By Edward Miller, CFA®, CMT®
As I wrote in our 1Q letter, 2023 continues to be a near mirror opposite of 2022. Whereas through the 2Q of last year the S&P 500 was down -20%, this year the S&P 500 is up 16.9% through the 2Q. Technology, Consumer Discretionary and Communication Services were the three worst performing equity sectors last year and yet they’re the best performing sectors so far in 2023. Even US bonds, which had their worst year in history last year, are up a respectable 2.1% through the 2Q. The best performing asset class last year, commodities, continues to be the worst performer this year, down nearly -8% YTD.
So one may reasonably ask, “What is going on here? Why all these reversals in performance less than one year later?” Initially, I can’t help but recall what was once told to me many years ago, that the market will do whatever it can to prove most people wrong most of the time. I laughed when I first heard this adage, but admittedly there’s much truth behind it. Investors as a group (“the market”) are always trying to digest current info and data and then discount the future based on this info/data. When the info/data changes, so too do markets. Last year, inflation continued to rise, the Fed was raising rates and it was increasingly likely a recession was imminent. And yet this year has seen inflation subsiding and the Fed indicating an end to rate hikes is near. In response, duration-sensitive growth equities (e.g. technology and consumer cyclicals) have surged, bonds have recovered and most commodities have retreated from their 2022 peak levels. It’s as if suddenly investors were convinced that the ever-elusive “soft landing” scenario for the economy has become a real achievable possibility.
With the change in years turning market sentiment from bearish to bullish, it must also be mentioned that the splashy debut of artificial intelligence (AI) late last year in the form of ChatGPT, and then Google’s Bard earlier this year, helped to further fuel the rapid shift in risk appetite for investors. Any company perceived to greatly benefit from AI, with accelerating future growth to come, likely saw their stock price liftoff earlier this year.
In fact, so far in 2023, this AI-effect has been clearly evident in the performance of the S&P 500 Index. Through the 2Q, the bulk of the positive performance for the S&P 500 can be attributed to just seven AI-related stocks: Apple, Microsoft, NVIDIA, Meta (Facebook), Amazon, Tesla and Alphabet (Google). The following chart best displays the degree to which these seven stocks have become glaring outliers within the Index.
Collectively, the “Magnificent Seven,” as they’ve been dubbed, have risen 58% YTD compared to just a 5% gain for the remaining 493 stocks in the S&P 500. Needless to say, such extreme concentration of returns within the Index makes it exceedingly difficult to outperform the benchmark. Not owning any or all of those seven stocks has most likely resulted in underperformance versus the S&P 500.
Frankly, I cannot recall a time when so few stocks fared this well in the S&P 500 compared to the other Index constituents. A similar phenomenon did occur during the dot-com bubble of 2000, when the internet was expected to deliver massive growth to several technology companies and their stock prices soared as investors front-loaded extremely optimistic assumptions into their valuations. Unfortunately, we know what happened next, and unless it’s different this time (which it usually is not), I remain very skeptical that this huge performance disparity can sustain.
As written in our 1Q investment letter, “Our client portfolios have been positioned defensively since late 2021 and have remained so to date.” Although we recognize and respect the more bullish message being sent by the S&P 500, many indicators we follow that historically have proven to be very prescient remain quite bearish. As an example, the following exhibit from ClearBridge Investments lists twelve key economic indicators that usually turn red or negative before a recession.
Notice the current status of the twelve indicators looks very similar to past recessions (excluding the very brief COVID-related recession in 2020).
Also, the NY Fed’s recession gauge recently hit a 40-year high, currently forecasting a 67% likelihood of a recession within twelve months.
Lastly, seasonally the market is entering its most difficult period in the calendar year. As the following chart depicts, the S&P 500 rally this year (red line) is likely to face some headwinds over the next few months, at least based on seasonal tendencies.
As always, if you have any questions, please feel free to call or email. The entire team at Measured Wealth wishes to thank you for entrusting us to deliver on your financial goals.
Ed Miller, CFA, CMT
Chief Investment Officer
Measured Wealth Private Client Group
Important Disclosures
Historical data is not a guarantee that any of the events described will occur or that any strategy will be successful. Past performance is not indicative of future results.
Returns citied above are from various sources including Factset, Bloomberg, Russell Associates, S&P Dow Jones, MSCI Inc., The St. Louis Federal Reserve and Y-Charts, Inc. The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Investing involves risks, including possible loss of principal. Please consider the investment objectives, risks, charges, and expenses of any security carefully before investing.
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