Q2 2023
Dear Client,
We hope you are having a pleasant summer and were able to enjoy the 4th of July holiday with friends and family! If you have any questions about your own investments or financial situation, or just want to have a review or “catch-up”, please get in touch. We would love to hear from you, and are happy to arrange a time to meet virtually or in person.
The second quarter ended at a high point for equity markets for the year, closing out a surprisingly strong first half. In general, there is some increasing optimism among market participants about the path of the economy. Inflation is trending downward even as employment and GDP have not been decimated (as expected) by the interest rate hikes the Fed has been doing up until the “pause” they announced at the June meeting. Having raised the Fed funds rate to 5.25% from zero over the last 18 months, the Fed decided to pause at the June meeting. They also went to great pains to express the strong likelihood that this is a pause only and further rate hikes should be expected. The further hikes may be on a slower schedule, as we all wait to see the real effects of the 500%+ increase over the course of the hiking cycle.
The numbers for the quarter and the year-to-date are as follows (calculated from wsj.com/market-data):
S&P 500 change: 8.49% Q2 and 15.5% YTD
S&P 500 Equal Weight Index: 3.47% Q2 and 5.97% YTD
Nasdaq Composite change: 13.52% Q2 and 30.54% YTD
Nasdaq Composite Equal Weight Index: 6.55% Q2 and 19.27% YTD
Dow Jones Industrial Average change: 3.49% Q2 and 3.8% YTD
Ten Year Treasury Yield change: 8.59% Q2 and 1.62% YTD
Crude Oil (WTI Front Month Contract) change: -11.81% Q2 and -12.32% YTD
Gold (GLD ETF) change: -3.04% Q2 and 4.06% YTD
I included the equal weight versions of the S&P 500 and the Nasdaq Composite indices this quarter to help illustrate a particular point: The rally thus far this year has been concentrated in the largest few companies, particularly in the tech space. That is important because mean reversion leads us to two likely outcomes. Either the portion of the market that outperformed in the first half will settle back, or the portion that underperformed will accelerate.
To some extent the mega-cap tech stocks have become the new staples, i.e. in times of uncertainty, investors find safety with the strong balance sheet and relatively economically-insensitive business models of these companies. There has also been an explosion in the AI (Artificial Intelligence) field, and every company is busy exhorting the value they will provide with AI or the efficiency AI will bring to their business. As with any leap forward in technology, we think it will take some time to sort out the true value of AI and to whom the value will accrue. However, it seems clear that the potential it offers will in some way be beneficial to several of the mega-cap tech businesses and their shareholders.
Q1 2023 earnings for the S&P 500 ended up at -2.7% when compared to Q1 2022. That was the second consecutive quarter of declining year-over-year earnings for that index. The expectation is that Q2 2023 will be a third quarter of declining earnings. In that sense we seem to already be in an earnings recession. That said, the size of the decline (-2.7%) for Q1 was less than expected, so the results outperformed expectations. That pattern of outperforming expectations (even if still negative) is part of what has allowed equity markets to show such strong performance. In other words, earnings have been less bad than expected, so that is good.
Overall, we are in a similar position now as we were at the end of Q1. We have been pleasantly surprised by the performance of the equity markets thus far but are cautious on the outlook as we wait for economic data and earnings to confirm that the strength has been justified. One positive result of the increased interest rates has been a relative bonanza for fixed income investors. We have been busy adding to treasury and agency bond positions with maturities ranging from 3 months to 2 years where appropriate.
We wish you all the best for the remainder of the summer and will be working hard on your behalf.
Best Regards,
Bo and Lesley
