2nd Quarter 2023 Market Commentary

David J. Haas CFP®
July 10th, 2023

June 30th marked the end of the first half of 2023 and it’s a great time to take stock of the market and the economy. When you look at the S&P 500 return for the half, you would think that everything is wonderful. The S&P500 was up 16.89%. Here is chart comparing the S&P500 (green) with the Morningstar US Value Index (Navy Blue), the Morningstar Developed Markets Ex-US Index (Orange), and The Russell 2000 Index (Violet).

Figure 1: Graph of market indicies from Kwanti

The S&P 500 is weighted by market capitalization which means the very largest stocks are a much higher percentage of the index than other stocks. Apple is 7.69% of the index, followed by Microsoft at 6.79%, Amazon at 3.12%, NVIDIA at 2.81%, and Alphabet at 1.91%. The top 5 stocks are 22.32% of the entire index. These tech stocks have done outstandingly well in the second quarter because of Artificial Intelligence (AI) hype. I am sure you have seen all the articles on AI. Everyone is ready to use it and prepare themselves for our robot overlords. Seriously though, the S&P 500 rise is based on the idea that AI is a game changer and it pays to be invested in the companies that will profit from it. Meanwhile, value stocks once again have trailed the indices. International developed markets (basically Europe and Japan), recovered nicely and were actually the best performers into mid May. Small caps, measured by the Russell 2000 index, started with a bang in January, was choppy the rest of the half, but still ended up 8% by the end of the half.

You might be asking, if the S&P 500 is always the best performing index (and it has been over 25 years), then why wouldn’t you just invest in that index and forget the rest? The answer is that other indices can do well over some periods. For most of the past 25 years, the Russell 2000 has done better than the S&P 500, up to about February of 2022, but AI hype has really pushed the S&P 500 up in the past couple of months. Meanwhile when you look at how cheap stocks are in Europe and Japan and how expensive the US dollar is, international stocks seem poised to outperform for the rest of the year. Value stocks are a good source of income and stability. There are good cases to be made to have a diversified portfolio to lower the risk level and take advantage of other opportunities.

Now let’s look at how expensive the top stocks in the S&P 500 are. One way to look at that is the price/earnings (P/E) ratio. When you buy stock, you are buying your share of the company’s earnings and you have to pay a certain price for that. The PE ratio measures how expensive stocks are. Apple’s PE ratio is now 32.37. Microsoft’s PE is 36.54, Amazon’s is 309, and NVIDIA’s is 221. By comparison, the PE ratio of VTI, Vanguard’s Total Stock Market ETF is 20.12. The major components of the S&P 500 are expensive. In some cases, much more expensive than the market overall. The question is: how much capacity do these stocks have to rise further and could they come down if they are priced for perfection? I am worried that these large tech stocks are ready for a fall (which does not mean a fall to zero).

What will happen the rest of the year? Here is my prediction:

1. The US will escape recession in 2023, although growth will moderate. Unemployment is too low, and the US consumer has too much buying power for the US to go into recession right away. It might be coming by 2025 though.
2. Inflation will stick around for the rest of the year and that means the Federal Reserve Bank will raise rates twice this year and certainly not lower rates. The bond market is pricing in a rate cut by the end of the year, and that is increasingly unlikely. This means long-term rates will rise, reducing bond prices. This is not the same as the rapid rate increases at the beginning of 2022, since 10-year bonds are paying 4% now. Even if bond prices go down, you probably won’t lose money on bonds in 2023. Still, it will pay to use short-term bonds and savings accounts and wait to invest in longer-term bonds. That might change by the end of the year.
3. The S&P 500 will not be higher at the end of the year than it is now, but there will be money to be made in other components of the stock market including international, emerging markets, and value stocks.
4. The Federal Reserve Bank will stop raising rates by the end of the year even though inflation will be above 2%. They may give an excuse, but the real reason is that the Fed does not want to see a recession in an election year because they will take the blame. It might even mean dropping rates to ensure that does not happen. It could happen anyway by the end of 2024.

As always, you should be focused on the long term with your investments. My predictions are apt to be wrong. Perhaps I am too pessimistic, or perhaps too optimistic. Good things can happen when you least expect it, and sometimes the bad things are not as bad as you expected. Please feel free to contact Mike or myself with questions about your portfolio, investing in general, or economics.

The information in this discussion is the opinion of the author and there are no guarantees on the accuracy or completeness of the data. Markets move for a variety of reasons and the author is likely to be wrong in one or more areas. Investing involves risk and your portfolio should be designed for your timeframe and risk tolerance. You should consult your financial advisor before making any investment decisions.