Market Update 2nd Quarter 2023

Markets began the second quarter with muted action, as investors weighed the potential for additional banking turmoil. Major indices were stuck in neutral until finding escape velocity in mid-May. The debt-ceiling drama led markets to believe the Fed was done raising rates, only to see a resolution and predictions of more hikes to come. Along the way, AI based tailwinds brought promise and whispers of another tech bubble.

Markets Rally

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Description automatically generatedThe second quarter saw total returns (including dividends) driven higher for the major indices. The S&P 500 rose 8.74%, the Dow Jones Industrial Average 3.97%, and the Nasdaq Composite 13.05%. The Bloomberg US Aggregate bond index fell slightly, down .84% on rate uncertainty. Markets are mainly being pulled higher by tech stocks, with chip makers and AI-related tech companies leading the charge. The five largest companies in the S&P 500 now account for nearly 25% of the index’s market capitalization. They are also responsible for the majority of gains in the index year to date.

The Federal Reserve raised interest rates in May, bringing the Fed Funds rate to 5-5.25%. Inflation is slowly coming down, but not as quickly as the Fed would like. The labor market is still strong, with unemployment near all-time lows. However, the number of job openings is declining, and wage growth is slowing for workers who change jobs. The Fed believes that these factors warrant further tightening, but it paused rate hikes in June to assess the impact of the previous increases. The Fed is also reducing its balance sheet, and banks are tightening lending standards.

AI: Bubble, or the Future?

Artificial Intelligence, or AI, is driving the conversation in every corner of the market. Some believe it will revolutionize white-collar jobs, and some believe it’s the next internet bubble. Time will tell the significance of AI’s impact on the markets. For now, we’ve asked for assistance from Google’s Bard regarding the results of bank stress testing during the second quarter. Here are the results:

The Federal Reserve prepares our banks for worst-case scenarios by conducting annual stress tests. The results of the most recent stress test, released in Q2 2023, show that our banking system is far healthier than many people believe. The stress test evaluated 23 large banks, and each one passed. The test simulated a severe global recession, including a 40% decline in commercial real estate and housing prices and a 10% increase in unemployment. Even under these extreme conditions, the banks were able to maintain their capital levels and continue lending. In addition to the recession, the stress test also included a market shock with higher inflation and interest rates. This was a new element for the test, and it was not expected that the banks would pass it. However, all 23 banks did pass, demonstrating their resilience even in the face of unexpected challenges. The results of the stress test show that our banking system is stronger than ever before. This is good news for consumers and businesses, as it means that banks will be able to continue lending even during difficult economic times.”

The Consumer

The U.S. Consumer has shown resilience while welcoming slowing inflation. We are a long way from broken supply chains and stimulus payments. Most counts of excess savings from the pandemic show the consumer still has a bit of work to do before spending all that was accumulated. As the job market loosens and lending tightens, we should slowly see that surplus turn back to normal (lower) levels of consumer savings. Some signs point to that conclusion being nearer than most would like. This quarter, 17% of new cars sold carried a payment of over $1000 per month. Credit cards delinquent for 90 days or more are on the rise. Student loans appear ready to begin repayment in the third quarter with anticipated relief struck down in recent court rulings. Consumers do face some headwinds but still have some gas left in the tank.

Debt Ceiling Drama

2023 will find itself added to the list of years in which Congress plays fast and loose with the full faith and credit of the United States. This has happened before and unfortunately is likely to happen again. While no one really believed a default would happen, the mere discussion gave pause to other factors and drove the narrative. Luckily for us, a resolution was found, and markets were able to move past the exercise. We have another bout conveniently scheduled for after the election season. U.S Treasurys underpin most of the world’s financial system and need to be a haven for global reserves. This is the last place either party should look to extract political favor.

We remain optimistic about long-term returns for equity and bond markets. An overlooked side effect of Fed rate hikes is the exposure of firms that have over-levered or mismanaged capital. This is where prudent investment selection and planning play a key role. Your plan should involve companies that properly allocate resources and have stood the test of time. A well-diversified portfolio of stocks and bonds can provide sufficient income for the long term. This is a welcome change of pace from the low-interest environment many have invested in throughout the last decade. Stick with high-quality investments in necessary areas of the economy and stick with your financial plan.