Mid-Year 2023: Embracing Opportunities Amidst Transformation
Saturday, July 29th, 2023

Key Takeaways

  • Strong corporate earnings and encouraging economic data have bolstered the U.S. economy in 2023.
  • Impending student loan payments and depleting savings may lead to more cautious consumer behavior.
  • Tech layoffs and declining profits pose challenges to business spending.
  • Inflation is receding, expected to decline further by year-end.
  • Despite economic headwinds, equity markets show strength backed by strong earnings and optimism about Fed policies.

In the ever-changing landscape of global economics and financial markets, 2023 has proven to be a pivotal year marked by transformation and uncertainty. As we keep a watchful eye on these dynamic shifts, our goal is to provide you with an informed perspective on the current state of the economy, the evolving investment landscape, and the inherent challenges and opportunities ahead.

Resilient U.S. Economy in the First Half of 2023

In a surprising turn of events, the U.S. economy has demonstrated remarkable durability during the first half of 2023. Supported by robust corporate earnings and encouraging economic data, the markets have defied predictions of a U.S. recession, with the forecasted onset now pushed to 2024. However, despite this resilience, the future promises subdued growth due to increasingly tight credit conditions, presenting potential challenges to economic activity in the upcoming quarters.

Consumer Spending and Monetary Policy

Consumer spending has displayed noteworthy perseverance, a testament to the strength of the U.S. economy. Nonetheless, the impending revival of student loan payments and depleting savings is likely to prompt a shift towards more cautious consumer behavior. In response, the Federal Reserve maintains a hawkish tone, indicating the potential for an additional rate hike before year-end. We believe a variety of mounting obstacles may keep the Fed on the sidelines in the long run, potentially leading to future monetary policy easing in the coming year.

Cautious Business Spending

Business spending emerges as one of the most vulnerable facets of the economy. Recent tech sector layoffs, lender wariness, and decelerating corporate profits are all factors that could reduce capital expenditures and research and development outlays. Additionally, vacant office and retail spaces may cast a shadow on construction spending and commercial real estate valuations.

Inflation Trends and Projections

After inflicting hardships upon consumers in the past two years, inflation is finally receding. Headline Consumer Price Index (CPI) inflation has begun its descent from its peak, and we anticipate a further decline throughout the year. While the rate of decline may not meet the Fed’s initial projections, it is expected to reach more manageable levels. Our forecasts indicate that CPI inflation will recede below 3% year-over-year by the end of this year and eventually converge towards the 2% range by the conclusion of 2024, even without the occurrence of a U.S. recession.

Equity Markets

Despite the prevailing economic headwinds, equity markets have exhibited notable strength and performance in 2023. Bolstered by solid first-quarter earnings and mounting expectations of an end to Fed tightening, they continue to beckon investors. However, prudence dictates a cautious approach, given the lurking risks to earnings. With expectations undergoing adjustments, equity multiples may face further downward pressure. Therefore, we are adopting a defensive stance in equities and prioritizing quality and cash flow generation given this challenging backdrop.

Narrow Group of Stocks Dominated Returns

An interesting development during the first half of 2023 has been the dominance of a narrow group of 10 US stocks, accounting for 79% of the S&P 500’s gains. Companies like NVIDIA, Microsoft, , Facebook, Apple, and Google have emerged as direct beneficiaries of generative AI’s potential to transform business productivity. While these stocks have outshone the market, market concentration also poses risks. Investors piling into a small group of AI-fueled names could face challenges if valuations stretch too far and returns reverse rapidly.

Valuations Under the Microscope

While market valuations appear relatively high after this year’s gains, when excluding the 10 best performers the market’s price to earnings ratio becomes much more reasonable offering estimated earnings growth of 8-10% for 2024. Investors who search more broadly across global equity markets can find stocks with attractive valuations and solid growth potential. Moreover, real interest rates (interest rates minus inflation rate) have turned positive which historically puts pressure on equity valuations. Companies with reasonable multiples and robust long-term earnings outlooks are well-positioned for this complex transition.

Artificial Intelligence, Hype or Reality?

The AI hype driving US market valuations reflects a fundamental challenge for investors today. However, identifying the long-term winners in the race for AI will take time. History has shown that early stars of disruptive revolutions are not always the long-term winners. Cautionary tales from the dotcom boom remind us of the dangers of irrational exuberance. As AI excitement unfolds, maintaining a focus on companies’ underlying businesses is key to successful equity investing in an ever-evolving future.

Navigating the Investment Landscape

As we forge ahead into the second half of 2023, it becomes paramount to assess the risks within the market. Investors should continue to rely on a diversified approach that encompasses international markets, dividend-paying stocks and alternative investments. On the other hand, certain sectors of the U.S. market, particularly large tech stocks, still bear the remnants of a costly performance in the second quarter and sky-high valuations. Fixed income instruments, including U.S. Treasuries, core bonds, and municipal bonds, retain their appeal given their highest yields in over a decade and valuations residing below historical averages. With this in mind, we have begun to rebalance our portfolios by trimming growth stocks in favor of equities and bonds with more reasonable prospects in this environment.

Final Thoughts

Opportunities and challenges abound in the economic and financial landscape. We remain cautiously optimistic about the broader market outside of large-tech, though our return expectations for stocks over the next few years are below historical averages. At Navalign, our commitment is to help you seize opportunities and navigate complexities in the pursuit of your financial goals. By embracing a diversified approach and staying vigilant amidst evolving market conditions, we are positioning your portfolio to succeed in this transformative environment.