Significant advances were seen in the main stock market indices in the first six months of the year.
These advances were driven by factors such as moderated inflation, a slowdown in Fed rate increases, the absence of a recession, stability in the banking sector, and a robust upswing in technology stocks.
The S&P 500 saw a substantial rise of 16.9% when considering reinvested dividends this year through June 30, 2023, while the Nasdaq and Dow have reported returns of 32.3% and 4.9% respectively. The markets have effectively regained much of the losses suffered last year, with the S&P 500 now just 7% short of its historic peak.
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Here's how markets have rebounded through July 3rd, 2023.
Similarly, interest rates have remained stable after last year's dramatic increase, with the 10-year Treasury yield settling around 3.8%, which has contributed to a rebound in bond prices.
What should investors keep in mind to understand this recent market progress as we transition into the second half of the year?
In light of the remarkable performance so far this year, a question many investors might be grappling with is whether this signifies the onset of a new bull market or if it's merely a rally within a bear market.
This contrasts with the initial apprehensions at the year's outset when investors and economists were mainly preoccupied with bear markets and recessions. Several reasons exist as to why the previous six months have only further emphasized the investment strategies that long-term investors ought to adhere to in order to realize their financial objectives
Investor Sentiment Can Shift Unexpectedly
Firstly, the market performance witnessed this year reinforces the idea that investor sentiment can shift unexpectedly and rapidly. Historical patterns of bear markets and brief corrections indicate that markets can bounce back at the most unforeseen times, particularly when investor outlook is at its gloomiest.
This was indeed the case at the year's onset when a recovery seemed almost implausible to most, just as it was during times like April 2020, March 2009, and the tech crash of 2000-2002.
Every market slump is triggered by a substantial event, such as an inflation surge, the pandemic, the U.S. debt downgrade, the global financial crisis, or even the infamous Black Monday in 1987.
Despite that, in each scenario, the common thread was that investors anticipated the situation to keep deteriorating, oblivious to the fact that fundamentals and valuations were subtly improving.
Hence, it's frequently more advantageous for regular investors to remain faithful to their meticulously planned financial strategies.
By the time a consensus is reached that a recovery is underway, considerable profits are often left unrealized.
This is not to undermine the distress caused by market downturns or suggest that markets only witness an upward trend. Instead, historical patterns indicate that it's generally more beneficial to maintain one's investments in a suitably structured portfolio.
In the most unfortunate scenario, investors who attempt to outguess the market and overly concentrate on short-term incidents might entirely miss out on the subsequent market rebounds.
Market Fundamentals Drive Stock Market Rallies
Secondly, forecasting the course of the market is as challenging as determining the longevity of a specific rally while it's in progress. Therefore, it's usually more beneficial for long-term investors to concentrate on the core fundamentals propelling the rally.
Despite the fact that markets can oscillate in any direction within days, weeks, or months, it's the stable economic expansion and enhancing corporate profits that usually steer markets to higher ground over quarters, years, and even decades
Therefore, the necessity for maintaining a robust economy is imperative. Just a year ago, many deemed the idea of the Federal Reserve successfully orchestrating a 'soft landing,' meaning that inflation would be mitigated without a recession, as highly improbable.
Although the challenge of core inflation still persists, the positive trend of overall consumer prices improving while unemployment rates stay at historically low levels bodes well for the markets. If corporate earnings start to show an upward trajectory, the attractiveness of market valuations could potentially increase over time.
Economic Uncertainties Remain
Lastly, it's not uncommon to view the situation pessimistically, given the numerous uncertainties that continue to cast a shadow. In the present scenario, even with improved stability in the financial system, challenges persist, most significantly those stemming from the earlier bank failures this year, particularly in the commercial real estate sector.
The upcoming wave of refinancing could pose a test to the system's stability as high interest rates persist and lending activities become more stringent.
Moreover, although a debt ceiling crisis was successfully dodged, the issue has only been deferred to the start of 2025.
Concurrently, geopolitics remains a source of concern with U.S. ties with China and Russia still under strain.
The upcoming presidential election in the following year is also poised to take center stage as markets evaluate these multifaceted risks.
Nonetheless, seasoned investors, who maintain a comprehensive view of the markets, understand that there are always risks to counterbalance against long-term returns. Such risks frequently seem overwhelming when being experienced in real-time.
However, once these risks are in the past, the focus of investor worries typically shifts to the sustainability of recoveries. These alternating patterns in investor sentiment are a standard and inherent feature of markets, underlining why long-term investors can enhance their chances of success by emphasizing more on the underlying trends.
In keeping with this, here are seven crucial insights drawn from the first half of the year that will likely hold equal importance in the second half.
1. Unexpectedly Robust Returns Over the Last Three Quarters Have Left Many Investors Astonished
The S&P 500 has now recorded three straight quarters of robust returns, commencing from the fourth quarter of 2022. This is a drastic reversal from the bear market returns observed during the initial three quarters of the preceding year, and this turnaround is taking place amidst a prevailing negative sentiment. Although there's no assurance that markets will persist with this vigorous upward trend, it emphasizes the notion that markets can shift their course unpredictably.
2. Limited Market Breadth as Giant-Cap Stocks Spearhead the Surge
Although the market surge has been advantageous to many investors, the gains haven't been evenly distributed among all stocks. Predominantly, the mega-cap stocks have taken the lead.
The related graph reveals that the biggest stocks within the S&P 500 have surpassed the broader index this year. Furthermore, an equal-weighted index, which assigns greater weight to smaller stocks compared to a market-weighted index, has trailed even further behind.
3. Returns of Sectors Have Varied Across the Stock Market Vs. 2022
Hence, a concern among investors is whether this year's returns have been 'skewed' by the tech sector's performance. Regrettably, it's true that the biggest stocks have steadily risen in significance over the past decade, attributed to the escalating economies of scale due to technology's impact on the economy. In recent times, the surging enthusiasm for artificial intelligence has further propelled gains in these sectors.
However, the current year's gains in these areas aren't solely a result of these trends. The returns observed among these companies also signify a recovery from the previous year, a period when these stocks were most severely impacted due to escalating interest rates and an increasingly gloomy future outlook. When considered together with last year's performance, the returns, though still oversized, appear much more rational.
4. Positive Trends in Inflation Despite Persistent Core Measures
One of the reasons for the pivot from last year's scenario is the discernible signs of improvement in inflation. The main Consumer Price Index has decreased from a high of 9.1% a year ago to 4% presently, primarily attributed to deflation in energy costs and other sectors such as used automobiles. However, the core inflation remains persistent, primarily driven by housing costs.
The Federal Reserve and other economists are of the belief that these prices will exhibit a positive trend as rent prices achieve stability and new leases get initiated. Investors should also keep their expectations in check regarding further advancements in inflation. Optimistically, both headline and core inflation are likely to remain elevated throughout a significant part of 2024. In the interim, there's a possibility that year-over-year inflation data may show deterioration due to comparisons with the previous year's levels.
5. Pace of Federal Reserve Rate Hikes Has Slowed
When inflation improves in conjunction with a robust economy, it offers the Federal Reserve an opportunity to decelerate its frequency of rate hikes. The Federal Reserve has consecutively elevated rates 10 times, moving from zero to 5%. The magnitude of each increment has gradually decreased over the past year, falling from a zenith of 75 basis points (0.75%) per meeting to a possible 25 basis points every alternate meeting.
The Federal Reserve has explicitly signaled its dedication to bringing inflation back to their 2% benchmark by sustaining elevated rates over an extended period. There has been a shift in market-based expectations this year, with consensus moving away from anticipating a rate cut later in the year, to now agreeing that there could be a further rise in rates.
6. Commercial Real Estate and Other Rate Sensitive Industries Face Problems
Among the various sectors affected by escalating rates and financial uncertainty, commercial real estate is perceived as the most significant risk by investors. This perception is not solely because commercial real estate has grappled with the aftereffects of the pandemic, including shifts in office usage and occupancy, but also due to the trillions of dollars in loans that will need refinancing in the near future. Increasing interest rates and stringent lending standards could potentially complicate this process, resulting in liquidity and solvency challenges for commercial real estate companies.
Fortunately, the increased stability observed in the banking system over recent months, coupled with support from the Federal Reserve and the government, have alleviated some of these risks. However, market stakeholders will continue to keep a keen eye on this sector in the upcoming months.
7. Smart Investors Create a Financial Plan for Retirement Especially During Times of Uncertainty
Investors, particularly those nearing retirement, might be pondering about the implications of market volatility on their portfolio. The well-established 4% rule outlines a "safe" withdrawal rate during retirement, founded on the historical performance of a hypothetical portfolio made up of 60% stocks and 40% bonds, as illustrated in the attached chart. This accounts for both prosperous and challenging market phases since 1900.
The chart, however, also reveals that safe withdrawal rates can significantly vary, with the average approximating 7%. Hence, while investors must reduce the danger of depleting their resources, it is equally essential for them to optimally utilize their retirement period, especially given increasing life expectancies. Rather than merely adhering to a general guideline, investors should comprehend their individual situations to more accurately estimate their safe withdrawal rates. This strategy can aid long-term investors in achieving their financial objectives, particularly during uncertain market times such as the present.
To sum it up, the markets have made a comeback in the first half of the year, catching numerous investors by surprise. Although markets don't ascend linearly, investors who concentrate on long-term fundamentals and steer clear of market timing will probably be better equipped to exploit market opportunities in the latter half of the year.
As you get closer to retirement, you tend to save more and invest conservatively. So knowing how your retirement savings is properly tied to your life plan is important. A financial advisor at Covenant Wealth Advisors can help you manage your retirement savings and plan for the future.
Author: Mark Fonville, CFP®
Mark is a fiduciary, fee-only financial advisor at Covenant Wealth Advisors specializing in helping individuals aged 50 plus plan, invest, and enjoy retirement without the stress of money.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosure: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible but no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice.