By Tim Courtney, Chief Investment Officer
The stock market performed well overall in the second quarter following a choppy first quarter,1 and the Federal Reserve recently announced a pause in interest rate increases after 15 consecutive months of hikes.2 Against this backdrop, here are three key factors that Exencial will be closely monitoring in the third quarter:
1. Potential Recessionary Signals: The start of 2023 was shadowed by fears of an economic slowdown and potential recession.3 But with relatively strong market performance through mid-February, some of those fears subsided. Then Silicon Valley Bank, Signature Bank and First Republic Bank all failed,4 leading to pessimism again. But confidence from the market and strength in jobs numbers over the past few months has enabled optimism to make a comeback.
While the pendulum of market sentiment keeps swinging, the contracting money supply and a series of sub-50 readings for the ISM Manufacturing Purchasing Managers’ Index5 still point toward a slowdown. Yet consumer spending remains robust,6 supported by strong home values and portfolio returns. All of these indicators bear watching over the next few months to see if the recessionary outlook becomes any clearer.
2. Narrow Concentration of S&P 500: While a handful of mega-cap names are enjoying a great year so far, most of the rest of the market has been static.1 This situation indicates that the market is willing to pay a premium for stability, growth, profitability and cash flows. But it has also led to unprecedented market concentration,7 raising concerns about future valuations
Prices are now so high for some mega-cap companies that they are essentially priced for perfection. That’s a challenging scenario, since negative developments are likely to occur at some point for any company. So we hope to see signs of broadening in the market, which would imply increasing investor confidence and a healthier economy.
3. Path of Inflation: Finally, the path of inflation remains a critical factor. The Consumer Price Index increased just 0.1% from April to May, representing a year-over-year increase of only 4% — the lowest reading since inflation began to spike in March 2021.8 This welcome development has helped provide the Federal Reserve with some leeway to pause its rate-hiking initiative.
While many observers might believe that the inflation risk is now over, that’s no certainty. The current year-over-year inflation rate is still far above the Fed’s target of 2%,9 and the employment market remains relatively tight.10 With all the money still in circulation, we anticipate several more quarters of elevated inflation, which could result in additional rate hikes.
Halfway into the year, we are still getting mixed signals on a near-term recession. Many recession predictions have been wrong over the last couple of years, primarily because the economic environment created by the pandemic and subsequent policy responses is so unprecedented. In this scenario, as with almost any other, the best strategy is to remain diversified. If you have any questions, please contact your Exencial advisor.
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The ISM manufacturing index, also known as the purchasing managers’ index (PMI), is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms. It is considered to be a key indicator of the state of the U.S. economy.
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living. The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation.