“Optimism often sounds like a sales pitch; pessimism sounds like someone trying to help you.” – Morgan Housel
June, historically a flat month for the stock market, was good for equity investors. All of the US indexes we follow were positive for the month, with the Dow Industrials, the S&P400 and the S&P600 all turning positive for 2023. The global stock indexes were also positive for the month. The dollar and the bond index both weakened as commodities, still down for the year, edged higher for the month.
All data as of 06/30/2023, Source: Wells Fargo Investment Institute. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
It is extremely helpful to think more like an engineer than a lawyer when contemplating the future direction of the stock market. Thinking like a lawyer starts with a theory or outlook, then finding information that confirms the desired story. In the world of investing this would be the perma-bulls (who almost never see bad times for the markets) and the perma-bears (those who see doom and gloom right around the corner).
Approaching the markets like an engineer would be to seek out the facts – what is happening today with an eye toward what has happened in the past – in forming one’s analysis. This is our preferred approach.
With the first half of the year over, we thought it would be a good time to take a look back at what has transpired over the previous six months with an eye toward what the next six months could bring investors.
First Half of 2023 in Review
After a hard 2022 for investors, it was easy to enter 2023 as a pessimist. The background wasn’t the best:
- The major stock market indexes we follow were all down double digits, as was the Aggregate Bond Index.
- An aggressive Federal Reserve increased short-term interest rates from just above zero to almost 5%.
- CPI Inflation, while lower than the June 2022 peak of 9.1%, was annualizing at 6.5% at the start of the year.
- Many economists and market observers were calling for an economic recession.
So far, the pessimists have been mostly wrong. Big picture, things look good with the S&P 500 up 13% since the start of the year. Those gains have accelerated in recent months with 5% of those occurring in June and 6.5% in the second quarter. The technology-heavy NASDAQ index has been even better, up 30% YTD.
Chart #1: www.stockcharts.com Data 01/01/23 – 06/30/23 as of 07/01/23. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results.
Under the surface, however, 2023 has been more challenging for investors. The Dow Industrial Average, S&P 400 (Mid-cap), S&P 600 (small cap) and the equal-weight S&P500 all substantially lagged S&P 500 performance.
This is the “stealth bear market” we talked about last month.¹ The performance of the S&P500, because it is a cap weighted index, is heavily influenced by the largest companies by market cap that are in the index. Sometimes referred to as the “MegaCap-8,” is a group of eight mega-cap technology stocks that have been driving the index higher.
What About the Next Six Months?
We continue to believe that in order for the bull market to truly have legs, future gains have to include not just the MegaCap-8, but also the other 492 stocks that make up the S&P500 as well as the broader stock market. According to our analysis, the move out of the stealth bear market may have started during the month of June.
Last month the Equally Weighted S&P500 was up 7.5%, the Mid-Cap S&P400 increased 8.96%, and the small cap S&P400 gained 8.02% – all outperforming the S&P500. We view this as a great first step. Moving forward, we believe these parts of the market need to continue to trend higher for the bull market thesis to be correct.
Chart #2: www.stockcharts.com Data 01/01/23 – 06/30/23 as of 07/01/23. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results.
While the move higher in the market indexes is positive, we are of the opinion that the fundamentals behind the economy need to continue to perform well to support higher equity values. And economic fundamentals will be affected by the direction of both inflation and interest rates.
On the inflation front, the consumer price index for May 2023 increased 0.1% for the month and at a 4% rate from a year ago, marking the lowest rate in two years². The core inflation number (excluding food and energy) rose 0.4% for the month and 5.3% year-over-year. All numbers were in line with consensus estimates and we view this as a positive.
Regarding the interest rate environment, at the June 14, 2023 meeting of the Federal Reserve (The Fed), they decided to not increase short-term lending rates. This comes after 11 consecutive increases in short-term rates. At that time and in the week since, Chairman Powell has indicated a bias toward an additional one or two increases in the coming months. With that being a known expectation, any additional increases beyond that we would view as problematic, but an extended pause or a statement that the rate hike cycle has been completed we believe would be a positive for the stock market.
Putting it all together, we are positive for the second half of 2023.
We get that optimism about the future can come off sounding like a sales pitch. Taking a more pessimistic tone can sound smart, even helpful. Some are always the former, others the latter. At Magellan Financial we prefer to take a more realistic approach by looking at the evidence in front of us when giving advice – think like an engineer – then coming to thoughtful conclusions based on analysis, not a predetermined idea.
The world has changed in many ways since the pandemic shut everything down in 2020. There are real problems like the Federal Government deficit, inflation, and climate change that cannot be overlooked. At the same time, there are positive changes that we believe will offset much of these negatives.
But we want to leave you with two thoughts. First, the market moves in cycles from of positive returns (Bull market) to periods of negative returns (Bear market). There are always reasons for why the market direction has turned, but the reasons aren’t the point.
Chart #3: JPMorgan 1st Quarter 2023 Guide to the Markets Past performance is not a guarantee of future results.
The second thought we have is that moving forward, the S&P500 achieving new highs in the next few years doesn’t feel unreasonable to us. The chart shows that an annual 6.4% return for three years or 8.8% for two years would get the index back to the highs.
If this sounds ambitious to you, history suggests it is not. Of course, past performance is not an indication of future results. Nonetheless, over the past 20 years (2002 to 2022), the average annualized return on the S&P 500 has been 8.19%³.
There were a lot of challenges the stock market had to reckon with over the last 20 years, including the Great Recession. Over the next 10-20 years there will likely be challenges big and small for your investments. Our expectation is that the S&P500 will not only get back to its January 2022 highs, but also move higher in the years and decades to come.
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Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
The CRB (Commodity Research Bureau) Index measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodities trades.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents.
U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. The index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.