Following a prosperous first quarter, the market continued to perform well in the second quarter. Most sectors of the market performed well with a few, albeit notable, exceptions. Below you can see a snapshot of market performance as of June 30th, 2023.
This is, of course, in stark contrast to the performance of 2022, in which all major stock and bond indices were down double digits.
Naturally, we love to see a rally such as this, but to be honest we don’t get too excited about these shorter-term market movements. We do, however, closely study the reasons for these movements and attempt to understand whether or not these shorter-term movements are telling a longer-term story.
In our opinion, the movements thus far this year are absolutely a result of a longer-term story/consensus. Simply put, investors believe that in the medium to long term, interest rates will be cut and ultimately stabilize quite lower than they are today.
Let me explain further: When interest rates are low (capital is cheap to borrow), then growth, technology, and cyclical companies tend to perform better than value, financial, and dividend-paying stocks. The Federal Reserve is approaching the end of its current interest rate hiking cycle. In my (not so humble) opinion, they should have been done six months ago. Once they are done hiking interest rates, the next logical direction (after a pause) would be to cut rates. Cutting rates is good news for growth stocks and if we look at the performance of market sectors year to date, most of the performance has come from growth stocks.
Those who have over-allocated to growth stocks have made a bet that the Fed is going to stop hiking rates very soon and cut rates sooner rather than later. That bet could prove right or it could prove to be a misguided short-term tactical bet. I’d rather not make a bet on a risk we cannot control. Of course, there are times when making portfolio changes makes sense, but jumping back and forth between value (performing better in 2022) and growth (performing better this year) is a fool’s errand.
Instead, we know that if we own a globally diversified portfolio of low-cost funds, weigh it towards fundamentally sound companies, and make adjustments along the way, we’ll achieve a desirable risk-adjusted return.
Speaking of global diversification, I would be remiss if I didn’t mention the performance of internationally developed and emerging market stocks. As you may have noticed above, internationally developed stocks are performing decently well year to date. They are up 11.67% vs. 16.89% for the S&P 500 vs. 8.09% for Small Cap U.S. Stocks. I should note that international indexes are composed of more value companies than the U.S. large-cap indices, which explains a large part of the relative underperformance thus far this year.
Emerging Markets on the other hand are up merely 4.89% as of the quarter end. This is not concerning necessarily as emerging markets tend to have a much larger variation in returns and are more slowly recovering from the pandemic than developed economies. This is mostly due to the financial burden on their currency in light of moves by central banks globally). We still believe that fundamentally emerging markets are cheap compared to their developed counterparts and are the best opportunity for excess growth over the long term.
Looking forward to the end of the year, all eyes are on the Fed. It appears that more interest rate hikes are on the way. Everyone is just wondering how many hikes we can expect. With one or two more hikes (and a pause), I believe the market will finish the year very strongly. With three or four more hikes, I think finishing the year higher than today could prove challenging for markets. Either way, we feel confident that our portfolios will continue to participate in the upside and protect on the downside. As always if you have any questions or concerns, please do not hesitate to contact us.Written by: Brice Carter
This commentary on this website reflects the personal opinions, viewpoints, and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.