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Q2 2023 Investment Commentary

Q2 2023 Investment Commentary

July 20, 2023

With the uncertainty of the debt ceiling in the rearview mirror, investors shifted their attention back to the Federal Reserve, earnings, and the economy. Despite the rapid rise in interest rates over the past year, the economy continues to hold up better than many anticipated. Corporate earnings remain relatively strong, and the labor market is resilient. With the S&P 500 just 7% below the all-time highs from early 2022, the million-dollar question is: Where do we go from here?

Stocks - Big Tech Leads the Way

The S&P 500 Index finished the second quarter higher by 10.32% in total return, while the technology­ heavy Nasdaq Composite index recorded another impressive quarter, rallying more than 1 5%. Growth continued to outperform value, with the Russell 1000 Growth gaining 14.73%, while the Russell 1000 Value gained approximately 5.44%. The banking crisis this spring took a toll on small caps, but the recent move higher in regional bank stocks has helped the Russell 2000 recover, leaving small caps higher by about 8% year-to-date.

In international stocks, the MSCI EAFE is higher by about 12% so far this year, while emerging markets are better by about 5%. Similar to the United States, inflation remains a concern for international economies. Inflation in the Euro area still sits around 6.1 %, forcing the hand of the central banks to hike interest rates further.

Market Breadth

It's been quite a year for the mega-cap stocks in the U.S., which have driven the majority of returns year­-to-date. Optimism around Artificial Intelligence, or Al, has helped fuel the rally in technology stocks through the first half of this year. The seven largest stocks in the S&P 500 now make up more than 2 5% of the S&P 500. These stocks consist of Amazon, Apple, Google, Meta (Facebook), Microsoft, NVIDIA and Tesla, and have returned on average approximately 80% so far this year. The average YTD return for the rest of the stocks in the S&P 500 is just shy of 6%. Apple, the largest company in the world, now boasts a market capitalization of approximately $3 trillion. This is larger than the entire combined market cap of the Russell 2000. We believe the concentration of U.S. indices in mega-cap tech stocks highlights the importance of diversification over the long term, even when it doesn't necessarily work in the short term.


Clipping Coupons Interest rate volatility has started to subside from extremely elevated levels throughout the first quarter of this year. After starting the quarter around 3.50%, the yield on the 10-year Treasury note finished the second quarter trading around 3.85%. This translated into slightly negative price returns for bond investors, with the Bloomberg US Aggregate Index lower by about 0.38% for the quarter. Municipal bonds benefited from tighter spreads across the board, and the Bloomberg Municipal Index managed to sneak out a positive return of about 0.04% for the quarter.

Despite the volatility in interest rates, both taxable and municipal bond indices are higher by nearly 2.5% on the year. So far this year, higher starting interest rates and coupons have allowed bond investors to clip their coupons (interest payments) and create a buffer that insulates them against short-term fluctuations in interest rates.

Federal Reserve - Pumping the Brakes

As anticipated, the central bank paused on rate hikes at its most recent policy announcement on June 14, holding the federal funds rate steady at a target range of 5% to 5.25%. The more interesting part of the announcement came from the Fed's updated summary of economic projections. Despite the recent pause, the FOMC members were a bit more hawkish than we would have anticipated, with the median member of the Fed expecting two more rate hikes before year-end. This would leave the fed funds rate at a range of 5.50% to 5.75% by year-end. As far as the markets are concerned, futures currently are pricing in about a 75% chance of an additional 25 basis point (0.25%) rate hike at the next Fed meeting in July, with a much lower chance of any additional hikes going forward. If core inflation readings continue to move sideways, the Fed's forward guidance should give them some much-needed breathing room to take interest rates higher, if warranted potentially.

Economic Outlook

In addition to the Federal Reserve's outlook on interest rates, the central bank also provided upward revisions to their economic expectations. The Fed now expects the U.S. to grow real GDP by approximately 1 % in 2023, up from the first quarter's estimate of 0.6%. In addition, they are forecasting the labor market to remain strong, with the unemployment rate gradually increasing from the current level of 3.7% to around 4.1 % by year-end. This falls largely in line with the incoming economic data, which shows a resilient economy and consumers. With that said, monetary policy is known to have long and variable lags. The money supply is shrinking, credit conditions have tightened, and there could still be unknown consequences to higher interest rates that have not yet shown up in the data, which could eventually push the economy into recession.