Assset /Invesmnent Management
Q3 2023 - Policy uncertainty, elevated inflation, and volatile markets require a different investment approach.
Absent a brief period of bank-stress related volatility, markets have displayed notable strength throughout 2023 as economic data has remained resilient and inflation has slowly cooled. Markets have displayed almost unwavering strength year to date (YTD). Markets have moved higher while volatility, as measured by the VIX Index, has fallen to levels not seen since just prior to the pandemic. Credit markets rose alongside equities with riskier, CCC-rated credits, leading the way. Despite stubborn concerns about the potential for a recession later this year or in 2024—concerns we share—investors have displayed little interest in adopting a risk-off approach so far. Lower-rated credit has strongly outperformed higher-rated securities YTD, yet there are reasons for caution in 2H 2023.
Fundamentals remain sound, but challenges await. Despite the positive backdrop, there are some signs of weakness and reasons for caution. The yield curve remains severely inverted and and jobless claims have risen more than 20% off their base. Rising rates have made the cost of debt prohibitive for many borrowers. For these reasons we forecast a recession in the medium to longer term. Within this environment, we believe active management and sound fundamental underwriting will be essential to driving returns in the second half of 2023.
Upside macro surprises have benefited risk-taking. We still see reasons for caution in our outlook, and the impact from higher rates, tightening credit. deteriorating margins and slow growth warrants a deep, bottoms-up understanding of fundamental risks. We have discussed that the year-to-date (YTD) return through May 31, 2023 of the S&P 500 Index was incredibly narrow. Specifically, just 7 Tech+ stocks accounted for all of the return of the S&P 500 Index to that point. Additionally, only the three big growth sectors (Information Technology, Consumer Discretionary, and Communication Services) had positive YTD returns through the end of May. In June, the market climbed another 7% but broadened out and was actually led by cyclical sectors, not Tech+; there are now seven sectors with positive YTD returns.
The decision to pay much higher multiples for the very largest stocks versus the rest of the large cap market index speaks to looking backward instead of forward, in our opinion. Additionally, the disparity in valuation is disconnected from the fundamentals in the large cap index, in our view. History tells us that, at some point, fundamentals will take over and investors will be better served by putting fewer dollars in the 10 largest stocks and more in the rest of the big companies in the S&P 500 Index. At this very early stage, the second quarter earnings season for the S&P 500 is off to a strong start. Both the number of positive earnings surprises and the magnitude of these earnings surprises are above their 10-year averages. As a result, the index is reporting higher earnings for the second quarter today relative to the end of last week. However, the index is still reporting its largest year-over-year decline in earnings since Q2 2020.
The luxury of being defensive and optimistic… We see several benefits of the Federal Reserve interest rate hikes and have been able to successfully exploit these opportunities. We strongly believe that investors benefit when scientific research and past experience combine to solve new investment challenges. Retirement Consultants, Inc. is a registered investment advisory firm that offers long-term investors innovative portfolio management solutions that work to capture gains while limiting losses from today’s market volatility. By referencing history and always looking forward and thinking ahead, ready for change and to go where the evidence leads, we believe our investment strategies are designed to meet the needs of today’s investors.