The Market Rallies…

The Market Rallies…

After a difficult year in 2022, the markets are off to a strong start halfway through 2023. The market rally has been driven in part by the excitement around artificial intelligence (AI) and its potential impact, as well as an economy that’s been resilient. The S&P 500 (500 large US companies) is up about 15% through 6/28/23. International stocks have also had a solid start to the year, with the MSCI EAFE up about 10.7%. The markets and overall economy have defied expectations for a downturn in spite of higher interest rates. Large cap stocks, especially the mega cap technology stocks, have had an oversized contribution to the returns this year. The S&P 500, like many other major market indices, is market capitalization weighted. This means that the larger a company is, the more of a weighting it has in an index. With a cap weighted index, significant changes in the price of shares for the biggest companies can have a substantial impact on the value of the overall index. Much of the returns for 2023 so far have come from a handful of the largest technology stocks (including Apple, Microsoft, Nvidia, Alphabet and Amazon). Typically, in positive stock market years, the largest stocks usually contribute a much smaller part of the market’s total gains. In fact, if you back out the technology sector from the S&P 500, the index is up just under 7% year-to-date (as of June 28th, 2023).

Highly concentrated markets are not unheard of, but the returns this year are more concentrated than at any time in the past. Not all sectors have participated in the market rally to the same extent as growth stocks. In particular, small cap value and international stocks currently trade at lower valuations compared to large cap technology and US stocks, respectively. In general, we would prefer to see broader market participation including other sectors of the market.

Since March 2022, the Fed has increased interest rates ten times in an effort to tame inflation. It’s been the Fed’s fastest hiking cycle in decades. The Fed decided to keep rates unchanged at their June meeting (for the first time in over 15 months) but signaled that more rate increases may be coming this year. The Fed will have more time to assess the inflation picture and economic conditions before deciding on further changes. A Fed pause has historically been a positive catalyst though for stocks and bonds. Higher bond yields continue to offer attractive opportunities for investors.

Much has changed in the bond market over the past year and a half. Yields are up significantly, showing the signs of the Fed rate hikes and higher inflation. At the end of 2021, the 10-year U.S. Treasury was yielding about 1.5%. Fast forward to today, and the 10-year currently yields about 3.8%. Intermediate-term and longer-term bonds have become more attractive as interest rates have risen to capture higher income for longer periods. They could also see appreciation if yields eventually begin to move lower (if the economy slows and the Fed were to cut rates). Through the end of the second quarter, high quality core bonds (as measured by the Bloomberg US Aggregate Index) are up 2.6% (through 6/28/23).

There’s no shortage of opinions around whether or not we’ll see a recession this year or next. Inflation has been moderating but remains too high. An economic slowdown may still potentially be in front of us. The full impact of the Fed rate hikes will likely be felt as time passes. As we move into the second half of the year, we expect continued bouts of market volatility as the economy slows. However, as we saw with the debt ceiling drama that recently transpired, it’s important to focus on the things that you can control, maintain perspective, and focus on the long-term.

Please contact your wealth advisor if you would like to talk about ways to earn more interest on your excess cash. The interest rates that we’re seeing today (such as 5% yields on money market funds, T-bills and CDs) will likely not last forever.

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