Q2 Recap
The second quarter of 2023 was volatile with more headline risk for the markets. The U.S. debt ceiling was a near-daily concern for investors throughout much of Q2.
Investors were told to be on high alert for a recession and added expectations Fed could soon be cutting rates. At the quarter’s end, there was still no economic downturn in sight, inflation remained sticky, and the Fed was expected to keep rates higher for longer.
U.S. equities rallied 8.7% on the quarter, while the bond market declined 0.8% and global commodities fell 2.5%.
An analysis of the Morningstar US Market Index shows that the returns of just seven stocks make up almost 75% of the total market return for this year.
Macro Trends to Watch in Q3
Although the US economy has slowed down, it still shows resilience. However, there are concerns about business spending due to potential layoffs in the tech sector, which could impact R&D spending. Consumers are also feeling the effects of reduced fiscal stimulus and higher inflation, leading to depleted savings. The personal savings rate has dropped to 4.2%, and consumer spending is expected to slow down in the upcoming months.
On the bright side, the housing market is stabilizing, though at low levels. While trade may have a slight negative impact on the economy, the global economy is gaining momentum. The US economy is likely to continue growing at a steady pace, but there are potential risks on the horizon, such as a possible decline in commercial real estate.
While the stock market may currently be performing well, it is important to be aware that profit margins are rapidly being squeezed. As a result, companies may be forced to limit their investments. However, it is crucial to understand that tech investments are expected to increase. It is important to exercise caution and not be overly optimistic about potential policy changes as this could lead to declines in market value. We strongly recommend focusing on high-quality, cash-generating assets when considering equity investments.
The following macro trends are likely to play a significant role in the markets in Q3:
Inflation: Inflation remains a major concern for investors. The Federal Reserve is expected to continue raising interest rates in an effort to bring inflation under control. However, there are concerns that the Fed's actions could lead to a recession.
Labor Market: There is evidence that the labor market is undergoing a change as jobless claims and layoffs continue to rise. This trend could ultimately result in a less favorable labor market composition with higher unemployment rates.
Sector Rotation: We may see a shift from growth to value stocks, but banks, energy, and industrial industries need to receive more inflows for this to be confirmed. Investors should look to take profits on overextended stocks and reinvest in undervalued names left behind by the rally.
Sectors to Watch in Q3
The following sectors are likely to be volatile in Q3:
Communications: The sector rose 10% in the second quarter through June 26 and a total of 32% QTD, but it remains the most undervalued sector. However, in this sector, Alphabet and Meta Platforms are now trading at much less discount to fair value. Within communications, we see potentially the best value in the more traditional telecom and media stocks.
Technology: The technology sector may seem overvalued with a 12% increase in Q2 and 37% surge so far this year. The overall consensus is to consider reducing exposure and investing in communications and cyclical sectors. However, strong momentum between AI and cloud computing may keep the rally running.
Emerging Markets: Developed markets have outperformed EM equities this year, despite the weaker U.S. dollar, which typically leads to EM outperformance. China's economic concerns have been a hindrance, and unfortunately, these concerns are unlikely to dissipate in the near future.
Overall Outlook for Q3
US stock markets have surged, led by tech stocks benefiting from excitement around AI. However, there are doubts about the impact on productivity, which historically takes years or decades to materialize. Central banks will need to maintain restrictive policies due to sticky prices and high wages. Many analysts are not optimistic about risk assets, and major assets are likely to trade within a range and keep a pulse of company valuations into the next earnings cycle.
Thank you for reading our 3rd quarter investment newsletter. We will continue to provide you with updates on the markets as we move through the quarter.
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