July 17, 2023
Stocks spent most of the first six months of 2023 marching higher and recovering from last year’s dismal performance.
Of course, this year's run-up in stock prices hasn’t been without bouts of volatility to keep investors on their toes. Remember the market’s heartburn over the banking stress back in March? The debt ceiling drama?
Simply, those dynamics were background noise to the front-stage performance of falling inflation and resilient economic growth that was much more influential on driving stock returns in the front half of the year. So, will the positive trendline for stocks continue through the end of 2023?
Here are the big takeaways, as well as a look back at the markets’ performance and a look ahead at the dynamics that could impact the latter half of the year.
A look at ... key takeaways
Here’s our midyear markets pulse check:
- What we learned so far: Investors were too pessimistic about growth coming into the year and incorrectly assumed a resilient economy was on the cusp of rolling over into a recession. Given the economy held up better than many expected while inflation moderated lower, stocks rallied.
- What our analysts and experts are closely watching: How economic trends develop and whether the current stock rally will broaden to areas outside the narrow set of stocks that initiated this year’s bounce higher.
- What actions investors may want to consider: We continue to suggest a slight overweight to fixed income and cash investments but believe opportunities are forming across the stock market for longer-term investors. Security selection remains critical. We would also stress that investors who may have deviated more aggressively away from their strategic/tactical allocations over the last year or so work with their Ameriprise financial advisor to get back on target with their longer-term investment strategies.
- What investors should expect moving forward: Current conditions, as well as the growth outlook for the second half, may continue to surprise to the upside. Nevertheless, investors should expect bumps in the road along the way, given high interest rates and still elevated inflation. We believe today’s environment argues for a careful but broadly balanced approach to start the year's second half.
A look back at … a better-than-expected first half
Investors were optimistic in the first half of the year, fueled by:
- Moderating inflation
- A resilient consumer
- Tight labor conditions
- Better-than-feared profit results
- Stabilizing interest rates
- A Federal Reserve close to moving to the sidelines after the most aggressive rate hiking campaign in decades
Following the unexpected banking stress in March and the resulting government initiatives installed to protect depositors, stocks spent the rest of the second quarter moving higher.
Consider these numbers:
- S&P 500 Index: The index rose nearly +17.0% in the first half and finished the first six months of 2023 over +27.0% above its October 2022 low.
- NASDAQ Composite: The tech-heavy index capped an extraordinary first half of the year, driven by AI momentum, stabilizing interest rates and a mean-reversion trade that powered the Composite higher by over +32.0% in the first six months of the year. Through the first half, the NASDAQ was over +36.0% above its October low.
- Dow Jones Industrials Average (+4.9%) and Russell 2000 Index (+8.1%): These two indices also finished the year's first half in positive territory but significantly trailed the growth-focused S&P 500 and NASDAQ benchmarks.
A look ahead at… the dynamics that could influence the second half
While stocks were strong in the first half, history suggests equities generally perform well in the second half of the year. Here are a few dynamics that could help — or hinder — that tendency.
Stocks face several challenges in the second half, including:
- Recession risks remain elevated
- Economic activity is slowing
- Profit growth remains negative
- Higher interest rates on bonds/cash-like investments offer competition for stocks
- Inflation is still too high
We see economic growth continuing to slow in the second half, but we also expect inflation to trend lower. These conditions may offer a mix of dynamics for investors to navigate as the year progresses, creating periods of stress and opportunity across markets.
The recession math appears to be weakening. In our view, earnings estimates for future quarters do not reflect a recession or modest economic downturn, which could be a risk to stock prices more broadly if macroeconomic conditions deteriorate in the second half. That said, the market outside of tech and the big Index heavyweights is less expensive than the broader averages imply. We suspect if the current market rally broadens in the second half, investors may seek out areas and industries that have not kept pace in the rally, particularly if it’s evident that central banks are near the end of their rate hiking campaign and inflation is continuing to cool.
Stock expectations are more optimistic — and the market is more expensive. If a broader swath of companies can meet or surpass analyst estimates moving forward (which admittedly may be a challenge as the year wears on), it’s conceivable that profits could eventually grow into this year’s multiple expansion over time. However, the overall market is not cheap today, expectations are no longer as deeply pessimistic as they were at the start of 2023 and stocks are already well off their lows. In our view, it’s okay to be more optimistic about the macroeconomic environment and future stock returns if one remains realistic about where returns can go from here and given the outstanding risks.
Markets turn into the second half
In golf terms, we have moved from the front nine to the back nine. And if the game hasn’t gone your way on the first nine, the back nine offers an opportunity to reset, refocus and turn the game around.
The turn into the year's second half is a great time to reassess conditions and review portfolio positions with your Ameriprise financial advisor.