- Positive Momentum. The first half of 2023 has brought a welcome market recovery, with investors benefiting from positive equity returns and more attractive income opportunities in the bond market. Stocks posted their second consecutive quarter of gains, building upon the rally that began after the bear-market lows in October. The positive momentum for the quarter was driven by an agreement on the U.S. debt ceiling, a surprising resilient economy, Q1 corporate results that came in better than expectations, and a more favorable outlook for inflation and Fed policy.
- Narrow Leadership. Performance so far has been dominated by a select group of mega-cap stocks. The year-to-date returns of the “Big 7” (Apple, Microsoft, Amazon, NVIDIA, Alphabet, Tesla, and Meta) have accounted for the majority of the S&P 500’s gains year-to-date. A prolonged narrow breadth market advance raises questions about the health and risk appetite of the broader market. However, market breadth is improving, with the rally starting to widen to other parts of the market.
- Disinflation Intensifying. The June reading on inflation, as measured by the Consumer Price Index (CPI), fell to an annual pace of 3%, undershooting expectations. This is the lowest reading in more than two years. The biggest drivers of the lower inflation include food, energy, utility gas, and used cars and trucks. The all-important shelter component remains stubbornly high, partly due to lag effects in the way it is calculated in the CPI. Inflation has now slowed for 12 straight months, and is down significantly from its peak of 9.1% last summer.
- Fed Pause. At the June meeting, the Federal Reserve voted unanimously to hold the federal funds rate target at the current level of 5% – 5.25%. Since the commencement of the tightening cycle in March 2022, the Fed had hiked rates in 10 consecutive meetings and raised rates by a cumulative 500 basis points. The Fed continued to hold its tough line against inflation, projecting that two more hikes are possible to combat inflation that is still above their 2.0% target. Another increase would push the short-term rate to a 22-year high.
- State of the U.S. Economy. There are some signs that certain parts of the economy may be slowing. Of particular note is the Conference Board Leading Economic Index (LEI), a respected bellwether of economic health. The LEI index reported the 14th consecutive monthly decline in May, the longest streak since 2009. On the other hand, payroll data continues to show continuing strength in hiring, and the housing market is showing renewed vigor despite elevated mortgage rates.
- Market Outlook. The market and the economy continue to show remarkable resiliency in the face of higher rates from the Fed. The much-anticipated recession that seem certain to overtake the economy continues to get pushed out in time. For the rest of the year, the state of inflation and the accompanying Fed’s monetary policy, as well as the potential and severity of an economic and earnings recession, will remain the primary focus. We will closely monitor the earnings season, which is just commencing, for additional clues on the path of economic conditions.
