July 3, 2023
Market Review: 2Q 2023
With both the banking and debt ceiling crises averted, and encouraging economic data suggesting a resilient US economy, stocks experienced strong growth over the second quarter. US large-cap stocks leaped forward 8.7% during the period and US small-cap stocks rallied 5.2%. Tech stocks primarily led the charge as the S&P 500 tech sector was up 17.2% for the quarter. Along with solid economic growth for the US, the allure of potentially game-changing productivity enhancements (not to mention the potential enhancements to corporate profitability growth) from generative artificial intelligence was also a significant contributor to higher stock prices. In the first half of the year, the tech-heavy Nasdaq index climbed 32.3% – its best first half in four decades.
US Consumers kept spending as real income growth expanded and job openings continued to be plentiful. Although a pick-up in layoffs is signaling some cracks, labor is still in a relatively strong position with a high number of job opportunities and elevated wage growth. On the back of expanding incomes, falling inflation, and a strong labor market, consumer sentiment also improved after being near historical lows for most of 2022.
US corporate earnings largely beat expectations for the second quarter and analysts expect to see profit growth in the second half of the year driven by expanding margins from lower costs. There are signs that input costs are falling as supply chains ease. This may provide relief to businesses that have been facing continuously increasing costs and may even help reverse the trend of shrinking margins over the coming quarters.
Foreign stocks also gained ground during the quarter, with developed markets up 3% and emerging markets up 0.9%. The US dollar strengthened over the quarter as the Fed’s more hawkish stance impacted currency markets, which in turn pressured foreign returns. Despite the stronger USD, foreign markets still delivered positive, albeit more muted, gains over the quarter.
Yields marched higher over the quarter as consensus expectations for a 2023 Fed pivot dissipated. This led to bond prices adjusting downward over the quarter, with intermediate-term US bonds down 0.8%. The fixed income markets are finally beginning to converge with the Fed’s communication that rates will be higher for longer. The Fed continues to reiterate its goal of pushing inflation down to 2%. Though we’ve seen incredible progress towards that 2% target over the past year, inflation still appears to be sticky in the services sector. Although the Fed paused its rate hiking cycle in June, they indicated that further hikes could be on the way as they work towards their longer-term inflationary goals.
Despite the fixed income market reflecting expectations of higher interest rates for an extended period, stock valuations climbed higher. Generally, changes in bond yields have exhibited an inverse relationship with stock valuations, but this quarter was an anomaly, with both rates and stock valuations moving higher. This may indicate the market’s hope that a soft landing is possible even if we see additional rate hikes, given the continued strength of the US economy.
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