Q2 Market Commentary: A Look Back & Ahead
MODERNIST’S ASSET CLASS INVESTING PORTFOLIOS ARE STRATEGICALLY INVESTED WITH A FOCUS ON LONG-TERM PERFORMANCE OBJECTIVES. PORTFOLIO ALLOCATIONS AND INVESTMENTS ARE NOT ADJUSTED IN RESPONSE TO MARKET NEWS OR ECONOMIC EVENTS; HOWEVER, OUR INVESTMENT COMMITTEE EVALUATES AND REPORTS ON MARKET AND ECONOMIC CONDITIONS TO PROVIDE OUR INVESTORS WITH PERSPECTIVE AND TO PUT PORTFOLIO PERFORMANCE IN PROPER CONTEXT.
As evidence-based investors, we use an approach fueled by data with over 50 years of research, rooted in diversification and tax conscious investment options. Time has proven the value of investing. While these quarterly market reviews are helpful for staying informed, we also love to remind our clients and community: focus on what you can control, remember the big picture, and stick to your plan.
market snapshot:
Global stock markets continue to grow, despite headwinds. Optimism around artificial intelligence has boosted stocks: At second-quarter end, nearly 80% of the S&P 500’s return was due to the performance of 10 tech-related companies.
Value stocks, meanwhile, continue to trade at valuations that would be indicative of a serious recession.
In the bond market, the yield curve remains inverted, meaning that long-term bonds are more expensive than their short-term counterparts. Although this typically precedes a recession, higher short-term yields present an opportunity for long-term investors.
KEY ECONOMIC INDICATORS: AREAS TO WATCH
Inflation Trajectory
Although year-over-year core inflation has declined from the peak in September 2022, inflation has proven resilient. The strong services sector, tight labor markets, continued fiscal stimulus, and trend toward deglobalization means inflation is likely to remain higher for longer than the Fed would like.
Fiscal Policy
The Congressional Budget Office projects a federal budget deficit of $1.4 trillion for 2023, with the deficits rising in future years. For example, it estimates the deficit will swell to 6.1% of GDP in 2024 and 2025 and will reach 6.9% by 2033. While rising interest rates were necessary to combat inflation, this increases the cost of servicing U.S. debt. Evidence shows that high levels of debt to GDP can adversely impact medium-and long-term economic growth.
Global Economy
Economies across the world are facing similar challenges as the U.S. when it comes to tamping down inflation. Core inflation in the eurozone increased by 5.3% in May, compared to 7.1% in the U.K. and 4.3% in Japan. In June, the Bank for International Settlements (BIS) called for more interest rate hikes, warning the world economy was now at a critical point as inflation is remaining stubbornly high worldwide.
Monetary Policy
Markets are expecting the Fed to raise rates by another 0.25% at its next meeting at the end of July, with a roughly 40% chance of a second rate hike before the end of 2023. The Fed is data dependent and will hike rates as needed if inflation numbers come in higher than expected.
Labor Market
The strength of the services sector has contributed to the strength of the labor market. The May jobs report showed an increase in employment of 339,000. And while the unemployment rate rose to 3.7% from 3.4%, the labor market remained tight, allowing wages to increase at a faster pace (hourly earnings grew 4.3% compared to the same period last year, similar to gains in the prior three months).
Consumer Spending
While households have been running down their excess savings built up during the pandemic, a study by the Federal Reserve Bank of San Francisco found that they still have sufficient savings to support spending through at least the fourth quarter of 2023. But the excess savings eventually will be eroded, and the three-year pause on student loan repayments will end this summer. In addition, should the unemployment rate rise, households are likely to have a greater appetite for savings and significantly shift their spending habits.
Commercial Real Estate
With hybrid work models now well established, a 50% occupancy rate may be the new permanent level for offices in many metropolitan areas. In June, the New York City office occupancy rate rebounded to just above 50% – the first time it crossed that level since the pandemic began. Other cities, such as Washington, D.C. and San Francisco, have yet to break the 50% mark. Because commercial real estate construction is roughly 2.6% of GDP and fewer skyscrapers and shopping malls are being built, the sector is likely to constrain economic growth over the coming years.
Housing Market
Although new home sales are at their highest level since February 2022, applications by home purchasers are down by roughly a third compared to this time last year, and refinances are down even more. The combination of rising interest rates and higher home prices has resulted in housing becoming the least affordable in over 30 years. The millions of homeowners that refinanced their mortgages during the pandemic, when rates were at historical lows, are less vulnerable to higher interest rates.
Thanks to our reliance on long-term evidence-based investing principals, we know that short term data is too noisy to determine our investing choices. Yet, we always like to offer our review of markets because we believe this information should be accessible to all!
