EQM Indexes 2Q 2023 Market Review
“Life is full of surprises. Why is that always surprising?” – Cathleen Schine
Coming into the year, the market was bracing for an economic recession as the Fed continued its aggressive tightening policy to thwart stubborn inflation. Throw in a bank crisis, political wrangling over the debt ceiling, a deeply inverted yield curve, and a Fed dead set on getting to a 2% inflation target, no matter what – and on paper, it doesn’t look pretty. And yet, US markets sit at the midpoint of the year in bull market territory, with the S&P 500 TR Index up 16.9% and the NASDAQ Composite up a whopping 32.3% thanks to an AI-fueled tech rally.
Looking at the bull market in the mouth, a lot of market naysayers are complaining about “bad breadth”, meaning only a few companies are participating in this market rally. Indeed, the Russell 2000 Index of small-cap stocks is up only 8.1% YTD. The Dow Jones Industry Average which is loaded with value names is up only 4.9%. And international markets both developed and emerging, also trail the U.S. broad market index, up only 11.7% and 4.9% respectively.
Certainly, if you look at the top performing names in the S&P 500 YTD, you can see the AI frenzy with chip-maker Nvidia, Facebook parent Meta, and EV automaker Tesla at the top of the list. But also among this year’s top performers are cruise stocks: Carnival, Royal Caribbean, and Norwegian. Cruises, air travel, and live events are back. After three years of pandemic restriction, consumers are shifting their spending from goods to experiences.
Looking at the list of top S&P 500 performers, there are 115 stocks up more than 20% YTD. So maybe the market’s breadth isn’t so bad after all? It does seem to be improving, with more names participating on the upside. And a lot of these market moves are indeed based on underlying fundamentals like earnings, not speculation.
Earnings a Mixed Bag
Looking at FactSet’s analysis of Q2 2023 earnings, earnings declined 6.8% for the quarter, the largest decline reported since Q2 2020. 67 companies issued negative guidance, but 46 companies guided up. Energy and Materials companies saw the largest earnings decreases, and Tech and Consumer Discretionary saw the best earnings growth. In fact, Consumer Discretionary reported a YOY earnings growth rate of 26%. Despite all the economic headwinds, the consumer remains resilient but leveraged, with a rising amount of consumer debt. But darn it, they still have jobs and are taking that cruise!
Not as Much Damage as Expected
Over the last 12 months, the Fed has ratcheted up interest rates to stymie demand and curb inflation. In June, they took a pause, but all indications are that they will resume their tightening path in July. But as mentioned, we see corporate profits exceeding expectations, inflation is easing, although still far from the 2% target, and it is likely that interest rates are almost at their peak. The economy and markets may have weathered the worst of the storm. To quote my friend, Kristina Hooper, Invesco’s Chief Market Strategist, “We anticipated more damage. We have been pleasantly surprised.”
The Rise of FOMO
Going into the second half of the year, many investment managers remain bearishly positioned for a recession, favoring value and quality names. But those areas of the market have vastly underperformed. Furthermore, as a result of the banking crisis and higher interest rates, there are $6 trillion in parked money market funds and cash equivalents earning a 5% return. A lot of investors failed to participate in this market rally and at some point, FOMO (fear of missing out) may kick in. That bodes well for end-of-year returns, particularly if the Fed stops tightening, inflation continues to run cooler, and corporate earnings remain robust. There are still plenty of naysayers, but that bearish sentiment may actually help sustain this bull market run.
With its back against a proverbial economic wall, China may become more friendly with its economic partners. A de-escalation of economic tensions between the U.S. and China, the world’s two largest economies, could offer a deflationary shot in the arm for the global economy. U.S. Treasury Secretary Janet Yellen is scheduled to visit China in July on the heels of Secretary of State Antony Blinkin’s trip there last month. China also releases its Q2 GDP figures in mid-July, which may offer insights into the need for more economic stimulus. Global market breadth is a good thing too.
So onward and forward to the second half of the year! I am sure there are more surprises to come.
CEO and Co-Founder