A Two Faced Market
2023 has been an interesting year for the markets, to say the least. The S&P500 is up close to 20% year to date, and moved from a bear market (down 20% off the high) to a bull market by (up over 20% off its lows). However, most other asset classes have not recovered nearly as much as the S&P500. Let’s take a look at what is driving S&P500 growth.
The S&P500 is a “Cap Weighted Index”. This means that the largest companies occupy greater percentages of the S&P500. For example, Apple is 7.4% and Microsoft is 6.9% of the index despite there being 500 companies in the index. In fact, the 10 largest companies of the 500 stocks in the S&P500 make up 31% of the index. Some large technology companies, such as NVIDIA, Meta (Facebook) and Tesla have more than doubled in value since the start of the year.
Another index often tracked is the “Equal Weighted S&P500”. This index gives every company equal footing in the index. While the S&P500 is up nearly 20% year to date, the equal weighted index is up only 9%. That’s because the majority of gains in the market have been concentrated in a relatively small handful of stocks. Specifically, any stock that is related to artificial intelligence has had a banner year and the tech-heavy NASDAQ is off to one of its best years ever, while small caps, emerging markets, and bonds all have lagging performance.
Despite this growth, significant risks remain in the market. We frequently track leading economic indicators, or metrics which point to where the economy may be heading. This includes things like commodity prices, truck shipments, job sentiment, manufacturing and new housing permits. Nearly all leading indicators are flashing red or substantially weakening. High interest rates have taken their toll and consumers are feeling the pinch of inflation. Despite market growth, the economy is undoubtably weakening.
The lesson from the first half of 2023 is that the market doesn’t always follow the economy or perform how you would expect. Although the economy may be weakening, the belief in AI driven productivity gains has driven the market to recover some of the losses seen in 2022. Further, when the market recovers more than 20% from its lows, that momentum usually carries the market to new highs. Additionally, many analysts have turned bullish for the year, projecting robust market growth in the 2nd half of 2023. Still, the possibility of an economic recession in the next 12 months, high interest rates and a weakening economy absolutely act as a headwind for future market growth.
So what do we do about this two-faced market? First, recognize that long-term participation in the market is the most important factor in determining financial success. As is often said, time in the market is more important than timing the market. However, it is time to look at rebalancing opportunities to lock in the current year-to-date gains. Also, specific asset classes still offer compelling valuation such as high yield bonds, short to mid-term fixed income, and downside hedged equity.
The stock market rarely provides clarity on its’ path forward over the short term so the decisions we make are always meant to provide the most long-term value possible. In a market environment like we’re seeing now, diversification is more important than ever. If you have any questions about your investments or would like to talk through current economic conditions, please don’t hesitate to reach out.