The News at Home and Abroad
Domestic news in the second quarter of 2023 was dominated by the debt ceiling—an issue we always held would be resolved by the government and the so-called crisis averted. Still, the 24-hour news cycle breathlessly reported on every meeting and call between Congress and the White House until an agreement was reached in early June, and we all promptly forgot about it and moved on.
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By Daniel Yu, CFA®, CFP®, AIF® – Co-Chief Investment Officer and Senior Investment Manager
& Robert Papelian, CFA®, CMT, CFP® – Co-Chief Investment Officer and Senior Wealth Advisor
U.S. stocks rose during the quarter, with gains accelerating during the month of June, meaning the S&P 500 increased over 6% in the second quarter with about two-thirds of the gain occurring in June, the last month of the quarter. Gains were particularly concentrated in a small number of large cap technology companies. Looking ahead, it is not our view that a handful of companies will dominate the market over the next several years (especially if we find ourselves in a recession, it’s unlikely they would lead us out of it). Rather, we believe there will be broader participation by smaller and mid-sized companies, as higher rates have changed the economic landscape. We also believe that quality and profitability will continue to be important investment factors across companies of all sizes, as working capital decisions will become more complex in the current environment, in light of the higher cost of debt.
Looking at the larger landscape, we continue to focus on international equities, as well. As growth stocks rally in the U.S., making our market more expensive, and with many foreign regions facing greater economic pressure – with the Eurozone in a recession – international equity valuations are very attractive relative to domestic markets. We know that disciplined investing over longer periods is a more successful approach than market timing, and so we’ve been opportunistically adding exposure to international assets for our clients over the last few quarters, and we will continue to do so as long as we find attractive opportunities. We expect international investments to experience volatility as regions face inflation issues in addition to the ongoing geopolitical instability caused by the Ukraine/Russia war. However, we see these more as shorter-term opportunities.
The Markets
Throughout the second quarter, the Federal Reserve also sought to bring inflation back down to its 2% target. The Fed funds rate has caught up to inflation as measured by the CPI, and this dynamic has typically created a backdrop for bonds to perform well over the following 12+ months. Given higher rates, we are finding more credit opportunities, with the understanding that volatility may persist, but higher current income will help to mitigate some of the volatility which may be felt when spreads widen.
The yield curve remains quite inverted. What we can glean from this, however, is that the market is pricing in a combination of lower future inflation and slowing economic growth. This is a different story from what the stock market is telling us: whereas stocks seem to have priced in a bit of an economic slowdown and are already looking ahead, yield curve developments are continuing to react to economic data updates in an effort to identify when, how deep, and how long a recession may occur—or, at the very least, how much more of a slowdown we will experience, if not an official recession.
The Impacts of Artificial Intelligence (AI)
This past quarter, we saw AI hit the news, and we certainly expect some exciting and perhaps challenging times ahead as AI begins to impact our lives. There will be some worrisome questions as well, such as how many jobs will be displaced in the economy as more companies use AI to automate tasks and activities. The true impact to the broader economy is impossible to predict with accuracy at this point, but studies do exist. PricewaterhouseCoopers, for example, conducted an analysis and believes automation (including robotics and other developments beyond AI) could replace around 30% of jobs by the mid-2030s.
For now, we believe opportunities in the public markets to invest in AI will be concentrated in a few megacap companies which are already profitable. Meaning, we do not see this as a bubble to worry about. There are 10-15 large companies out there which play key roles in the AI movement; as products and services are rolled out, sales will pick up, but the bottom line from companies buying these products should improve as well. In other words, with large, diversified revenue sources, AI might help give producers a bit of a boost through improved sales, while companies benefiting from AI will likely see some improved sales, but more importantly, lower operating costs that translate to an improved bottom line.
What’s Ahead
We wouldn’t be surprised to see news on artificial intelligence persist through the end of the year and beyond, but it may well take a back seat to coverage of the 2024 elections. Regardless of one’s political leanings, we find it important to remind investors that in the long-term, the capital markets are driven by economics, but to recognize there can be temporary
(short-term or intermediate-term) disconnects between what the stock market is telling us and what the anticipated economic impact of an election may be.
In the coming months, there will be a lot of noise coming from the political forums, but we believe in the short-term it will be just that: noise. As we think about our strategic allocations to our investments, we will be focused on the specific and more granular impacts of the fiscal policies and themes being proposed by candidates. We will weigh those impacts as they relate to our economic and market outlooks and will adjust our approach accordingly. While we’re sure more noise will be directed at the masses before the year ends, we know it is wise to follow the economics and maintain a long-term outlook as to how we approach the capital markets.
© 2023 REDW Wealth LLC. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice. Advisory, Assurance, and Tax is offered through REDW LLC. Wealth Management is offered through REDW Wealth LLC.
