Second Quarter Perspectives

The second quarter began with markets still dealing with the uncertainty of the regional bank crisis following the March failures of Silicon Valley Bank and Signature Bank. Those concerns proved mostly overdone, however, as regional banks stabilized in the second quarter. That stability allowed investors to re-focus on corporate earnings, and the results were much better than feared as nearly 80% of S&P 500 companies reported better-than-expected first quarter earnings.. Additionally, 75% of reporting companies beat revenue estimates for the first quarter, also well above the long-term average. Solid earnings were a welcome sight for investors which allowed stocks to drift steadily higher throughout most of April. However, following an underwhelming earnings report, concerns about the solvency of First Republic Bank weighed on markets late in the month and the S&P 500 declined into the end of April to finish with a modest gain.

Fears of a First Republic Bank failure were realized on May 1^st, as the bank was seized by regulators. However, that same day, JPMorgan announced it was acquiring the bank from the FDIC, and that move helped to calm investor anxiety about financial contagion risks. The Federal Reserve also helped calm investors from the First Republic failure, as the Fed hiked rates in May, but importantly altering the statement to imply it would pause rate hikes at the next meeting. This was anticipated by investors and as such it failed to ignite a meaningful rally in stocks. Instead, the tech sector helped push the S&P 500 higher in mid-May, thanks to an explosion of investor and financial media enthusiasm around artificial intelligence stocks. However, like in April, the end of the month saw an increase in volatility due to lack of progress on a U.S. debt ceiling extension and rising fears of a default. Ultimately, the politicians kicked the can down the road last minute and a two-year debt ceiling extension was agreed to by Speaker McCarthy and President Biden on May 28^th avoiding a crisis. The S&P 500 finished May with a slight gain.

With the debt ceiling resolved, a Fed pause in rate hikes and continued stability in regional banks, the rally in stocks resumed in early June and was aided by several potentially positive developments. First, inflation declined as the CPI hit the lowest level in two years. Second, economic data remained impressively resilient, reducing fears of a near-term recession. Finally, the Fed confirmed market expectations by pausing rate hikes and that helped fuel a broad rally in stocks that saw the S&P 500 hit its highest levels since early in 2022. The last two weeks of the month saw some downside volatility, but the S&P 500 still finished June with strong gains.

Markets were impressively resilient in the second quarter and throughout the first half of 2023, as better-than-feared earnings, expectations for less-aggressive central bank rate hikes, more evidence of a “soft” economic landing and relative stability in the regional banks pushed the S&P 500 to a 14-month high.

Looking Ahead

As we begin the third quarter of 2023, the outlook for stocks and bonds is arguably the most positive it’s been since late 2021, inflation is at a two-year low, economic growth and the labor market remain impressively resilient, the Fed has temporarily paused hiking rates, the debt ceiling is resolved, and there has been no significant contagion from the regional bank failures from earlier this year. The improvement in the near-term economic outlook has been reflected in both stock and bond prices this year.

For the stock market to sustain the current levels, three scenarios need to materialize. 1) No material economic slowdown. 2) Inflation continues to fall. 3) The Fed doesn’t hike more than one or two more times. These scenarios are mostly priced into today’s market, so if one or more of them fails to happen, the we likely see a pullback in the back half of the year. To extend gains meaningfully from here, we would need to see some combination of interest rate cuts, accelerating economic growth and/or increase in corporate earnings later this year.

There have been many positive developments so far in 2023 that have helped the stock market rebound and we are certainly pleased with 2023 performance so far. However, it’s important to remember that risks remain for the economy and markets.  The market is pricing in a lot of positive scenarios and if a few of them do not materialize we would anticipate volatility to the downside going into year end.

We hope you are having a great summer season! If you have any questions or would like to schedule a review of your portfolio or financial plan, please do not hesitate to reach out.