July 2023 Market Perspective

June saw the first half of 2023 end on a high note, with all three major indices up for the month. For June, the Nasdaq climbed 6.61%, while the Dow Jones Industrial Average (Dow) and S&P 500 rose 4.68% and 6.65%, respectively. For the first half of the year, the Nasdaq continued its dominance due to a narrow-based market rally. The tech-heavy index, driven by the artificial intelligence (A.I.) craze, had its best year since 1985 (its year of inception), returning 31.73%. The S&P 500 and Dow increased 16.89% and 2.50%, respectively.

Throughout the first of the year, we have seen several notable events not only in the U.S. but throughout the globe. The Russia-Ukraine war is still ongoing, March saw the collapse of three prominent banks (sparking fears of systemic issues within the banking system), tensions between the U.S. and China persist, and the Federal Reserve is not done in its fight against inflation. In its last meeting in June, the Federal Open Market Committee, the policy-setting arm of the Fed, indicated that more rate hikes this year are possible. Many analysts are expecting the Fed to increase rates two more times (25-basis points each) before pausing for the remainder of the year. Currently, the CME FedWatch Tool is predicting a 93% probability of another 25-basis point hike at their next meeting, scheduled for July 25-26.

The narrow market rally seen during the first half of the year, driven by a handful of mega-cap stocks, has been attributed to the seemingly endless potential of A.I. This lack of market breadth also signals that near-term improvement in economic growth is not expected. While technology stocks were the primary drivers of the strong year-to-date performance, there was a clear rotation into cyclicals (stocks that are affected by the macroeconomic landscape; consumer discretionary items that consumers buy more of during economic expansion) throughout the month of June. While all eleven sectors of the S&P 500 finished the first half of the year in the green, consumer discretionary (cyclical stocks) was the top performing sector (12.1%), followed by industrials (11.3%) and materials (11.1%).

One indicator investors have been closely eyeing are price-to-earnings (P/E) ratios across the market. Currently, the S&P 500 index is trading at approximately 22 times earnings. However, the mega-cap tech stocks, fueled by the A.I. craze, are trading as much as 200 times earnings - reminiscent of the tech bubble seen in 1999-2000. Put another way, the blue-chip stocks driving the performance of the market are extremely overvalued. If earnings do not keep pace with expectations, there could be a significant reversal of their 2023 year-to-date performance.

International stocks have fared well thus far, however not as well as their U.S. counterparts. The international equity index, the MSCI EAFE, was up 4.89% for the first half of 2023. International stocks outperformed U.S. stocks last year and it is widely expected that they will continue to do so this year. As a more broad-based rally becomes reality, international stocks will likely catch up and possibly surpass domestic stocks.

In addition to stocks having a stellar first half of 2023, the bond market performance was somewhat more muted. The Bloomberg U.S. Aggregate Bond Index rose 2.09%, while the Bloomberg Corporate Bond Index and the Bloomberg U.S. Government/Credit Long-Term Index returned 3.21% and 4.39%, respectively. Bonds continue to be battered by rising interest rates, despite the general consensus that the Fed is near the end of its rate hiking cycle.

The release of June’s Consumer Price Index (CPI) report gave some much needed respite for investors. Last month’s reading showed CPI increased 3.0% from a year ago (4.0% in May), which is the lowest level recorded since March 2021. On a monthly basis, the index rose 0.2%. Both readings beat Dow Jones estimates of 3.1% and 0.3%, respectively. The latest CPI numbers reignited hope that the Fed may be near or at the end of its rate hiking cycle. George Mateyo, chief investment officer at Key Private Bank, recently stated, “The Fed will embrace this report as validation that their policies are having the desired effect – inflation has fallen while growth has not yet stalled.” Based on the latest batch of economic data, some analysts are ramping up expectations that the Fed may achieve the elusive “soft landing” – slowing the economy enough to lower inflation without driving it into a recession.

The focus of the market and investors has been and continues to be inflation, the path of the Federal Reserve, and the possibility of recession. Although the near-constant mention of a recession has been present, the U.S. economy continues to remain relatively resilient. Nevertheless, recessions signals remain – inverted yield curve, tight credit conditions, and elevated inflation. Experts are divided on the probability of recession, if one occurs, and its severity and duration. However, many are postulating that if a recession does occur, it will be shallow. Analysts continue to comb through Fed meeting minutes, inflation reports, consumer sentiment reports, and other economic data in attempting to determine the probability of a recession.