Off to an Interesting Start
One of the most anticipated recessions in U.S. history has yet to materialize despite developing geopolitical risks, a banking crisis (remember that?) and the Federal Reserve (Fed) continuing to raise rates. There is a saying in market research, “analysis of averages leads to average analysis”. It appears many forecasters entering 2023 fell prey to this approach and proclaimed, based on historical recession data, that 2023 was a recession year. But if 2023 has yet to humble those who seek to time the market, perhaps they missed that the S&P 500 was up nearly 17% in the first half of the year and the technology-driven NASDAQ Composite Index advanced an impressive 32%.
At the beginning of the year, we wrote about a few themes that we thought might indicate what was in store for 2023. We review those themes below in light of what has transpired in the first half of the year:
2023 Themes – Revisited
The landscape of the financial world has undergone a significant shift from the low-rate, low-inflation and low-growth environment of the past decade. We find ourselves in a new regime characterized by higher interest rates, increased inflation and uncertain growth prospects. In this transformed setting, we believe volatility will be more prevalent and this belief has been validated in the early months of 2023 with volatile interest rates, the substantial divergence between winners and losers in equity markets and varying macroeconomic conditions across the globe. A likely result of this new regime: asset allocation may hold even greater significance than it has in recent years.
Coming into 2023, our hope was for a meaningful decline in inflation, even though we did not expect the Fed would “solve” the inflation crisis within the span of 12 months. While inflation has not declined to the Fed’s long-term target of 2%, they have made significant progress. June Headline CPI reached 3%, down from a peak of 9.1% seen in June of 2022. Beneath the surface of 3% CPI, there are additional positive indications. Nearer-term data continues to decelerate giving the Fed more flexibility in future policy. Over the last six months, “super core” CPI (CPI less shelter, food and energy) has risen by 2.8% on an annualized basis. These near-term inflation trends indicate even more progress than is reflected in the annual headline figures.
Bear Market Bottom
As we highlighted in our outlook earlier this year, we have no ability or need to precisely call the market bottom. It was nevertheless prudent to prepare for share prices to rise and indeed they have. The rally witnessed in U.S. stocks has exhibited a somewhat unique characteristic, whereby a small number of securities have accounted for a significant portion of the overall return. Specifically, 56% of the rally in the S&P 500 can be attributed to just five stocks. To put it differently, more than 9% of the 16.9% return of the index was derived from these five securities alone. It is crucial to recognize that narrow markets, characterized by concentrated leadership, can act as both a catalyst for upward movements, as witnessed this year, and for downward movements. Intuitively, this makes sense, as upward momentum in the market becomes reliant on a small handful of securities.
Defying Recessionary Odds
The clock is running out on 2023 and no recession has yet materialized. However, the likelihood of a recession occurring in the foreseeable future does appear to be rising based on a growing body of forward-looking economic data showing the potential for slower future growth.
While 2023 has offered new opportunities and challenges than were envisioned at the outset of the year, our near-term outlook has not changed considerably. We’re encouraged by the meaningful decline in inflation and strong equity market returns while cautious about uncertain growth prospects and potential recession.
Even if one could perfectly time recessions, markets tend to anticipate economic contractions both on the way down and the way up. Recessions are a normal part of the economic cycle, and rather than fearing them, we believe in constructing resilient portfolios that embrace their inevitability. Many investors have become conditioned to view recessions as catastrophic events akin to the global financial crisis or the COVID-19 pandemic. In reality, while uncomfortable, economic contractions are natural and healthy components of the economic cycle. Therefore, whether your portfolio is actively managed or if you do it yourself, portfolio allocations should anticipate and reflect these already embedded risks.
The views expressed represent an assessment at a specific point in time, are opinions only and should not be relied upon as investment advice regarding investments, strategies, sectors or markets in general. The above commentary has been obtained from sources we believe are reliable, but we cannot guarantee their accuracy or completeness. Past performance is no guarantee of future results. This is not a complete analysis of every material fact. All expressions of opinion are subject to change without notice.
The information contained in this document does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Talk to your financial advisor before acting on information in this document.