Quarterly Update

The second quarter (Q2) of 2023 was great for stocks at home and abroad, with much of the positive performance coming from a small group of stocks within a few sectors. Bonds struggled to maintain positive performance so far this year amid fears of higher interest rates and consternation about the federal government potentially defaulting on its debt. In short, it was another eventful quarter for investors that ended well, all things considered.

Here’s a roundup of how major markets performed during the quarter and year-to-date, respectively:

• US Large Cap Stocks: up 8.7%, up 16.8%
• US Small Cap Stocks: up 5.7%, up 8%
• US Core Bonds: down nearly 1%, up 2.4%
• Developed Foreign Markets: up 3.3%, up 12.5%
• Emerging Markets: up 1%, up 5.2%

Clear winners during the first half of 2023 and Q2 were stocks that did poorly last year. Stocks in sectors like Technology, Communication Services, and Consumer Discretionary were up 40%, 36%, and 32% this year, respectively, as the quarter closed. The largest stocks beat the smallest handily, with the large-cap tech-heavy NASDAQ 100 index up 39% this year versus various small company indexes up in the mid-single digits. This large-cap bias helped the S&P 500, the typical US stock benchmark, rise 6.5% during June to finish the first half of the year up nearly 17%. This was quite the turnaround after these market indexes declined from 18% to nearly 40% last year!

The primary drivers of this uptick for stocks were declining inflation and our resilient economy, rising interest in artificial intelligence, and a relief rally after government officials avoided a debt default early in June.

Inflation peaked last summer at 9% and has been declining steadily since, dropping to 4% in May. The Federal Reserve has a stated goal of 2% inflation and has raised interest rates ten times since March of last year to slow the economy down. Among other things, this has increased short-term borrowing costs in the economy by about 5%. The Fed held off raising rates at its June meeting while suggesting that more rate increases could come later this year. Only time will tell if and how much more the Fed raises rates, but we’re marching closer to their 2% objective and more rate increases are getting harder to justify. This soothed investor concerns a bit during Q2, but lingering pessimism about Fed policy still took some wind out of the bond market’s sails as the quarter closed.

Also at play was the surging popularity of AI. Hyperbolic notions about the technology’s risk to humanity notwithstanding, investors caught the AI bug during Q2. This helped drive stocks like Apple, Microsoft, Alphabet (Google) to each rise 30+%, and chip maker NVIDIA to rise almost 190%! These companies help make up the top 25 list of the benchmark S&P 500 and this group’s total publicly traded share value has grown by nearly $4.5 trillion so far this year. The entire index grew by $5 trillion, according to Bespoke Investment Group, so it’s easy to see how one-sided this rally has been so far.

Also helping stocks was the eleventh-hour resolution of the drama around our nation’s debt ceiling and potential debt default. While nothing new per se, this time around the debt ceiling “crisis” took a toll on investor sentiment, helping various metrics reach some of the lowest points on record. Once the issue was resolved (or merely delayed, depending on your perspective) investors got back on the stocks bandwagon and drove indicators like CNN’s “Fear & Greed Index” to “Extreme Greed” after being at “Extreme Fear” barely a year prior. The popular AAII Bullish Sentiment index also jumped to its highest level in two years. Generally speaking, large upward moves in investor sentiment tend to linger and can help drive stock prices further in the short-term.

All of that sounds pretty good while being in stark contrast to where we felt we were a handful of months ago. But the outlook is mixed. We continue to see surprisingly good consumption, housing, and jobs numbers in the economy, but the impact of higher interest rates should eventually slow the wealth effect. Student loan repayments will restart soon, and analysts disagree on how much that will impact consumption. The commercial real estate picture in some major metros looks dire and the financial impact of that also takes a while to play out. Stocks were up while commodities were down nearly 9% last quarter as global manufacturing demand slowed. All this should eventually slow our economy in a meaningful way, we just don’t know by how much. Analyst opinions differ on near-term recession risk and potential severity while investors seem keen to shrug off recession risk in the short-term. Whose right is anyone’s guess.

One takeaway from Q2 juxtaposed with the market’s poor performance last year is how hard it is to forecast the future in a consistently accurate way. Stock market analysts get paid to do this and the good ones are right just a bit more than they’re wrong when averaged over, say, a ten-year period. That math works if you can hold on when the news gets scary and markets get volatile. But many people can’t. The rest of us try to focus on controlling what we can control and let time work for us. We don’t chase market trends – we diversify and rebalance as needed. And we don’t try to guess the “right” time to buy or sell, even though that’s what the media pushes every day. This approach isn’t always popular or even one that feels good all the time, but it’s one that works if you let it.

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