The S&P 500 Index gained 8.7% over the second quarter of 2023, marking a new bull market as the index is up more than 20% since the October 2022 low. The index was propelled by growth stocks, with the top few companies contributing nearly all the return. The Fed raised rates once during the quarter, pausing for the first time since the rate hiking cycle began after 10 consecutive raises. International markets trailed their domestic counterparts, with the MSCI EAFE Index increasing by 3.0% in Q2 as inflation proved more difficult to tame overseas. Emerging markets, as measured by the MSCI Emerging Markets Index, ticked up 0.9% during the quarter, with China’s economy slowing after its initial post-lockdown improvement. Fixed income markets struggled, with the Bloomberg US Universal Index posting a loss of -0.6% over the second quarter of the year. The economy showed mixed messages, with GDP rising on the heels of consistent consumer spending but consumer debt rising in tandem. The labor market began to show signs of rolling over but proved resilient again toward the end of the quarter. Stock returns broadened in June, and if the Fed can end hikes fairly soon, we anticipate that both stocks and bonds could produce attractive returns in the second half of the year.
The S&P 500 Index rose 8.7% during the second quarter of 2023, with nearly all the gain coming in June. During the quarter, the large-cap index closed over 20% higher than the October 2022 low, signaling the start of a bull market. Inflation continued to trend downward throughout the quarter, with the Consumer Price Index (CPI) dropping to just over 4.0%—the lowest reading in more than two years. The Federal Reserve (Fed) raised interest rates in May, marking the tenth straight rate hike and pushing the overnight rate above 5.0% for the first time since 2007. The Fed held rates steady in June but clarified it as a pause rather than an end to the campaign, with officials indicating two more 0.25% hikes were likely this year. Sentiment waned earlier in the quarter as consumer debt hit all-time highs, and concerns regarding the debt ceiling took hold. Congress agreed on terms to raise the debt ceiling; just days before the US was projected to default on its payments.
All but two underlying sectors in the S&P 500 Index posted gains in the quarter. Growth sectors continued the rise, with technology, consumer discretionary, and communication services posting double-digit gains. Seven mega-cap stocks drove a vast majority of the gains, representing about 27% of the index and posting combined gains of almost 60%. On the other end of the spectrum were utilities and energy, posting losses in the quarter.
Large-cap stocks outperformed small-cap stocks, and growth stocks handily outpaced value stocks throughout the quarter. The Russell 1000 Growth Index rose 12.8% in Q2, and the Russell 1000 Value Index returned 4.1% in the quarter. Despite the attractive performance by large-cap US growth stocks, the quarter ended with strong returns in June by small-cap companies as well as value as the rally broadened.
International developed market stocks experienced more turbulence than their domestic counterparts in Q2. The MSCI EAFE Index rose in April, declined in May, and increased again in June for an overall gain of 3.0% in the quarter. After two quarters of outperforming domestic markets, international developed stocks gave up their leadership position. The Eurozone entered a technical recession after the first quarter GDP came in at -0.1% for the second consecutive quarter. Eurozone inflation trended lower each month of the quarter, but core inflation, which excludes volatile food and energy prices, ticked up. The European Central Bank (ECB) raised rates by 25 basis points to the highest level in 22 years and suggested another hike in July. In the UK, the budget deficit rose to the highest level on record in April. Further, core inflation hit a 21-year high and prompted the Bank of England (BOE) to raise rates for the thirteenth consecutive time, landing at the highest level in 15 years. Japan was the index’s best-performing country in Q2, reaching 30-year highs. Markets began to retreat toward the end of the quarter, however, as rising inflation weighed on consumer sentiment, and the yen finished the quarter -8.8% weaker than the dollar.
Elsewhere, the MSCI Emerging Markets Index eked out a 0.9% gain in the quarter, with June recovering the prior two months’ losses. China finished the quarter as the index’s worst performer, falling -9.7%. China’s economy has not rebounded as anticipated following its post-COVID-lockdown period. Industrial output and retail sales grew at weaker-than-expected paces in Q2, and poor credit growth signaled sluggish domestic demand. Further, youth unemployment hit a record 20.8% in May, all contributing to the country’s slowing global growth. Conversely, India was one of the index’s top-performing countries, jumping 12.2% in Q2 as consumption by the upper-middle income population propelled growth.
Over the second quarter of the year, the Bloomberg US Aggregate Index fell -0.8%, and the broader Bloomberg US Universal Index slid -0.6% as the Fed signaled more rate hiking was necessary. Respectively, year-to-date returns for the indexes now stand at 2.1% and 2.3%.
The yield on the 10-year US treasury increased 0.3% during the quarter, ending at 3.81%. The yield curve remained inverted, with the two-year yield persisting above the 10-year yield. Short-duration yields, which are closely tied to Fed rate moves, rose even higher, with the two-year treasury increasing by 81 basis points and ending the quarter at 4.87%. Although the inverted yield curve continues to portend a mild recession, future rate cuts have been pushed into 2024 as the employment situation remains strong and inflation is slowly declining. Credit spreads narrowed during the quarter as the Fed inched closer to ending rate hikes, and the economy remained resilient.
US gross domestic product (GDP) grew at an annualized rate of 2.0% over the first quarter of 2023, the latest period for which data are available. Consumer spending was the main proponent of the increase, along with government spending and exports. As consumers continue to spend at record levels, credit card debt is increasing faster than users can pay it off, indicating an increase in defaults down the line. Inflation continued to decrease throughout the second quarter of 2023, and although the consensus is that inflation peaked, it remains well above normal levels.
The labor market showed mixed messages throughout the quarter. Jobless claims hit the highest four-week moving average since November 2021, and job openings dropped to a two-year low, made worse by layoffs that had increased to the highest level since December 2020. Later in the quarter, however, the labor market’s resilience was reaffirmed as hourly earnings exceeded expectations and job openings continued to grow. The labor market has remained extremely resilient in the face of elevated inflation and rising interest rates.
While the Fed would like higher unemployment rates to contribute to receding inflation, the unemployment rate fell to the lowest level since 1969 during Q2. The Fed reaffirmed its campaign to combat inflation but eased the rate at which it did so by raising rates just 25 basis points in May and pausing in June. The pause came after 10 consecutive increases since the hiking campaign began in March 2022. Investors are pricing in one final 0.25% rate hike this year, despite Fed officials indicating that two more 0.25% increases are on the horizon.
Throughout the first half of the year, equity markets held up better than anticipated. Stocks finished the quarter in significant positive territory, a welcome reprieve from last year. While many thought bonds were well positioned to outperform stocks this year, rising rates have held back returns (although bond returns are positive on a year-to-date basis). While several recession indicators signal a mild recession on the horizon, the timing of it seems to be getting pushed further and further out. Consumers continue to spend despite higher borrowing costs, and debt is rising to record levels. The Fed has reiterated its commitment to raising interest rates twice this year, and the market believes the Fed will hold rates steady well into 2024 before making any cuts. Given the strength of the US economy and labor market, a higher-for-longer rate period is now expected.
We anticipate any impending recession to be mild, with the most interest rate sensitive areas of the economy suffering most of the pain. Unemployment remains near record lows; it is unlikely unemployment will rise sharply even during a recession as aging workers continue to exit the workforce. Markets have also largely priced in a recession, as 2022 returns were deeply negative despite solid earnings and economic growth. Earnings are projected to fall this year, but the S&P 500 has historically posted positive returns during years of falling earnings, as forward-looking investors tend to price in earnings declines before they occur. Even with a mild recession, we expect stocks to continue their upward trend throughout the back half of 2023. Outside of a few mega-cap stocks, most stocks have yet to surpass their prices from 18 months ago. However, a broader rally will be needed as it is unlikely that the same stocks that have driven this year’s upside can continue to outperform. We see relatively attractive return potential among international equities, which are more discounted than their domestic counterparts and could benefit from currency gains once the Fed stops hiking rates. Additionally, bonds offer the highest yields in 15 years, and as the Fed ends its hiking campaign, returns should stabilize and present attractive income opportunities.
This information is for educational purposes and is the opinion of Aldrich Wealth LP (“Aldrich Wealth”). Facts and figures are believed to be from reliable sources, but no liability is accepted for any inaccuracies. Nothing in this commentary should be construed as an investment recommendation. Past performance does not guarantee future results and all investments involve risk. Aldrich Wealth is an investment adviser registered with the US Securities and Exchange Commission.
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Darin Richards, CFA®
Aldrich Wealth LP
Darin joined the Portland wealth management firm in 2004, bringing more than a decade of investment and financial consulting experience with him. As chief investment officer for Aldrich Wealth, Darin is responsible for developing, and implementing our investment philosophy and leading the investment committee. He works directly with some of our most complex and largest clients and also…
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