Despite lingering concerns around stubbornly high inflation, slowing global growth, and regional bank failures, equity markets continued their rally into the second quarter of the year. However, bond yields rose again after falling in the first quarter and are again near multi-decade highs.
Headline inflation is still high at 4.1% year-over-year as of the May reading, above the Fed’s target, but well below the high of 8.9% seen last year.[1] Oil, which rose as high as $123.70 a barrel in 2022, is now down to under $72.[2] US GDP posted two negative quarters in a row (often accepted as the definition of a recession) but the first quarter reading was revised upwards to a robust 2% annualized, and expectations for Q2 are similar.[3] These issues are not resolved yet. Fed policy impacts the economy with a lag, and the Fed plans to continue raising rates. The battle against inflation continues.
Big tech stocks in the US continued their outperformance amid optimism for an AI revolution. In fact, up until recently the returns of seven big tech companies made up 88% of the S&P 500’s gains for the year.[4] At the end of the quarter the 10 largest stocks represented almost 32% of the total value of the S&P 500, the highest level in decades, and growth stocks appear very expensive relative to value stocks.[5] The outsized gains of the “big tech” stocks in the S&P 500 and their high valuations relative to the rest of the equity market present a potential risk to investors who are not well-diversified, as we have seen these kinds of trends reverse quickly and sharply (as recently as last year).
Small cap and international stocks produced more modest returns in the second quarter. Investment grade bonds were down slightly in the second quarter as yields rose, but they are still positive for the year. That is very different from the harsh impact of sharply rising rates that we saw in 2022. Bonds have recovered to a degree since then, but the real benefits will be seen over time, as higher interest payments to bondholders in aggregate outweigh the losses seen in the previous year. High yield and emerging markets bonds, which tend to be less sensitive to interest rate changes, had positive results.
While markets are reacting positively to the trend of inflation and growth in the US and abroad, they may continue to be volatile as we see how world economies react to central bank tightening in the face of continuing inflation. A well-diversified portfolio can help smooth the ride through uncertain economic times.
[1] JPM Guide to the Markets, Inflation Heat Map, slide 32. Accessed 7/6/2023.
[2] JPM Guide to the Markets, Oil Markets, slide 35. Accessed 7/6/2023.
[3] Cox, Jeff. “First-quarter Economic Growth Was Actually 2%, up From 1.3% First Reported in Major GDP Revision.” CNBC, 29 June 2023, www.cnbc.com/2023/06/29/first-quarter-economic-growth-was-actually-2percent-up-from-1point3percent-first-reported-in-major-gdp-revision.html.
[4] Harley-McKeown, Lucy. “Tech Stock Stars of 2023: Companies Powering S&P 500 Rally.” Yahoo, 20 June 2023, www.yahoo.com/news/tech-stocks-sp-500-rally-alphabet-apple-meta-nvidia-amazon-094348657.html.
[5] JPM Guide to the Markets, Value vs. Growth (slide 10) and S&P 500 Index concentration, valuations and earnings (slide 11). Accessed 7/7/2023.
Important Disclosures
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The volatilities of any comparative indices included in this presentation may be materially different from the individual performance attained by a specific client in a Team Hewins strategy. In addition, client holdings may differ significantly from the securities that comprise the indices. The indices have not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather are disclosed to allow for comparison to the performances of certain well-known and widely recognized indices. The indices are unmanaged, include reinvestment of dividends, capital gain distributions or other earnings and do not reflect any fees or expenses. Indices cannot be invested in directly. Set forth below are descriptions of the indices included in the presentation.
Past performance is not an indication of future returns. Comments provided herein reflects Team Hewins’ views as of the date of this write up and are provided for informational purposes only. Such views are subject to change at any point without notice. Some of the information was obtained from third party sources believed to be reliable but the information is not guaranteed. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. Due to various risks and uncertainties no reliance should be placed on any such statements or forecasts when making any investment decision. Nothing presented herein is or intended to be investment advice or a recommendation to buy or sell any securities and no investment decision should be made based solely on the information provided. Team Hewins is not responsible for the consequences of any decisions or actions taken as a result of information provided in this writeup and does not warrant or guarantee the accuracy or completeness of the information. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses.
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Index Descriptions
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S&P 500 Index (Large Cap U.S. Stocks): measures the performance of large capitalization U.S. Stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, NYSE MKT, and NASDAQ. The weightings make each company’s influence on the Index performance directly proportional to that company’s market value.
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Russell 2000 Index (Small Cap U.S. Stocks): An unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index, representing approximately 10% of the total market capitalization of that index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group owns the Russell Index data, including all applicable trademarks and copyrights.
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MSCI EAFE Index (International Developed Stocks): The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
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MSCI Emerging Markets Index (Emerging Markets Stocks): is a Morgan Stanley Capital International Index that is designed to measure the performance of equity markets in 25 emerging countries around the world.
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Bloomberg Barclays US Aggregate Bond Index (Investment Grade U.S. Bonds): includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.
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Bloomberg Barclays Muni Bond Index 1-10 Yr Blend (1-12) (Int-Term Municipal Bonds): A market value-weighted index which covers the short and intermediate components of the Barclays Capital Municipal Bond Index. The 1-10 Year Municipal Blend index tracks tax-exempt municipal General Obligation, Revenue, Insured, and Prerefunded bonds with a minimum $5 million par amount outstanding, issued as part of a transaction of at least $50 million, and with a remaining maturity from 1 up to (but not including) 12 years.
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ICE BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index (High Yield U.S. Bonds): Tracks the performance of US dollar-denominated below-investment-grade (BBB rated) corporate debt publicly issued in the US domestic market. Qualifying bonds are capitalization-weighted provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis.
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JPM GBI EM GD USD Unhedged Index (Emerging Markets Bonds): The JP Morgan EMBI Global Diversified is a uniquely weighted index that tracks total returns for U.S. dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities. The index limits the weights of countries with larger debt stocks by only including a specified portion of these countries’ eligible current face amounts of debt outstanding.