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Quarterly Review and Outlook: June 2023

"I'm Proud to Be an American"

Loyd Johnson Photo

By Loyd Johnson, Chief Investment Officer
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A Look Back

What better time to mention and remember after we just celebrated Independence Day here in America? The original song, "Proud to be an American," was written and recorded by country star, Lee Greenwood. It was released in 1984 and peaked at #7 on Billboard’s Hot Country Singles chart. It’s been recorded by Dolly Parton and Beyoncé and many others. It is the original by Greenwood that gets me every time. My oldest son played it as we watched fireworks after a hot, long July 4th recently, and I had the same teary-eyed, chest-sticking-out reaction that I’ve always had. U.S.A.! U.S.A.! I am a little biased…and it certainly doesn’t mean that we have the market cornered on everything that is right in the world…but, it does mean that I wouldn’t want to be anywhere else, and the ideas that so many have fought for in our young history has profound meaning. It is against this backdrop that we look at our markets and economy currently.

As the table above shows, Large-Cap U.S. stocks have been the place to be, not just this year, but really for the last five years and more. The S&P 500 has delivered nearly 17% in returns in the first half of 2023. The five year annualized return is 12.3%, which is 2.5% higher per year than the long-term historical average! If only we could just straight-line that out into the future indefinitely. Small-Cap stocks had a strong June, but are still around only half of the S&P 500, at 8.09%. Core bonds were down slightly in the month and the quarter, and are now up only 2.09% YTD. We do believe that bonds, in particular, have a chance to do much better over the next one to two years as yields offer significant coupon payment and the Fed is most likely near the top end of the Fed Funds rate-hiking campaign. That does not mean that rates are necessarily going to plummet back down to near zero again…or even quickly settle into the Fed’s terminal rate preference of around 3%. However, even if short-term rates top out at 5.5-6% over the next several months and then sit there or go gradually down, that still should be a positive scenario for bonds to perform well. Commodities finally delivered some strong performance in June as oil and gold led the way with the index returning +4.39% in June.
There is another important information nugget to mention relating to Large-Cap U.S. performance over the first half of the year. It has been extremely narrow and dominated by a handful of well-known names. The Information Technology sector within the S&P 500 has contributed greatly to the overall performance and was up over 44% in the first six months of the year. Further, as the table on the next page shows, the five largest stocks dominated even more.

Those five names (NVidia, Amazon, Google, Microsoft, Apple) were up nearly 75% by themselves in 2023! In fact, if you take out those five, the S&P 500 would have only been up a few percent points…and if you take out the top 7 names, the index would have been negative at the end of May. That means that, although the S&P 500 was indeed up nearly 17% in just six months, it was an extremely narrow advance. As many stock pickers trying to beat the index well know, it mattered greatly which names you held so far this year.

Another significant recent news release was the inflation report in June. As measured by the CPI, inflation ticked down to 3% for a year over year number. The trend has definitely been down in 2023, but we need to point out that the most recent numbers are being compared to the peak inflation numbers we saw in June of 2022, as shown by the blue line. Even if the annual rate is around 3%, we should expect the trend to stall, or even tick higher over the back half of the year, as shown by the green line…not a complete downer, but something worth watching.

Although Large-Cap domestic stocks have clearly led the way this year, the asset class table above continues to show the relevance of a diversified allocation approach. If you follow that white box above, it is never going to be at the very top…by definition it can’t if it is made up of a combination of the various asset classes. But, it is decidedly never near the bottom, and in fact, has returned nearly 8% in six months to those well-rounded investors.

A Look Forward

It feels quite a bit different as we sit here in mid-July talking about the first half of 2023 than it did on January 1st. We had just come off one of the worst years for diversified investors ever…worse than even 2008 in the Great Recession. Although down, it was not really stocks telling most of the story. It was the more-conservative bonds that surprised with a historically bad year in 2022, as the Fed took short-term rates from zero to over 4% in such a short timeframe. We’ve discussed before, but it had an equally negative affect on longer-duration Core bonds. So, let’s take a look at where we stand now.
The table below shows yields on investment-grade and high-yield bonds. After peaking at 6% earlier this year, investment-grades are still around 5.5%, with the risker high-yields standing above 8%. That represents a real alternative to what we saw in yields just 18 months ago…and that should prove to be a really good thing for the average investor over the next couple of years as rates normalize/stabilize.

We end on a positive note. We’ve highlighted that with all that was going on in the economy and geo-politically, that most were surprised with the outperformance of the S&P 500 so far this year. One might wonder what markets have done in similar situations? The table below attempts to answer just that. The first column shows gains through the first half of years where the index was positive by at least 10%. The second column shows what actually happened over the next six months. There are 28 calendar years since 1929 with the strong first-half performance. In 21, or 75% of those years, the index was still positive six months later…not a guarantee, but pretty good odds. Further, it has been positive, and usually significantly so, the last 11 times in a row.

We certainly have no blinders on. We recognize that we have hurdles to clear. Higher rates, although good for investors, make it more expensive to borrow. For better or worse, we had been used to financing debt at historically low rates over the last decade plus. That is changing. The table above really speaks to the resiliency of our markets. We could have shown a similar table with markets being negative the first half of the year and we would see returns higher over the next six months as well. Stocks are generally a good place to be. Recessions and market declines, although uncomfortable, should not be feared from an investment perspective…they are part of the cycle. We have enjoyed an incredible run over the last 14 years, and maybe the leaders will shift somewhat going forward, but Lee Greenwood had it right…I love this land. God Bless the USA.

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