Declining Inflation and Resilient Growth Push Stocks Higher in Q2

The S&P 500 ended the second quarter and first half of 2023 at a 14-month high and most major stock indices logged solid gains in the second quarter following a pause in the Fed’s rate hike campaign, stronger-than-expected corporate earnings (especially in the tech sector) and the relatively drama-free resolution of the debt-ceiling.

Second quarter began with markets still in the throes of the regional bank crisis following failures of Silicon Valley Bank and Signature Bank, and investors started April wary of contagion risks. Those concerns proved mostly overdone, however, as throughout most of the month regional banks were stable. That stability allowed investors to re-focus on corporate earnings, and the results were better than feared as 78% of S&P 500 companies reported better-than-expected Q1 earnings. Additionally, 75% of reporting companies beat revenue estimates for the first quarter, both 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.

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 aided by several potentially positive developments. First, inflation declined as the Consumer Price Index (CPI) 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 rate hikes and that helped fuel a broad rally in stocks that saw the S&P 500 move through 4,400 and hit the highest levels since April 2022.

Second Quarter Performance Review

The second quarter of 2023 saw an acceleration of the tech sector outperformance witnessed in the first quarter, as “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 the first quarter, the less-tech-focused Russell 2000 and Dow Industrials logged more modest, but still solidly positive, quarterly returns.

By market capitalization, large caps outperformed small caps, as they did in the first quarter of 2023. Regional bank concerns and higher interest rates still weighted on small caps as smaller companies are historically more dependent on financing to maintain operations and fuel growth.

Third Quarter Market Outlook

As we begin the third quarter of 2023, the outlook for stocks and bonds is arguably the most positive it’s been since late 2021. That improvement in the fundamental outlook has been reflected in both stock and bond prices 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.

Some risks remain to the economy and the markets. First, the economy has not yet felt the full impact of the Fed’s aggressive hike campaign, and while the economy has proved surprisingly resilient so far, we know the impact of rate hikes can take longer than most expect to impact economic growth. Put plainly, it’s premature to think we are “in the clear” from recession risks and we should expect the economy to slow more as we move into the second half of 2023. The key for markets will be the intensity of the slowing, as at these valuation levels stocks are not pricing in a significant slowdown.

Clearly there’s been progress in taming inflation, as year-over-year CPI has fallen from over 9% in 2022 to 4% in less than a year’s time. However, even at 4%, the CPI remains far above the 2% target. If inflation bounces back, or fails to continue its decline, the Fed could hike rates more.

In sum, clearly there have been positive macro developments so far in 2023 that have helped stocks rebound. However, it’s important to remember that multiple and varied risks remain for the economy and markets.

As such, while we are happy with the market’s performance, we remain vigilant towards economic and market risks and are focused on managing both risk and return potential. We understand a well-planned, long-term-focused and diversified financial plan can withstand market surprises and related bouts of volatility, including bank failures, multi-decade highs in inflation, high interest rates, geopolitical tensions, and rising recession risks.

It’s critical to stay invested, remain patient, and stick to the plan Bruce worked out with you. to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.

We remain focused on both opportunities and risks in the markets, and we thank you for your ongoing confidence and trust. Please rest assured that our entire team will remain dedicated to helping you successfully navigate this market environment.

We understand risks facing markets and the economy, and we are committed to helping you navigate this investment environment. Successful investing is a marathon, not a sprint, and even intense volatility is unlikely to alter a diversified approach set up to meet your long-term investment goals.

Therefore, it’s critical to stay invested, remain patient, and stick to the plan, as we’ve worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.

We remain vigilant towards risks to portfolios and the economy, and we thank you for your ongoing confidence and trust. Our entire team remains dedicated to helping you navigate this market environment. Please contact us with any questions, comments, or to schedule a portfolio review.