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EXCERPT FROM CLIENT LETTER 6/30/2023 (see full letter above for tables, charts, and full commentary)
FROM THE DESK OF BOB CENTRELLA, CFA July 8, 2023
I hope you all are having a nice start to the summer. A belated Happy July 4th to all. I’m going to bet that many of you are travelling this summer. Everybody is travelling. Travel stocks have been en fuego. Let’s hope covid stays at bay and we all can enjoy getting away a bit safely. The heat and humidity have started in earnest back here in Jersey. With the hot weather upon us, my drink tip for the summer is the Italian Aperol Spritz. Prosecco, Aperol, a splash of lemon-lime seltzer and Orange slice over ice and you can transport yourself to the Piazza’s in Italy in case you can’t get there in person!
The second quarter was marked by slowly declining inflation, still rising interest rates, a fixation on AI (Automated Intelligence) and calming in the banking industry which had rattled financial markets in Q1. As a result, the S&P 500 exited its bear market from October ‘22 lows and entered a bull market phase after rising 20% from that bottom. Equity markets marched higher as investors are getting more comfortable with a possible soft landing by the Fed. Again, investors gravitated to Mega Cap growth stocks as both a flight to safety and the best play on AI.
Which brings me to this quarter’s investment quote. “The stock market clearly values companies that can deliver disruptive innovation” – Steve Blank. This quote certainly applies to the mania we are seeing over AI stocks. Nvidia started the surge when they surprised investors with a massive lift in guidance due to the strong demand for their AI chips.
Many tech stocks followed suit on the way up and although valuations are stretched, the lure of more upside in future sales was too much to pass up. The Nasdaq 100 rose 15.4% as a result while the S&P 500 returned 8.3% with much of those gains coming from a handful of large stocks. The Equal-weighted S&P 500 returned 3.92%, more in line with the broad market. For the year, the equal-weighted S&P 500 is up 6.9% compared to the S&P 500 which returned 16.8% and the Nasdaq 100 which has climbed 39%. Here are price returns of several asset classes for Q2.
The first half of the year against odds, saw stocks appear to outperform dramatically. The headline total return for the S&P 500 is over 16%, all good right? Below that, as mentioned earlier, the Equal-Weight S&P 500 has returned 6.9%, a solid return itself but about 10% below the cap-weighted S&P 500. A handful of mega-cap stocks is what is making the biggest difference. Midcaps (+8.9%) and Small caps (+6%) also have turned in decent performance, but are overshadowed by the large caps. Absent the stunning performance of the Mega-Cap stocks, it would still be considered a nice first half. Meanwhile, bonds have returned about 2.25% for 6 months, not bad for a lower-risk asset. Where to from here?
In my base case and highest probability, I don’t see a traditional recession happening given the labor market resilience unless the Fed must get more aggressive to tame inflation. The rolling recession theory, if you believe it, could allow stocks to continue to move higher in the 2nd half as sectors improve. It will not be in a straight line, but by year-end I believe we will be higher 5%-10% in this scenario and the S&P 500 taking out its January 2022 high. I also think the non-Mega-caps outperform the Mega-caps as they make up some lost ground. Something like the equal-weighted S&P index should perform better than the S&P 500. I expect European equities can perform in line with US stocks as well. All this assumes we do not enter a traditional recession because of higher rates and inflation. I think bonds will return 2%-2.5% or so in the second half as the Fed does raise rates a few more times. I continue to recommend holding equities and bonds for balanced accounts and am more a buyer on weakness, though would look to trim some winners back a bit on strength. I wouldn’t be surprised to see a traditional seasonal pullback later in the summer in August and September. My bear case to which I assign a much lower probability (especially after today’s CPI) is persistent inflation and a recession to occur leading to even lower corporate profits for a few more quarters. The Fed could also overshoot and raise rates too high. This would likely mean a 10%+ fall in stock prices until the Fed stops raising rates and investors key on their likely pivot to lowering rates. This is a lower probability but still can happen in this uncertain environment.
Have a great summer and as always feel free to call or email me with your thoughts.
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Bob Centrella, CFA
Forza Investment Advisory, LLC
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