2023 Mid-Year Market Outlook: Out of the Woods?

Most of what was expected to happen in the first half of this year actually happened. Inflation has eased, US economic growth has slowed, the Federal Reserve appears to be nearing the end of its rate hike cycle, and the US government’s debt ceiling is in a stalemate. A potential default was resolved before.

One thing we didn’t expect was the overall strength of the stock market. We thought the stock market could face rough waters in the first half and clear ups in the second half.In fact, the S&P500^® As of June 14, the index is up more than 13% year-to-date.^thMeanwhile, the Nasdaq Composite rose more than 30%, an unexpectedly strong performance albeit driven by a handful of mega-cap stocks.

Fixed income market returns were positive across almost all asset classes, from short-term Treasuries to high-yield corporate bonds, through early June, and we generally expect more similar returns in the second half of the year. We still think international stocks are attractive, supported by more attractive valuations and rapid earnings growth, but a surge in artificial intelligence (AI) stocks could boost relative U.S. stocks further I also recognize that there is

So are we out of the woods yet? No, the US stock market is linked to continued uncertainty about Fed policy, weak corporate earnings, possibly bubbled investor sentiment, and the risk of a “rolling” recession affecting various regions and industries. and may still experience volatility or weakness. You’re going to be in deep recession. Get an overview of our current thinking, with links to more detailed reports.

While overall equity index performance has been relatively strong year-to-date, performance below the surface is more reflective of ongoing macro uncertainties such as:

1. Weak leading indicators. The Conference Board’s Leading Economic Index (LEI), which has historically had a solid track record of leading the top and bottom of the economy, is down nearly 10% from its peak 16 months ago.

2. Institute for Supply Management (ISM) prices suggest lower inflation. Manufacturing prices are on the decline. Service prices are trending downward, but have not yet contracted. The good news is that this bodes well for the direction of inflation, but he has two problems. First, the decline in ISM service prices has yet to translate into a similar decline in the core services inflation indicator (which the Fed monitors closely as it adjusts its anti-inflation policy). Second, a significant drop in both ISM price components could historically coincide with a recession.

3. There are cracks in the labor market. Getting inflation back into the bottle without a commensurate rise in unemployment has been the goal throughout the Fed’s rate hike cycle. We continue to find it difficult to achieve. For example, the job-seeking rate, which shows how many previously unemployed people are now able to find work, has fallen to its lowest level since September 2021. If this rate continues to fall and unemployment claims rise, we expect the cracks in the labor market to widen and slow (if not negative) employment growth.

4. A credit crunch may be imminent. Lending standards are tightening, which is affecting corporate earnings, arguably the most important direct fundamental underpinning the stock market. After about three quarters of lag so far, the tight lending environment suggests further downside to earnings for the S&P 500.

5. The market rise needs to be further expanded. Stock market performance in the first half was “top heavy”, with some large-cap stocks leading the rally. It is not uncommon for large caps to dominate the performance of market capitalization weighted indices such as the S&P 500 and Nasdaq, but concentration risk increases when the majority of constituents underperform the overall index. Recently, there are signs that the bull market is starting to expand. At the end of May, only 15% of the S&P 500 had outperformed the overall index over the past three months, but as of June 9, that number had improved to 24%.^th. Continued improvement would bode well for the market.

6. Soaring AI stocks could be a bubble. Launched in late 2022, ChatGPT, an artificially intelligent chatbot, has surpassed 100 million users in just two months. AI can have a huge impact not only on how we live and work, but also on productivity and perhaps long-term inflation (or disinflation) trends. The problem is that the timing of all this is uncertain, even if enthusiasm is certainly growing.

7. Investor sentiment could bubble. One of the emerging risks heading into the second half is investor sentiment. We investigate a myriad of both behavioral and attitudinal sentiment indicators, including the NDR Crowd Sentiment Survey, which integrates seven different sentiment indicators. Right now, the stock market is in the best zone (based on history). The problem is that the surge of optimism can become excessive, making the outlook even more volatile or weaker. We would like to keep an eye on the situation of sentiment toward the second half.

Surprisingly, despite the high volatility in the bond market in the first half of the year, there was not much change. While short-term yields have risen on the back of the Fed’s tightening policy, yields on US Treasuries with maturities of three years or more have remained virtually unchanged since the beginning of the year.

The Fed kept interest rates unchanged at its policy meeting in June, but hinted at the possibility of another rate hike later this year. In other words, a rise in short-term interest rates is still a concern. However, we still expect yields on US Treasury bonds, which mature in two years or more, to continue to fall as the factors that initially pushed Treasuries lower – tightening monetary and fiscal policies – continue. The yield curve is likely to remain inverted until there is a signal that the Fed will move to accommodative policy.

After more than a year of tightening policy, risks to growth and inflation appear skewed to the downside, as the economy responds to changes in Fed policy late. Moreover, fiscal policy has turned from a positive to a negative factor for the economy. The fiscal impulse, which measures the contribution of fiscal policy to gross domestic product (GDP) growth, turned slightly negative after a surge during the pandemic.

The second half of the year may be less dramatic, but moderater returns for investors, due to what we call the ‘cardboard box recession’. In a typical global recession, all sectors of the economy suffer. But for much of the past year, the economic pain has been concentrated in manufacturing and shipping, sectors where products and services tend to include boxes. Demand for corrugated linerboard (from which most corrugated boxes are made) is declining, consistent with the pattern seen during previous recessions dating back to 1997.¹ By contrast, the service industry, which accounts for the largest share of output in the developed world, continues to grow. The Global Purchasing Managers Service Business Activity Index remains well above 50, the line between contraction and growth.²

The tech-driven narrow progress in the US stock market contrasts with the broader performance of international equities. Equal-weighted indices represent an “average” stock, with each stock having the same weight. Equal-Weighted MSCI EAFE Index of International Equities Gains Well Over 20% from End-October 2022 to June 13, 2022 (U.S. Dollar Equivalents)^th, will meet the technical definition of a new bull market in 2023. But the equally-weighted S&P 500 index is up just 5% over the same period. In general, the more stocks that contribute to the overall market boost, the more supportive the market. Global equities averages continue to outperform U.S. equities, providing broad support for the bull market in global equities.

We remain neutral on the performance of emerging market equities this year, but they appear to remain dependent on the US-China tensions as well as the continued economic recovery in China (MSCI Emerging Markets Index Recall that Chinese stocks are the most heavily weighted (30%). Geopolitical tensions appear to have had little impact on China’s domestically-led economic growth, but appear to be weighing on Chinese stocks. China’s stock market fell after the small-balloon controversy erupted in early February, despite a strong, better-than-expected economic performance. The recession has disrupted a three-month recovery of 60% that existed from the end of October to its year-to-date peak on January 27.^th.

With the U.S. debt ceiling deal in place until early 2025, global central banks moving toward a moratorium on interest rates, banking stresses stabilizing, and signs of easing potential U.S.-China tensions, the 2023 There may be fewer surprises in the second half. Global equity market dominance, suspended in May, could resume in the second half of this year, but equities face headwinds if weakness spills over to the services sector as inflation and job growth both slow there’s a possibility that.