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I. The Recession That Never Came
In December 2022, nearly everyone was in agreement: the U.S. economy was either already in a recession or headed for one in 2023.
The list of indicators said to be predicting a recession was a long one, including a falling stock market, historic lows in consumer sentiment, and the inversion in the yield curve.
But as Yogi Berra famously said, it’s tough to make predictions, especially about the future.
And halfway through 2023, we’re still waiting for the recession prophesies to be fulfilled.
First quarter real GDP was positive (+2% annualized) and the current expectation is that the second quarter will be as well (Atlanta Fed “GDPNow” is forecasting +2.1% growth).
A key driver of that growth has been the continued strength in the labor market, with 30 consecutive months of job gains and an Unemployment Rate that hit a 54-year low in April (3.4%).
II. Tearing Down the Wall of Worry
The 27% bear market decline in 2022 featured a wall of worry that was a mile high, consisting of sky-high inflation, rising interest rates, fed tightening, the war in Ukraine, and recession fears.
Strategists were actually predicting a down year for stocks in 2023, a rarity on the perennially bullish Wall Street.
What has actually transpired? One of the best starts to a year in history, with the S&P 500 up nearly 16% in the first half.
Perhaps even more surprising was the collapse in volatility, with the $VIX closing below 13, levels we haven’t seen since early 2020.
III. A Run on the Banks
You wouldn’t know it by looking at the S&P 500’s return this year, but there was a mini-panic in the banking sector which saw the 2nd, 3rd, and 4th largest bank failures in U.S. history.
Fears of another 2008 were quickly put to rest, however, with the FDIC absorbing all losses above the limit and all depositors walking away unscathed. At the same time, the Fed provided a massive boost in liquidity to banks ($392 billion), interrupting the steady balance sheet reduction that had started in April 2022.
By the end of June, though, all of this was reversed ($393 reduction in the balance sheet). The Fed was back on its preset quantitative tightening course, with the bank failures fading from memory with incredible speed.
If someone had told you that we would see the 2nd, 3rd, and 4th largest bank failures occur in the first half of the year, you would probably assume that the stock market would be down big. But instead, the pain was limited to regional banks ($KRE -29%) while the broad markets surged higher ($SPY +17%, $QQQ +39%).
IV. Higher For Longer
In 2022, the Fed surprised the market by hiking rates much more than anyone expected, and that trend has continued thus far in 2023.
Early in the year the market was pricing in a Fed Funds Rate peak of 4.75-5.00%, with rate cuts starting in the back half of 2023.
But the Fed hiked rates above 5% in May, and after a pause in June, is now widely expected to hike once more in July (to a range of 5.25-5.50%).
As for the start of the rate cuts, expectations have been pushed out into 2024. “Higher for longer” seems to be the new mantra.
V. The Road Back to Normal
Fears of the inflationary spiral of 2021-22 continuing in 2023 have not materialized. Overall CPI has now declined for 11 consecutive months, moving down to 4% in May from a peak of 9.2% in June 2022.
When June CPI is reported next week, it’s expected to show a continuation of this trend, with CPI moving down to 3.2%.
Meanwhile, real-time inflation measures point to an even lower number, with Truflation’s gauge moving down to 2.3%.
The supply chains have healed from the many pandemic disruptions, with Freight rates back to 2019 levels.
And for the first time since March 2021, wages are outpacing inflation.
VI. Housing Market Resiliency
At the end of 2022, all signs were pointing to a sharp decline in home prices, with sky-rocketing mortgage rates leading to a collapse in affordability.
But that has yet to materialize, with the Case-Shiller National Home Price Index less than 2% below its prior high.
While demand has collapsed, supply has as well, and that lack of inventory is supporting prices.
Why are inventories so low?
62% of US mortgage holders have a rate below 4% and 92% have a rate below 6%. With current mortgage rates at close to 7%, many existing homeowners are staying put, leading to a dearth of homes for sale.
According to Redfin, the 1.37 million homes for sale in May was the fewest on record with data going back to 2012.
With fewer existing homeowners selling their homes, new homes are becoming a much larger share of the market. Investors have embraced this trend, sending the Home Construction ETF ($ITB) back to new highs.
What are they pricing in? Many more homes being built, and we got a glimpse of that in the most recent report on housing starts (+6% YoY), which showed a meaningful spike higher.
VII. Earnings Recovery
The earnings recession that began in 2022 was widely expected to continue in 2023.
But market participants did not appreciate how rapidly companies had adapted to changing conditions, and S&P 500 earnings actually showed a 5% year-over-year increase.
Driving that increase as an expansion in profit margins, which came as a surprise to many.
VIII. AI Mania & Resurgence of Big Tech
No one was talking about Chat GPT last year but all of that changed in a hurry with the service becoming the fastest ever to reach 100 million users.
The Q1 earnings season was all about AI, with mentions of the term surging higher.
NVIDIA quickly became the most prominent company in the space, leading all stocks in the S&P 500 by a wide margin with a first-half gain of 189%.
In doing so, it joined the $1 trillion club back in May.
Multiple expansion in Tech was back with NVIDIA leading the way with a price to sales ratio of over 40x.
The AI mania caused a resurgence in big tech, with the Enormous Eight (Nvidia, Meta, Tesla, Amazon, Apple, Netflix, Microsoft, and Google) generating outsized returns relative to everyone else.
The bellwether Apple closed out the first half with a market cap above $3 trillion.
Its 7.6% weighting in the S&P 500 is largest ever for a single stock with data going back to 1980.
IX. Travel Boom
Retail sales slumped in the first half of the year with year-over-year growth moving below 1%.
But while consumers may be purchasing fewer goods, they have not pulled back whatsoever when it comes to traveling.
There was an average of 2.65 million US airline travelers per day in the week leading up to the 4th of July, which was higher than any 7-day period in 2019.
Delta and United are both up over 40% this year on that trend. And with cruises expected to see a record number of bookings this summer, Royal Caribbean and Carnival have more than doubled.
Finally, conferences are back, with Vegas attendance and hotel bookings at new highs.
X. Triumph of the Optimists
There was no shortage of things for investors to worry about in 2022, but those who stuck with or added to portfolios were rewarded with one of the best first halves on record.
Nearly every major asset class moved higher, the polar opposite of 2022.
XI. Have a Great Summer
These were some of the biggest surprises in first half of 2023. As always, the narratives in the market followed prices. As prices change in the back half of the year, the narratives will change as well.
- Where will the S&P 500 end 2023?
- How about the 10-Year Yield?
- Where is Crude Oil headed?
- Is Gold or Bitcoin a better investment here?
- Will inflation continue to trend lower or is another spike coming?
- How many more times will the Fed hike rates?
- When will the next recession begin?
I don’t know the answer to any of these questions.
As Lao Tzu said, “those who have knowledge don’t predict. Those who do predict don’t have knowledge.”
What’s the alternative?
Weigh the evidence as it comes, invest based on probabilities, be forever humble and thankful, and leave the predictions to those whose job it is to entertain. That’s the best you can do in this fickle business of investing – try to find the path that’s right for you and stick with it long enough to reap the enormous benefits of compounding.
In the last 6 months of 2023, I predict one thing and one thing only: you will see many more surprises. That is the nature of markets.
If we can help guide you on your path, reach out.
Have a great summer!
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