At Nixon Peabody Trust Company, we continually evaluate real-time economic data and short- and long-term forecasts to build customized strategies that grow your money.
If the flood of financial headlines leaves you a bit confused, you can be confident that we’ve designed a portfolio-positioning strategy to maximize your success.
Portfolio positioning
High-quality fixed-income investments are a compelling option for many clients, with inflation easing and interest rates at 16-year highs. High-quality bonds are likely to be more resilient in an environment of higher interest rates and uncertain economic growth.
The economic environment also lends itself to a focus on selectivity and diversification within equity portfolios. Well-managed companies with strong balance sheets, and the ability to grow market share and participate in growing-end markets, are best prepared to thrive in the current environment. Diversified equity portfolios should include a mix of growth, value, and defensive stocks.
Thoughtful rebalancing is just as important as diversification—trimming back on investments that have been strong performers and selectively adding to weaker performers. The market rally during the first half of the year was relatively narrow—a small number of stocks accounted for most of the equity market returns. Consequently, we are assessing holdings that may have moved “too far, too fast” to determine whether to sell or reduce our positions.
So let’s dig deep on some key factors driving the Q2 and first half 2023 market performance. If you have questions or comments—about your personal portfolio or any of the trends and strategies we’ve outlined here—please reach out to us or any member of your Nixon Peabody Trust Company team. We’re always happy to hear from you.
Q2 2023 in review
Stock markets surged to close the second quarter, rallying in June despite concerns that a tightening Fed, banking stress, and dwindling consumer savings could be catalysts for a recession. Equities responded positively to progress on inflation, which could pave the way for the Fed to pause rate hikes before year-end and boost expectations that any recession would be short and shallow.
| Q2 | YTD | |
| Equity | ||
| MSCI All Country World Index | 6.33% | 14.26% |
| S&P 500 Index | 8.74% | 16.88% |
| NASDAQ Composite Index | 13.05% | 32.32% |
| Russell 2000 Index | 5.19% | 8.06% |
| MSCI EAFE Index | 3.19% | 12.16% |
| MSCI Emerging Markets Index | 0.97% | 5.02% |
| Fixed Income | ||
| Bloomberg Aggregate Index | -0.84% | 2.09% |
| Bloomberg 1-5 Year Gov/Credit | -0.62% | 1.19% |
| Bloomberg Municipals | -0.10% | 2.67% |
| Bloomberg 3-Month T-Bill | 1.22% | 2.35% |
The S&P 500 gained nearly 17%, its best first half since 2019. However, market leadership remained narrow during the quarter and for the half-year period. According to investment research provider Strategas, 76.9% of S&P 500 Index performance in the first half was driven by the 10 largest constituents of the index, the second-most concentrated positive performance in the past three decades. Nvidia, Apple, and Amazon were among the small number of stocks that accounted for much of the market surge. The 32% gain for the NASDAQ Index was its best first half performance since 1983 and reflects a rebound in many of the leading technology stocks that performed poorly in 2022. Artificial intelligence was an important factor contributing to market sentiment, with the rise in visibility of ChatGPT and optimistic AI-earnings guidance from Nvidia in late May among the noteworthy developments.
Growth stocks continued to lead the market rally, while value stocks rebounded less vigorously from the first quarter amidst upheaval in the financial services sector. The Russell 1000 growth index outperformed its value counterpart by more than 23%. In S&P 500 sector terms, technology, communications services, and consumer discretionary were market leaders. Utilities, energy, and healthcare lost ground during the first half of the year.
The market rally outside the US faded in the second quarter. Europe’s economic growth slowed after better-than-expected results earlier in the year, while investors were disappointed by China’s economic performance after easing its “zero COVID” policy.
The bond market declined slightly as the Fed signaled it may not be done raising rates. The market consensus at quarter-end was that the Fed would resume hiking rates in July after holding steady in June. The yield on the two-year Treasury Note ended the quarter at 4.87%, dramatically above year-earlier levels.
Recession watch
Many economic indicators suggest that the US economy is heading toward a recession. Interest rate-sensitive segments of the economy have already slowed in response to Fed rate hikes. Credit conditions are tightening. And consumers have depleted much of the savings that accumulated during the pandemic.
The transmission mechanism of monetary policy takes time, and the drag on growth from Fed hikes over the coming year is likely to extend more broadly. Consequently, a recession is a more likely outcome than a soft landing in which the economy avoids recession. Although a recession may be coming, there are compelling reasons to think it is likely to be mild. Household debt and debt servicing ratios are far below the heights reached during the global financial crisis. The housing market is slowing, but in contrast to 2008, lending standards are much stronger, housing inventories are much lower, and most US mortgages are fixed rate rather than adjustable.
The job market
The June jobs report supports the picture of a gradually cooling labor market. The labor market remains tight, but there are indications that demand is gradually slowing in a way that over time will bring supply and demand into balance. The strong labor market is not inherently a problem; however, the Fed’s concern is that a tight labor market becomes a problem if wage growth stays persistently high and fuels inflation. The Employment Cost Index was 4.8% in the first quarter—a number persistently above 4% could increase the Fed’s worry.
The ratio of job openings to job seekers remains high, in part because labor participation has not returned to pre-COVID levels. The Fed’s hope is that job openings continue to come down while labor participation rebounds, allowing the job market and wage growth to soften without creating a significant increase in unemployment.
Inflation and central bank policy
The Fed held rates level in June, with investors debating whether the break was temporary or the beginning of a longer pause. Given inflation remains above the Fed’s target of 2% and the job market is still strong, the consensus gradually has shifted to expect the Fed will raise rates in July and possibly again in September. The Fed has signaled that it views tamping down inflation as a higher priority than avoiding a recession.
Artificial Intelligence
Artificial Intelligence (AI) was an important driver of market sentiment in the second quarter. There has been a notable surge in AI-related activity, including AI startups and patent counts. Surveys also show that the business sector is ramping up its AI-related investment. AI is potentially transformative technology that will foster innovation, offering far-reaching opportunities and consequences. Although we are enthusiastic about the long-term potential of AI, we are mindful of the need to be realistic about how quickly its growth potential will be realized. There typically is a long lag between technological progress and the commercialization of new, innovative ideas. Even if AI is as transformative as many experts suggest, it may be several years before it contributes to meaningful growth in productivity.