Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- The S&P 500 completes its best first half since 2019, up 16.9% YTD
- Tech-heavy Nasdaq 100 surges 39.4% in the first half of the year, recouping much of its 2022 losses
- Key measures of U.S. inflation cooled in May
- Expectations of a Federal Reserve (“Fed”) rate cut now pushed out to 2024
- CBOE Volatility Index (“VIX”) at 13.6, a 3-year low
Concerns around economic fundamentals and uncertainty around the Fed’s future rate trajectory did not deter U.S. equities from posting gains across the board in the second quarter, with the S&P 500 completing its best first half since 2019, up 16.9% YTD.
The tech-heavy Nasdaq 100 surged 39.4% in the first half of the year, recouping much of its 2022 losses. A handful of its biggest stocks — contenders in the Artificial Intelligence (“AI”) race — pushed the market-cap weighted S&P 500 Index up 9.9% more than its equal-weighted version. The Russell 2000, often seen as a proxy for small-cap health, posted a more modest advance of 8.1% YTD, all of it coming in June.
There are two possible explanations as to why the performance of risk assets has been so impressive YTD. The bullish case is that the market may be discounting a revolutionary change in the economy. AI could indeed bring a long-term boom in productivity. A more bearish explanation is that, ironically, the U.S. hitting its debt ceiling and the regional banks’ failures led to a meaningful liquidity injection into the financial system. A double dose of liquidity from monetary and fiscal stimulus is, however, not consistent with the goal of fighting inflation.
In a sign of strong risk-on sentiment, Growth, and High Beta led the pack for factor-based indices, while Low Volatility and High Yield Dividend strategies lagged. Information Technology led among sectors with an impressive gain of 15.4% in Q2, while Utilities was the laggard at -2.5%. The rally in risk assets continued in the second quarter with the Information Technology, Consumer Discretionary, and Communication Services sectors outperforming the S&P 500 by a wide margin.
June Asset Class Performance
On a total return basis, all sectors were up in June, from 1.6% for Utilities to as much as 12.2% for Consumer Discretionary. Information Technology and Communication Services were the best-performing sectors YTD, up 40.3% and 36.2%, respectively, while Energy and Utilities showed the largest decline, falling 5.4% and 5.7%, respectively. Large-Cap Growth stocks outperformed Large-Cap Value stocks by 20 basis-points in June. The Russell 1000 Growth Index is now outperforming the Russell 1000 Value Index by 23.9% YTD. However, over the last three years, the total return numbers of both Large-Cap Growth and Large-Cap Value stocks are only 1% apart (~+50%). The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was up 6.8% in June, 0.2% better than the S&P 500. Over the last three years, the ESG index is up 49.2% and 3.5% behind the S&P 500 on a total return basis.
Key measures of U.S. inflation cooled in May and consumer spending stagnated, suggesting the economy’s main engine is starting to lose some momentum. The personal consumption expenditures price index (“PCE”), one of the Fed’s preferred inflation gauges, rose 0.1% in May. From a year ago, the measure stepped down to 3.8%, the smallest annual advance in more than two years. Excluding Food and Energy, the so-called Core PCE price index increased 0.3% from the prior month and 4.6% from May 2022. This is in line with annual readings back to late 2022 and shows minimal relief from elevated underlying price pressures. Core PCE is considered to be a better gauge of underlying inflation. A key metric flagged by Fed Chair Jerome Powell showed a welcome slowdown. Services inflation excluding housing and energy services (the so-called “supercore inflation”) increased 0.2% in May from a month earlier, the smallest advance since July of last year. The figure was up 4.5% from a year ago.
While the Fed should take some comfort in knowing that its preferred inflation measure (the Core PCE) has fallen from its peak, recent comments from the Fed would suggest that sustained monetary easing is still a long way off. Signals from Fed Chair Jerome Powell for two more rate hikes in 2023 sparked a spike in Treasury yields in June. Yet, unlike in 2022, when the sight of higher borrowing costs sent stocks reeling, now this is perceived as an endorsement of the idea that a widely feared recession is not an imminent threat. Rising interest rates are likely to remain a key theme for the rest of the year. Expectations of a Fed rate cut have now been pushed out to 2024, while European Central Bank officials have said the hiking cycle is unlikely to end anytime soon. The labor market data will continue to be critical in assessing the future of monetary policy. Although there are some signs of cracks in the employment picture, the labor market remains tight by almost any measure.
Treasuries finished June with losses across the curve. The yield on the benchmark U.S. 10-year Treasury now stands at 3.84% compared to 3.47% at the end of March. Shorter term 2-year U.S. Treasury now yields 4.90%. The yield curve remains inverted, with the U.S. 2-year Treasuries yielding 106 basis-points more than 10-year maturities as compared to a 55 basis-point inversion at the beginning of the year.
Oil prices, as measured by the WTI Crude Oil, were up 3.7% in June to $71/bbl but remained down 12.0% YTD. WTI traded as high as $123.70 back in March 2022, a 14-year high. Gold spot prices retrenched by 2.5% in the second quarter to close at $1,919/Oz, still up 5.2% YTD. Cryptocurrencies had a strong first half of 2023 with Bitcoin up 83.7% YTD while Ethereum was up 60.7% YTD. In mid-June, BlackRock, the world’s largest asset manager, applied to the Security and Exchange Commission (“SEC”) for a Bitcoin ETF, triggering a surge of optimism among other funds and the broader cryptocurrency markets. The U.S. Dollar Index (DXY) lost 1.4% in June. YTD, the U.S. Dollar Index is now down 0.6% on the expectation that the foreign central banks are lagging the Fed on their rate hikes.
Interest rate volatility has been constant since the Fed began its rate-hiking cycle last year. While equity investors look to the CBOE Volatility Index (“VIX”), bond investors focus on the ICE BofA MOVE (“MOVE”) Index, which measures bond market volatility. The MOVE Index remains elevated at 111 compared to historical averages, which reflects the highly uncertain rate environment. The VIX, on the other hand, is trading at historically low levels, closing June at 13.6, a level not seen since early 2020, pre-pandemic.
Chart of the Month – U.S. Treasury Yield Curve
The U.S. Treasury yield curve is a graphical representation of the interest rates (or yields) on U.S. government debt securities of various maturities. It shows the relationship between the interest rate (or yield) and the time to maturity for Treasury bonds, notes, and bills.
Typically, the yield curve is upward-sloping, meaning that longer-term bonds have higher yields compared to shorter-term bonds. This upward slope reflects the expectation of higher interest rates in the future and compensates investors for the increased risk associated with holding longer-term securities.
However, yield curves can also take other shapes, such as being flat or inverted. A flat yield curve occurs when there is little difference in yields between short-term and long-term securities. An inverted yield curve, on the other hand, occurs when short-term yields are higher than long-term yields. An inverted yield curve is often seen as a potential indicator of an impending economic downturn.
Investing in the yield curve involves various strategies based on the expectations of interest rate movements. For example, if an investor expects interest rates to rise, they may invest in shorter-term debt instruments to take advantage of higher interest rates in the near term. Conversely, if an investor expects interest rates to fall, they may invest in longer-term debt instruments to lock in higher interest rates for a longer period.
The yield curve is now inverted. The yield on the benchmark U.S. 10-year Treasury stood at 3.84% at the end of June while the shorter-term 2-year U.S. Treasury yielded 4.90%. The yield curve remains inverted, with the U.S. 2-year Treasuries yielding 106 basis-points more than 10-year maturities as compared to a 55 basis-point inversion at the beginning of the year.
Quote of the Month
“The idea that a bell rings to signal when to get into or out of the stock market is simply not credible. After nearly fifty years in this business, I don’t know anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has.” – Jack Bogle
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.
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