July 3, 2023 | 2 MIN READ

Weekly Market Update

A Surprisingly Strong 1st Half

What happened last week?

  • The S&P 500 gained 2.35%
  • The Dow Jones added 2.02%
  • The Nasdaq composite rose by 2.19%

For the past 18 months the fear of recession has left investors sidelined, waiting for a single economic collapse.

Their behavior fails to acknowledge that the stampede out of equities and bonds last year accounted for a substantial portion of the market’s collapse and that the economy is in a rolling recession, with some industries far into their own downtrend.

Good portfolio management is not about market timing. Rather, strategic asset allocation followed by specific tactical allocations is the best way to help optimize potential opportunities and diversify risks.

3 Things to Know

Opportunities beneath market excess

Fear and greed drive bull and bear markets, often to excess. Remember the Nasdaq’s five-year run of 88% per year through 1999? But more recently, in 2020, consider the drop in nominal 30-year US Treasury yields to 1%.

In both cases, severe asset class corrections followed.

In 2022, global stocks and bonds both saw double-digit declines. For a 60/40 index blend of S&P 500/10-Year US Treasury, the annual loss was the largest since 1931.

1931 and 1969 were the only two prior years this century when both stocks and bonds declined together.

But what followed? After those rare double-dip equity and bond declines, strong returns were earned just two years later. In the two years post-1931 and 1969, 60/40 portfolios earned more than 20% over 24 months.

Despite a rapid slowdown in inflation — as fast as the decline in the 1980s — US labor markets have outperformed through the Fed’s sharp tightening. While we do not expect a plunge in employment, this labor resilience isn’t likely to be sustained.

The Fed will likely achieve its “goal” of raising US unemployment over the next two years. However, business output has already fallen for five quarters, mostly as a result of declining investment.

In other words, those waiting for a contracting economy should recognize that lower output is recessionary.

Fewer benefits from playing defense

The poor performance of US private businesses has already been digested by the equity markets. For example, a handful of AI-themed shares have seen sharp gains, but market breadth (even for IT shares) has been poor.

As investors sought safety in strong balance sheets, an unusually large valuation gap has opened up in favor of smaller companies, which have experienced an underperformance consistent with a mild recession.

As CGWI discussed in April when it took profits on the overweight in large cap pharmaceuticals shares, CGWI sees diminished benefits from “playing defense” in equities. The relative valuation of defensive industries and quality balance sheets has surged.

Many of these firms now offer neither growth nor value, but rather a static performance that doesn’t suit the returns we seek in the equity component of portfolios.

Citi Global Wealth Investments
Charlie Reinhard - Head of North America Investment Strategy
Lorainne Schmitt - North America Investment Strategy

See our weekly CIO Strategy Bulletin for more details