MARKET COMMENTARY: Q2 2023

QUARTER IN REVIEW

During the second quarter of 2023, investors rode a wave of economic uncertainty as markets grappled with persistent inflation, central bank activity, the fallout of banking sector struggles, and debt-ceiling drama.

Better-than-expected Q1 earnings results, led by American tech giants, helped prevent stock markets from heading into free-fall and provided temporary stability early in the quarter. However, it was short-lived, as economic data in May pointed to persistent inflation fueling uncertainty about the future of the Federal Reserve’s interest rate hikes.

In addition, brinksmanship in Washington over the debt-ceiling deal added pressure to already burdened markets. Yet, despite somewhat lackluster performance throughout April and May, equities markets rallied in June and finished with one of the better first halves of a year in quite some time. The Nasdaq, S&P 500, and Dow were up 32.32%, 16.89%, and 4.94% for the year, respectively. It was Nasdaq’s best first half of a year since 1983, primarily due to growth in tech stocks driven by the surge in AI.*

Meanwhile, the mayhem of March’s bank failures fueled turbulent swings in short-term Treasury yields and reverberated across bond markets in early Q2. The debt-ceiling standoff further stoked bond market turbulence as investors piled into ultrashort-term Treasury bills to avoid getting caught up in the debt-ceiling drama, causing the spread between the one- and three-month to hit historic levels.

Yields rebounded in June as strains from bank failures and the debt-ceiling crisis eased, and expectations of ongoing rate increases in the near future floated the short end of the curve, causing the 2Y-10Y yield curve to hit its deepest inversion since 1981.

The rise in yields impacted the performance of bonds for the quarter, and the Bloomberg US Aggregate Bond Index posted a -0.84%, while the Bloomberg Global Aggregate Bond Index finished down -1.53% for the quarter, though on the strength of Q1’s performance, both indexes remain in positive territory for the year.*

* Source: Morningstar Direct, as of June 30, 2023

WHAT’S BEEN DRIVING MARKETS? - The Economy, Inflation, The Fed and ChatGPT

The Economy, Inflation, and The Fed

Resilient economic data (stronger than anticipated growth coupled with historically low unemployment) has reignited talk of a potential “soft landing.” Meanwhile, headline inflation continues to cool slowly, but core prices, which exclude food and energy, have remained sticky. The Fed’s preferred inflation gauge, the core personal consumption expenditures price index (PCE), increased in May by 4.6% from a year earlier.

After 10 consecutive increases since March 2022, the Fed paused in June and held its benchmark federal funds rate steady in a range between 5% and 5.25%. However, given the strength of the labor market and persistent inflation data, market participants fully expect that the Fed will resume rate increases starting in July.**

** Robles, C., & Cambon, S. C. (2023, June 29). U.S. Economy Shows Surprising Vigor in First Half of 2023. WSJ. https://www.wsj.com/articles/u-s-econo-my-shows-surprising-vigor-in-first-half-of-2023-1a8a32eb?mod=economy_more_pos7

ChatGPT, AI and Technology Stocks

The launch of ChatGPT marked a technological, economic, and social inflection point. Exuberance over the potentially transformational technology of artificial intelligence (AI) fueled investors’ appetites for companies like Alphabet (Google), Amazon, Apple, Meta, Microsoft, and Nvidia. All experienced a significant surge in their share prices. Apple closed the month of June with a share price that made it the first company in history to be valued at over $3 trillion, while Nvidia’s shares tripled in six months, propelling them into the $1 trillion club..*** By the end of May, these stocks were responsible for most of the market’s 2023 gains.

However, by the end of the quarter, the equity market rally broadened out. Throughout June, shares of 454 companies in the S&P 500 were up, with 155 up at least 10%. The rally also expanded to include mid- and small-cap stocks and equities from international and emerging markets.****

*** Phillips, M. (June 1, 2023). The S&P 500’s gains are almost entirely from just five companies. Axios. https://www.axios.com/2023/06/01/sp500-tech-com-panies-stock-price

**** S&P Dow Jones Performance Report, U.S. Equities June 2023

FINAL THOUGHTS

Over the short term, markets tend to be sentiment driven because they are driven by people, who, in turn, are driven by narratives. Post-pandemic, investors have been lured by the promise of the “metaverse,” which has given way to the frenzy of the AI boom, and tech stocks have been the prime beneficiaries of both.

Over the long term, however, markets are driven by earnings. Still, 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.

What does the second half of 2023 hold for investors? No one knows. But we do know that, over time, markets reward patience. We will monitor the movements of markets over the short term while continuing to focus on your long-term goals, help you be patient, and harvest the potential rewards over time.

 

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