended Q2 and H1 2023 at a fourteen-month high and other major stock indices logged solid gains following a pause in the Fed’s rate hike campaign, stronger-than-expected corporate earnings (especially in the tech sector) and the rather drama-free resolution of the debt ceiling issue.
The quarter began with markets still in the midst of what was considered to possibly be a regional bank “crisis” following the March failures of Silicon Valley Bank and Signature Bank, and investors started the month of April wary of contagion risks. Those concerns proved mostly overblown, however, as throughout most of the month regional banks showed stability. That allowed investors to re-focus on corporate earnings and the results were much better-than-feared as 78% of S&P 500 companies reported higher-than-expected Q1 earnings, a number solidly above the 66% long-term average.
Additionally, 75% of reporting companies beat revenue estimates for Q1, also well above the long-term average. That solid corporate performance was a welcome sight for investors and coupled with general macroeconomic calm, allowed stocks to drift steadily higher throughout most of April. However, following an underwhelming earnings report, concerns about the solvency of First Republic Bank weighed on markets late in the month and the S&P 500 declined into the end of the month to finish with just a modest gain for April.
The fears of a First Republic Bank failure were realized on May 1st, as the bank was seized by regulators. That same day, JPMorgan announced it was acquiring the bank from the Federal Deposit Insurance Corporation (FDIC) and that move helped to calm investor anxiety about the risk of financial contagion. The Federal Reserve also helped to distract investors from the First Republic failure, as it hiked interest rates at its May 2nd meeting but, importantly, also altered language in its statement to imply it may well pause rate hikes at the next meeting. That change was expected by investors, however, and as such it failed to ignite a meaningful rally in stocks.
Instead, the tech sector helped push the S&P 500 higher in mid-May, thanks to a sudden explosion of investor and rampant media-fueled enthusiasm around artificial intelligence (AI), which was highlighted by a massive rally in Nvidia (NVDA) following a strong earnings report. Overnight, everyone seemed to become obsessed with, and an expert in, AI. However, like in April, the end of the month saw a spike in volatility which took the gloss off the monthly return.
This time it was thanks to the lack of progress and threats (which turned out to be ultimately empty) of mischief-making from extremist trouble-makers in Congress re: a US debt ceiling extension and consequent rising fears of a debt ceiling breach leading to a possible US debt default. However, a two-year debt ceiling extension was agreed to by Speaker McCarthy and President Biden on May 28th and was signed into law a few days later, avoiding a complete financial calamity. The S&P 500 finished May with a slight gain.
With the debt ceiling resolved, a Fed pause in rate hikes expected and continued stability in regional banks, the rally in stocks resumed in early June and was bolstered by several positive developments.
First, inflation declined as the Consumer Price Index (CPI) measure of retail inflation hit the lowest level in two years.
Second, economic data remained impressively resilient, reducing fears of a near-term recession.
Finally, in mid-June, the Federal Reserve confirmed market expectations by pausing its fifteen-month long rate-hike campaign and that helped fuel a broad rally in stocks that saw the S&P 500 move up through the 4,400 barrier and hit its highest levels since April 2022.
The last two weeks of the month saw some consolidation of that rally resulting from more mixed economic data, political turmoil in Russia and hawkish rhetoric from global central banks, but the indexes still finished June with strong gains.
In sum, markets were impressively resilient in Q2 and really throughout the whole first half of the year, as better-than-feared earnings, expectations for less-aggressive central bank rate hikes, more evidence of a soft economic landing (i.e., inflation conquered without a meaningful recession) and relative stability in the regional banks pushed the S&P 500 to its fourteen-month high.
Q2 Performance Review
Q2 2023 saw an acceleration of the tech sector outperformance witnessed in Q1 as giddy AI enthusiasm drove several mega-cap tech stocks sharply higher. Those strong gains resulted in large rallies in the tech-focused NASDAQ and, to a lesser extent, the S&P 500 as the tech sector is the largest weighted sector in that index. Also like in Q1, the less-tech-focused Russell 2000 Small Cap Index and Dow Jones Industrial Average logged more modest, but still solidly positive, quarterly returns.
By market capitalization, Large Caps outperformed Small Caps, as they did in the Q1. Regional bank concerns and higher interest rates still weighed on Small Caps as smaller companies are historically more dependent on financing to maintain operations and fuel growth.
From an investment style standpoint, growth handily outperformed value again in the second quarter, continuing the sharp reversal from 2022 when growth stocks were battered. Tech-heavy growth funds benefited from the aforementioned AI fever. Value funds, which have larger weightings towards financials and industrials, relatively underperformed growth funds, as the performance of non-tech sectors more reflected the broad economic reality of mostly stable, but unspectacular, economic growth.
On a sector level, eight of the eleven S&P 500 sectors finished Q2 with positive returns. As was the case in Q1, the Consumer Discretionary, Technology, and Communication Services sectors were the quarter’s best performers. The surge in many mega-cap tech stocks such as Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Meta Platforms (META), and Nvidia (NVDA) drove the gains in those three sectors, and they handily outperformed the remaining eight S&P 500 sectors. Industrials, Financials, and Materials also saw moderate gains over the past three months, thanks to rising optimism regarding the soft economic landing.
Turning to the laggards, traditional defensive sectors such as Consumer Staples and Utilities declined slightly over the past three months, as resilient economic data caused investors to rotate to sectors that would benefit from stronger than expected economic growth. Energy also posted a slightly negative return for the second quarter, thanks to ongoing weakness in oil prices.
Internationally, foreign markets lagged the S&P 500 thanks mostly to the relative lack of Large Cap AI-exposed stocks in major foreign indices, combined with some late-quarter worries about the EU economy and pace of Bank of England rate hikes, although foreign markets did finish Q2 with a modestly positive return. Foreign developed markets outperformed emerging markets thanks to a lack of significant economic stimulus in China, which weighed on emerging markets late in the quarter.
Commodities saw modest losses in the quarter as most major commodities declined over the past three months. Oil prices witnessed a moderate drop despite a surprise production cut from Saudi Arabia and an increase in geopolitical tensions in Russia, as concerns about future economic growth and oversupply weighed on oil. Gold, meanwhile, posted a modestly negative return as inflation declined while the dollar failed to meaningfully drop.
Switching to fixed income markets, the leading benchmark for bonds (Bloomberg Barclays US Aggregate Bond Index) realized a slightly negative return for the second quarter of 2023, as the resilient economy and hope of a near-term end to Fed rate hikes led investors to embrace riskier assets.
Looking deeper into the fixed income markets, shorter-duration bonds outperformed those with longer durations in Q2, as bond investors priced in a near-term end to the Fed’s rate hike campaign, while optimism regarding economic growth caused investors to rotate out of the safety of longer-dated fixed income.
Turning to the corporate bond market, lower-quality, but higher-yielding “junk” bonds rose modestly in Q2 while higher-rated, investment-grade debt logged only a slight gain. That performance gap reflected investor optimism on the economy, which led to taking more risk in exchange for a higher return.
Q3 Market Outlook
As we begin Q3 2023, the outlook on the surface for stocks and bonds is the most positive it’s been since late 2021, as inflation hit a two-year low, economic growth and the labor market remain impressively resilient, the Fed has temporarily paused its historic rate-hiking campaign, the debt ceiling extension was pretty painlessly resolved and there’s been no significant contagion from the regional bank failures from earlier this year.
That improvement in the fundamental outlook has been reflected in the major stock and bond indexes so far this year, as the S&P 500 hit the best levels since last April and more cyclically-focused sectors led markets higher late in the quarter on rising hopes for a broad economic expansion.
However, while clearly the past quarter brought positive developments in the economy and the markets, leading the financial media to breathlessly proclaim the dawn of a new bull market, it’s important to remember that potentially significant risks remain to the economy and markets.
Put more bluntly, the stock market has boxed itself in by making the decision to take an extremely positive view on the ultimate resolution of multiple macroeconomic unknowns whose outcomes remain very uncertain and thanks to the strong year to date rally, there is now very little room indeed for any kind of disappointment without price consequences.
First, the economy has not yet felt the full impact of the Fed’s historically aggressive hike campaign, and while the data has proved surprisingly resilient so far, we know from history that the impacts of rate hikes can take far longer than most expect to impact economic growth.
In other words, it’s premature to think the economy is in the clear from recession risks and we should all expect the economy to slow more as we move into the second half of the year. The key for markets will be the intensity of that slowing, as at these levels, stocks are not pricing in a significant economic slowdown.
On inflation, clearly there’s been progress in bringing inflation down, as the year-over-year headline CPI has fallen from over 9% to 4% in less than a year. However, even at 4%, CPI remains far above the Fed’s 2% target. If inflation rears its head again, or even just fails to continue to decline, then the Fed will very likely swiftly go back to raising interest rates again, just like the Bank of Canada and Reserve Bank of Australia did last month, following pauses of their own. Such higher rates would weigh further on economic growth.
Turning to banks, markets have mostly taken the regional bank failures in stride, as seen by the minimal volatility that followed the collapse of First Republic. However, it’s likely still premature to consider things all clear on that front, especially with the yield curve so heavily inverted (short term interest rates higher than long term instead of the “normal” shape which is the other way around) and for so long - the inversion has been non-stop for a full year now - which damages the banks’ business models the longer it lasts and the deeper it is (you can follow the yield curve week-by-week as I publish it in Angles, my free newsletter sent out every Sunday).
At a minimum, reduced lending by regional banks poses an additional threat to the ravaged commercial real estate market and small businesses more broadly. Bottom line, measures taken by the Fed in March seem to have successfully ring-fenced the regional bank stress for now, but some associated risks do remain.
Finally, markets are trading at their highest valuation in over a year, and investor sentiment has turned suddenly and intensely optimistic. The CNN Fear/Greed Index ended the quarter at “Extreme Greed” levels, while the American Association for Individual Investors (AAII) Bullish/Bearish Sentiment Index hit the most bullish level since November 2021, not long before the market collapse started in early 2022 (you can follow these data points week-by-week as I publish them both in Angles, my free newsletter sent out every Sunday).
Positive sentiment does not automatically mean markets will decline, but the sudden burst of enthusiasm needs to be considered in the context of what is a still uncertain macroeconomic environment and markets no longer have the protection of low expectations and depressed valuations to cushion declines, which now risk potentially being quite vicious.
Indices now stand appreciably higher than where they were on January 1st, 2023: The NASDAQ-100 is up >38%, the S&P 500 is up >15%, and the Russell 2000 small cap index is up almost 7%. These numbers would make for a respectable year, let alone six months.
Think back to January when all you heard was fund managers, economists, strategists and assorted pundits going through their ridiculous recency-bias-riddled annual ritual of consequence-free, complete guesswork disguised as informed information, telling us that armageddon was upon us in the form of a recession and stocks would be continue to be crushed.
If you could do just one thing to help your investment performance, I’d suggest that to completely stop listening to and disregard these people would be a really good choice.
From a technical standpoint, several things still concern market technicians, mostly revolving around the lack of breadth demonstrated by the rally and the undeniable (but little-publicized) fact that most stocks are simply not participating. It also worries them that the lows of last October simply do not conform to the historical technical requirements of a market bottom.
In sum, clearly there have been positive macro developments so far in 2023 that have helped the stock market rebound. However, it’s important to remember that multiple and varied risks remain for the economy and markets.
As the founder and principal of Anglia Advisors with decades of experience in financial markets, I understand that a well-planned, long-term-focused and diversified financial plan built on a solid foundation of appropriate asset allocations for different time horizons can withstand virtually any market surprise and related bout of volatility, including the challenges of bank failures, multi-decade highs in inflation, rising interest rates, geopolitical tensions and growing recession risks.
I remain vigilant on behalf of Anglia Advisors’ clients regarding both portfolio risk and the economy and will continue to keep you informed of my views with my weekly market review each Sunday.
If you are already a client, I want to thank you for your ongoing confidence and trust. Please do not hesitate to contact me with any questions, comments or to schedule a portfolio review.
If you aren’t a client yet, please reach out and I’d be delighted to discuss bringing you into the Anglia Advisors family.
Simon Brady CFP® CETF®. Founder, principal Anglia Advisors.
WWW.ANGLIAADVISORS.COM | SIMON@ANGLIAADVISORS.COM | CALL OR TEXT: (929) 677 6774 | FOLLOW ANGLIA ADVISORS ON INSTAGRAM
This material represents a highly opinionated assessment of the financial market environment based on assumptions and prevailing data at a specific point in time and is always subject to change at any time. No warranty of its accuracy or completeness is given. It is never to be interpreted as an attempt to forecast any future events, nor does it offer any kind of guarantee of any future results, circumstances or outcomes.
The material contained herein is not necessarily complete and is wholly insufficient to be exclusively relied upon as research or investment advice or as a sole basis for any kind of investment decision or action. The user assumes the entire risk of any decisions made or actions taken based in whole or in part on any of the information provided in this or any Anglia Advisors communication of any kind. Under no circumstances is any of Anglia Advisors’ content ever intended to constitute tax, legal or medical advice and should never be taken as such. Neither the information contained or any opinion expressed herein constitutes a solicitation for the purchase of any security or asset class.
Clients of, and those associated with, Anglia Advisors may maintain positions in securities and asset classes mentioned in this post.
Attached below is supporting documentation for this report:
