Equity markets rebounded sharply in the first half of 2023 amid (unexpected) resilience in the US economy. Looking ahead we think strength can persist, but suggest investors rebalance equity exposure.
KEY POINTS
Resilient economy drives market rebound
- The US economy avoided a recession in the first half of 2023 despite the consensus prediction of most economists. Resilient labor markets, personal spending, and US GDP all support further strength in the economy.
- The “era of free money” appears over as the Fed continued to hike interest rates and made clear that rates were likely to go higher, and stay higher.
- Equity markets rebounded sharply off 2022 lows driven by an “AI” surge in technology stocks. Corporate earnings beat expectations but remain lower y/y, which could be a headwind to further upside.
- Inflation remains the biggest tail risk to further market upside and economic growth, but is showing signs of easing.
- We lowered our outlook for Fixed Income amid concerns over increasing defaults and rising bankruptcy filings; we favor short-duration, high quality debt.
- Three regional bank failures rattled markets and brought fears of another 2008-style financial crisis; by quarter end banking system concerns eased, but remained.
Exhibit 1:
Key Markets Performance in 2Q23
At the beginning of 2023 we suggested a “post-pandemic new normal” economic foundation could arrive later this year. Halfway through 2023 we believe that the foundation is here. But before we delve into the current environment a recap one year ago: The Fed had raised interest rates by 1.5% in a little over three months, inflation touched 9%, Russia had invaded Ukraine and upended commodity markets, wage inflation was soaring, and markets were in turmoil as the S&P 500’s first half of 2022 return was its worst start to a calendar year since 1970.
Fast forward to today and the economic outlook, and consensus opinion, is markedly changed. The recession every economist predicted for this year has not materialized (and appears unlikely), oil prices are 33% lower, inflation is down to just over 4%, and the S&P 500 is up nearly 17% driven by a surge in technology stocks (the NASDAQ is up 39% for the year, its best first half in over four decades). Furthermore, the US economy appears to be firing on all cylinders in contrast to the rest of the world which still hasn’t recovered from the pandemic.
Exhibit 2:
Major Market Performance 2023YTD
The question on most investor’s mind is where do we go from here? In our view inflation remains the biggest headwind to further progress. The Fed’s hawkish constitution is unwavering and inflation, while trending lower, remains double the target of 2%. Concerns over the Fed’s ability to perform a “soft landing” are compounded by corporate earnings which are experiencing y/y declines.
Exhibit 3:
Leading Economic Indicators vs. Coincident
We see positive economic momentum outweighing the tail risks largely due to the persistent strength of the US labor market (June employment data surpassed its pre-pandemic peak). We favor a risk-on tilt for investors and suggest rebalancing equity exposure to take advantage of a broadening rally across sectors and companies. At the same time we caution over-extending credit exposure and suggest taking advantage of high quality, short duration fixed income.
Read the Full 2023 Midyear Recap
Our complete 2Q23 Midyear recap includes additional commentary and charts on the economy and markets, as well as our updated asset class views into year end.
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ENDNOTES
Disclosures
This commentary reflects the personal opinions, viewpoints and analyses of the author providing such comments, and should not be regarded as a description of advisory services provided by Defiant Capital Group or performance returns of any Defiant Capital Group client. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Defiant Capital Group manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
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A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.