In the heat of summer, returns across both stocks and bonds were decidedly cold. The main driver of underperformance for the month was expectations of the future path of interest rates.
June continued a run of surprising stock market returns for the year. The S&P 500 index was up 6.61% for the month, bringing the return this year to 16.89%. The strong performance was not limited to the S&P 500, with foreign and small US stocks all participating in a strong rally for the month. Notably, small and mid-sized US company stocks outperformed the S&P 500, as measured by the Russell 2000 Index’s 8.13% gain.
One month does not make a trend, but it is comforting to see more stocks post positive performance.
For much of this year, a few large companies have had outsized gains, moving the stock market up. These companies have been aided by the promise of Artificial Intelligence (AI). The stock market was positively impacted by the debt ceiling deal that was completed at the end of May, and the Federal Reserve pausing rate increases in June. Federal Reserve (Fed) Chairman Jerome Powell did not provide the markets much comfort by indicating that one or more rate increases may still be coming this year. More rate increases could put a damper on market returns, and potentially push the US into a recession.
It typically takes 12-18 months for increases to work their way through the economy.
It is month 16 since the first increase of the cycle and month 13 since the first supersized 0.75% rate hike. Inflation has come down significantly since the first hike but is still not at the Fed’s 2% target. Several economic indicators are still flashing warning signs, global growth continues to slow, and banks are getting tighter with lending; these are all reasons to be pessimistic about the stock market and question if the returns can hold up throughout the rest of the year. On the optimistic side, corporate earnings were stronger than most analysts predicted, unemployment is low, and inflation continues to cool led by significant drops in commodity prices. If earnings continue to hold up, the US market could finish the year strong.
The US is sitting in an enviable position compared to most other markets.
In Europe, rates continue to move higher as central banks across the continent battle inflation. Per OECD, the UK’s inflation is still rising, checking in at 7.9% as of May. The European Union’s May reading was down slightly from the previous month but remains high at 7.1% per Eurostat. Raising rates pressure both stock and bond returns, but much like the US, the major stock market indexes have moved up throughout the year. The war in Ukraine continues to be a wild card for all markets. Additionally, China’s economy has continued to slow, which creates implications for the rest of the world. The change late last year from a highly restrictive COVID policy to essentially no restrictions was thought to be a catalyst for growth as it was in the US, but that has not been the reality. Slowing economic growth in China takes pressure off commodity prices, but also hurts countries and companies that are dependent on exports.
At the midway point of 2023, we continue to favor US markets relative to foreign markets for stocks and bonds.
Although there are reasons to be optimistic, the pressure in the financial system continues to build globally. All major indexes for stocks and bonds are up for the year which makes it a great time to reassess the risk in your investment portfolio and create or revisit your financial plan. Interest rates are higher, meaning that bonds and other fixed income investments are now providing more income, making them attractive and a viable alternative to stocks. A financial plan is a great way to understand how your investments are utilized to make your future more secure.
Investment commentary by Jason Flores, CFA, CAIA – Executive Vice President & Chief Investment Officer at Central Trust Company.
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