By: Dave Chenet, CFA, CAIA
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||3.81%|
Source: YCharts, Yahoo! Finance, WSJ
The First Half of the Year Is in the Books!
Halfway through 2023, little on Wall Street has gone according to plan. Entering the year, many Wall Street banks were preparing for a rocky first half based on the expectation that the Fed monetary policy tightening would spill over to the economy and lead to recession. While the Fed did indeed continue its path to higher rates, the stress in the banking system was enough to lead the Fed to pause (although, Fed Char Powell insists that the pause will be momentary and rate hikes will continue to be necessary). Despite economic risks piling up, investors cheered the AI boom and resumed torrid buying of tech stocks. As we turn the page to the 2nd half of the year, we pause to reflect on the following economic and market indicators which will drive asset class returns going forward:
- Interest Rates & Inflation: The 2022 broad market sell-off was prompted by the reversal of ultra-low interest rates as policy markers combatted rampant inflation. We have seen inflation moderate, yet Core PCE (the Fed’s preferred measure of inflation) remains above 4% and is showing few signs of a quick return to the 2% mandate. Meanwhile, short-term interest rates are at their highest levels since 2007, the yield curve is more inverted than it has been since the 1980s, and the Fed is insistent that it will continue to tighten until inflation reaches 2%.
- Earnings & Valuations: S&P 500 corporate earnings fell in the first quarter and 2nd quarter expectations are expected to continue to show lower earnings as higher wages and interest rates reduce profit margins (from still very high levels); yet the rally in share prices has pushed the Price to Earnings ratio to 19.2x, almost a 10% increase since the beginning of the year.
- Economic Growth: Forward-looking economic indicators, such as the ISM Manufacturing Purchasing Managers Index, credit conditions, the yield curve and initial employment claims point to slower economic growth.
With the year half-way through, the same Wall St banks which predicted a rocky first half and a buoyant second half of the year are raising their year-end expectations and painting a rosy picture of a ‘goldilocks’ scenario of a prolonged pause from the Fed, moderating inflation and tech stocks living up to their very optimistic expectations. While market rallies can extend beyond “reasonable” levels, investors may be well-served by taking some profit and seeing how the growth/inflation picture plays out.
What We’re Reading:
Chart of the Week:
Source: CNN Fear/Greed Index