Welcome to the July edition of Top of Mind!
What’s Top of Mind this month?
Sometimes you don’t need the sun to shine for the stock market to rally. You just need the rain not to fall.
That’s the story of the first half of 2023. The economy has not been stellar, but several storm clouds that threatened the outlook have diminished. Recession worries have faded, regional banking turmoil has eased, and the much-feared debt ceiling deadline proved a non-event. The absence of bad news has been enough to lift markets.
Here’s a snapshot of first-half performance:
So, What’s Next?
Bulls and Bears both present good arguments for the remainder of 2023.
Bears caution that Federal Reserve rate hikes have historically triggered recessions and market declines. We take this risk seriously.
On the other hand, Bulls can point to several positive developments:
- Inflation has fallen surprisingly quickly.
- Consumers are eager to spend as they reclaim their lives following COVID.
- Exciting prospects for Artificial Intelligence (AI) are emboldening investors to look beyond near-term risks.
- China has re-opened its economy from COVID.
- There are few signs of a credit crunch. Fed rate hikes typically lead to a recession when lending activity dries up, but quick action by regulators on regional banking turmoil may have preempted a credit crisis.
Our take? The truth likely lies somewhere in the middle.
While a mild recession due to Fed rate hikes is possible, last year’s 25% market decline already factored in significant economic weakness. Last October was likely the market low. On the flipside, markets may not be off to the races, either. With unemployment levels near 50-year lows, concerns about inflation and Fed rate hikes may linger.
The upshot is likely more market choppiness over the near term, but still a positive long-term outlook.
How We’re Positioning Your Portfolio: Questions and Answers
Our portfolio positioning reflects both questions and answers we have about the outlook.
We’ll start with the answers, which apply mostly to the fixed income markets. Investors can gauge the return potential for bonds based on current interest rates and bond prices. To that end, we like what we see.
Several opportunities are reflected in portfolios:
- Money Market Mutual Funds: Fed rate hikes have lifted money market yields to attractive levels.
- Mortgage Backed Securities: Mortgage rates have spiked, leading to attractive yields for bonds that are tied to mortgage payments.
- High Yield Corporate Bonds: All-in yields today are competitive with historical stock market returns.
- Long-term Municipal Bonds: This sector remains cheap in our opinion following last year’s historic sell-off.
Here's how yields have evolved across these sectors:
If bond market returns are as good as yields suggest, stocks could deliver below average returns and a diversified portfolio of stocks and bonds could still deliver solid results.
In terms of positioning your equity portfolio, we have several unanswered questions about the outlook, particularly around the burgeoning AI sector.
AI is poised to transform the economy in ways that are not yet fully known. Being on the right side of those changes will be critical for investors.
Some of our questions:
- Which companies will create the infrastructure that supports AI?
- Which companies will deliver AI solutions to businesses and consumers? Will it be the large incumbent technology companies (Microsoft, Google, etc.)? Or will new players emerge?
- Which companies will incorporate AI to become more profitable? Will it be "old economy" companies like financials and industrials that are considered Value-style stocks?
- Which companies will be disrupted by AI? Will some upstart technology companies become outmoded?
Given the importance of these questions, we hesitate to emphasize any single part of the markets until we have more clarity on the answers. In the meantime, we’ll remain diversified while the mutual fund managers in your portfolio wrestle with these same questions and position assets accordingly.
While we don’t know exactly how AI will impact markets, we do think the overall effect will be quite positive as companies use the technology to become more productive. Thus, we remain confident in the long-term outlook for stocks as this new technology emerges.
That’s what’s Top of Mind for us! As always, we’d love to know what’s top of mind for you. Until then, best wishes for a safe and relaxing summer.
Sincerely,
Kurt, Cassidy, Ken, Teresa, Brian, and Jacque
Past performance does not predict future results. Diversification and asset allocation do not ensure a profit or guard against loss