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Market Commentary

 Q3 2023 Outlook

It’s hard to believe how fast this year has gone and that we’ve already wrapped up the first half of 2023.

Markets have defied all expectations in the first half of 2023 with a risk-on appetite despite a banking crisis, the threat of a U.S. default, continued interest rate increases from the Federal Reserve, and ongoing recession fears. Even with these factors, major U.S. equity surged during the first half of 2023 with the DJIA, S&P 500, and Nasdaq posting gains of 3.8%, 15.9%, and 31.7%, respectively in the first six months. Strong equity performance in the first half surprised many market prognosticators, especially those who strongly believed the U.S. economy was charging toward a significant recession.

Of course, that recession is yet to be seen. The U.S. Commerce Department released data last week showing the U.S. economy grew at a 2% annualized pace in the first quarter, which is substantially higher than the previous 1.3% estimate. The unemployment rate has barely nudged in the first half of the year, and the labor market continues to add jobs at a rapid clip. Consumer spending remains solid.

Let’s look at two trends that have driven the strong performance so far this year and how they could continue to drive performance for the rest of the year:

  1. Resilient U.S Consumer

Much of the resiliency we’ve seen in both the economy and markets rests squarely on the strength of the U.S. consumer, who, fueled by a strong job market, higher wages, sufficient savings, and meaningful home equity, has continued to spend with confidence. This is critically important, as consumption alone is responsible for more than 68% of U.S. Gross Domestic Product. Inflation has made essential purchases much more expensive, but the consumer has shown resilience in the face of rising prices.

We discussed company earnings in our last market commentary, however, our expectations were that overall companies within the S&P 500 would beat earnings expectations. They did and in fact, 77% of these companies posted higher-than-expected earnings. These earnings “beats” can be credited to the resilient consumer. We will continue to monitor corporate earnings as we head into earnings season, however, we expect the U.S. consumer to remain resilient.  For example, Amazon just wrapped up its “Prime Day” promotion on July 12th. On July 13th, the company called the first 24 hours of Prime Day the “single largest sales day in company history”.

  1. Inflation and the Fed

Headline inflation has continued to fall from 40-year highs in 2022, with June CPI hitting its lowest year-over-year level since March 2021 at 3%. Core inflation, which excludes food and energy, has proven to be stickier. Goods prices have fallen as supply chain issues gradually worked their way out of the system, but spending preferences have shifted toward services, which remain stubbornly elevated.

After ten straight hikes, the Federal Reserve chose not to raise rates following their June meeting. However, there may still be work to get inflation down to their 2% target, and rates are likely to remain higher for longer.

We believe we will see one or two additional rate hikes this year, with no cuts until mid-2024.  This slowdown in rate hikes will bode nicely for equities, but also fixed income as well.  Even during times of higher inflation, stocks and bonds have generally provided solid returns, as shown in the chart below.

It’s mostly at the extremes, when inflation is above 6% or negative, that financial assets have tended to struggle.


Will the economic strength continue in the second half of 2023?

While the economy has proven incredibly resilient in the first half of 2023, the impact of aggressive rate hikes often takes time to fully materialize. Cracks are beginning to emerge in the labor market. Weekly jobless claims, a leading indicator of job market strength, trended higher in May and June. Claims decreased in July, but remain an area of focus. At the same time, “quits” have been trending lower, which can be taken as a sign workers are not as confident about their job prospects.

Finally, federal student loan borrowers will need to resume making monthly debt repayments in October, when interest begins to accrue on September 1st signaling less discretionary spending. These headwinds are not all bad, however, and each will have a disinflationary impact and will aid the Federal Reserve to achieve its 2% inflation target rate. This will in turn lead to rate cuts, driving equities and fixed income higher.    

Is it possible that the U.S. economy enters a recession sometime in the next few quarters? Of course. But signs right now point to any downturn being close to in line with broad expectations, which the markets are already pricing in.  Keep in mind that the market isn’t the economy.  Even with a mild recession, we don’t see a strong case for being out of equities/stocks. Remember, bull markets are built on “walls of worry”, as evidenced so far this year. What is important is “time in the market” rather than “timing the market”.   

As shown in the chart above, missing the best days in the market can be costly. It is nearly impossible to accurately time the market, which is why investing for the long-term in a well-diversified portfolio can help drive better outcomes. No matter how stocks and other assets perform this year, you’ll want to maintain an actively managed financial plan that caters to your specific financial goals, circumstances, risk-tolerance level, and investing horizon. As always, you can be confident that we’ll continue to monitor economic conditions and let you know if there’s anything that needs to be changed or addressed. If you have questions or concerns, we’re always available to talk.