Q2 2023 Market Update

The second quarter and the first half of 2023 have brought investment returns that would please
almost any investor. It is hard to look at the first half of the year and find any major negatives. All things considered, markets have done very well, and at least for the time being some of our biggest concerns have lessened. In our view, the markets are a grey area, as shifting geopolitics and global
economics play out. However, as we have seen, it can be an environment in which markets do well, as exciting investment opportunities present themselves.

In our last commentary, we talked about the AI revolution, and this was certainly a driving force behind the S&P 500’s returns during the quarter. Anything AI related has seen significant returns in the first half of the year, and the Technology sector is once again leading markets higher. On one hand, this remains an exciting area with huge long-term potential, but on the other, it has led to a top-heavy market, with just a handful of names driving much of the return.
 
Market concentration has been an issue at different points over the last 10-15 years, and we typically do not like to see this occur. However, there is an interesting phenomenon taking place within the top names, we are seeing a broadening out of those companies. What started with the so-called “FANG trade” (Facebook, Apple, Netflix, Google), expanded to FAANG (adding Amazon), and then FAAMNG (adding Microsoft), and recently we have seen the terms “Magnificent Seven” (adding Nvidia) and “Elite Eight” (adding Tesla) thrown around. Collectively these “Elite Eight” companies make up nearly 30% of the S&P 500 and have contributed a large percentage of the S&P 500’s 16.89% first-half return. For comparison purposes, the equally weighted S&P index was up just 7.03% during the same timeframe. These companies are all leaders in their respective industries and are a testament to the scale and scope of the US economy and markets. Anyone with exposure to the S&P 500 has benefited from their incredible growth. We should not, however, get carried away with chasing performance here, as we must look for other areas of opportunity. In the short term, these names may continue to do well, but their valuations have become stretched and they need to show real results to keep this momentum. In the medium to longer term, we remain excited about the prospects for smaller companies and other sectors to grow alongside the top companies.
 
The aforementioned companies have benefited from an incredibly resilient US economy. According to many predictions, we were supposed to be in a recession by now. In reality, the US economy continues to chug along with steady growth seen throughout the first half of the year. There was a slowdown in certain areas such as housing and the industrial space from late last year into the early part of this year, however, those areas have been showing signs of picking up. Construction spending broadly, and manufacturing construction more specifically, are at multi-decade highs, not something we would expect to see if the economy were headed for a meaningful slowdown. The all-important US consumer continues to be in fairly good shape, as we continue to work through the excess savings that built up during the pandemic. There is some concern that those will dwindle by the end of the year and consumers will have to tighten their budgets, but that is more likely a mid to latter 2024 concern. Meanwhile, the regional banking and debt ceiling concerns that plagued us earlier this year seem like distant memories now. The last few years have us conditioned to expect the unexpected and anything could certainly happen in the second half of the year, but all in all, things are looking more positive now than they did at the end of the first quarter.

As we move through the summer and into the fall, we will see the real start of the 2024 election season take hold. While many of us are sick of politics and the never-ending news cycle, there is one very important point we would like to make about recent government actions. Despite breathless reports, and admittedly, many examples to the contrary, bipartisanship still exists and our government is still capable of getting some things done. The recent completion of the debt ceiling compromise is an excellent example. It passed by a significant margin in both houses of congress despite strong attempts to crush and discredit it from both the far right and far left. The US has a firm economic policy that has transcended president and party. We are witnessing the greatest US reindustrialization of any of our lifetimes, and while this is a multi-decade process that might be hard to discern at any one moment in time, it has huge investment implications.
 
Over the past 15 or so years, under administrations of both parties, the US began to move away from the global stage and the period of globalization that characterized the past generation. Significant parts of our economy and manufacturing base are being “re-shored”. Policies that have aimed to increase infrastructure spending, restrict the influence of China, stimulate the economy during the pandemic, increase the domestic production of computer chips and (hopefully) reduce inflation have all passed with some degree of bipartisan support in Congress. The current spending on construction is clear evidence of these policies. As the US (and North America) expands its manufacturing base it will be additive to economic growth, and in the near term, inflation. Although inflation figures have been trending downwards, we do not believe that we are headed back to a steady 2% that the Fed says it would like to see. Instead, we expect a higher base level and more fluctuation over the coming years.
 
Gradually we all seem to be adjusting to this new regime. As the sticker shock of higher rates wears off, companies and individuals will adjust their expectations accordingly. For instance, we got so used to low rates that the idea of paying 6-7% on a mortgage is overwhelming to many, and contributed to the slowdown in housing. Certainly, anyone fortunate enough to lock in a 3% or lower rate is hesitant to give that up. However, at some point, those that need to move or buy a house will do just that and life will go on. Today’s rates, while certainly higher than we have seen for much of the last 10-15 years, are actually very much in line with long-term historical averages. It would obviously be nice if the Fed could slow the increases and eventually settle at a lower level, but for the time being, we should expect higher rates for longer, particularly if the economy continues to hold up as well as it has to this point.
 
These are interesting times, as we are at the forefront of another potentially transformative technology boom and economic reinvigoration. We continue to see these factors play across markets and remain firm believers in the potential for the US economy and those closely linked to us. There remain several competing influences and cross-currents across the global economy, but the overall outlook has improved significantly in recent months.
 
We hope you all enjoy your summer and encourage you to reach out with any questions or concerns.