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Reviewing the Second Quarter, and What’s to Come

Markets in a Minute: Reviewing the Second Quarter, and What’s to Come
Stocks enjoyed a strong rebound, the S&P rose 17% in the first half of the year, and tech stocks outperformed while the financial and energy sectors lagged. Check out this week’s Markets in a Minute for a quick read on what drove performance this quarter and what’s to come in the second half of the year.

Q2 Market Review and Outlook

After a turbulent 2022, the equity market rebounded in the first half of 2023 as the S&P 500 rose 17%. Technology stocks soared as companies introduced new products that leverage artificial intelligence (AI). At the same time, consumer prices rose by the lowest rate in two years, and the US government managed to avoid a debt-ceiling debacle.

This resiliency was offset by middling returns in the fixed-income market as the Federal Reserve continued its interest rate hikes. What’s next for the economy and markets? Let’s discuss.

Asset Class Returns, Q2 2023 (%)

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Note: views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. Source: Kestra Investment Management with data from FactSet. Index proxies: Bloomberg U.S. AGG Bond Index, ICE BofA U.S. Corporate, ICE BofA U.S. High Yield, S&P 500, MSCI EM, MSCI World ex US Index, Dow Jones U.S. Select REIT, and Bloomberg Commodity Index. Data as of June 30, 2023. 

Delayed Economic Landing

  • In the first half, economic growth, while weaker than average, managed to remain in positive territory, helped by consumer spending and a robust job market.
  • Inflation, while subsiding, remains above the Federal Reserve’s long-term goal. As such, the Fed is likely to keep rates at a relatively high level for longer.
  • Other economic indicators, such as manufacturing surveys and an inverted yield curve, point to slowing ahead, but the timeline has been extended due to present economic strength.
  • Any potential downturn should be fairly shallow due to robust consumer and commercial balance sheets.
  • Above-average stock valuations and heightened sovereign debt across the developed world remain risks to watch.

Economic Dashboard
Despite leading indicators signaling tougher economic conditions on the horizon, economic growth remained in positive territory in Q2. Weakness on the manufacturing front has been balanced out by stronger consumer spending and confidence, with the added benefit of resilient labor and housing market.

Source: Kestra Investment Management

The Business Cycle

In our 2023 Market Outlook from January, we discussed two reliable indicators of a pending recession—the treasury yield curve and the ISM Manufacturing index. Both indicators have continued to flash warning signs throughout the first half of 2023. That said, continued consumer spending, a strong labor market, and a resilient housing market have kept the economy expanding, albeit modestly. 

Yields on the 10-year Treasury bond have dropped well below its 2-year counterpart. After initially inverting in May 2022, that portion of the yield curve is now inverted by almost 100 basis points (a full percentage point)—roughly a 30-point increase since the beginning of 2023. Since late 2022, the ISM Manufacturing Index has offered a similar cautionary signal. Earlier this month, the data for June revealed an eighth consecutive month of contraction, clocking in at 46. 

ISM Manufacturing PMI
Contributions to Headline Index

Forward looking projections may not come to pass.
Source: Kestra Investment Management, Institute For Supply Management and FactSet. Data as of June 30, 2023.

While the yield curve and manufacturing are sending warning signals for the economy, other areas remain resilient. Consumer spending, buoyed by improved consumer confidence and a very strong labor market, remains a bright spot. Despite higher interest rates, house prices and activity have held in because of a limited number of homes for sale.

U.S. Supply of Existing Single-Family Homes For Sale

Source: Kestra Investment Management, U.S. National Association of Realtors with data from FactSet. Data as of June 30, 2023. 


The stock market rally during the first half of the year was remarkable not just for its swiftness, but also because it was driven by just a handful of stocks. Two factors emerged since January that have accounted for a stock’s outperformance: growth orientation and size. The faster-growing, the better, and the larger, the better. With only a few exceptions, growth stocks have consistently outperformed the overall market while value stocks have struggled. 

Additionally, the size of companies, measured by market capitalization, emerged as a crucial determinant of market winners. The S&P 500 index, the most commonly cited stock index, includes, as the name suggests, 500 of the largest stocks in the United States. That measure was up an impressive 16.6%. But those returns looked paltry compared to the seven largest stocks in the index, which rose an average of 82.5% during the same time frame—an extraordinary difference. 

In addition, there were noticeable discrepancies in the performance of various sectors over the course of the year. The sectors that led the recovery have been information technology, communication services, and consumer discretionary, sectors that had underperformed by a large margin in 2022. Technology stocks, in particular, fared exceptionally well due to improved earnings and the enthusiasm surrounding artificial intelligence. Conversely, financials and healthcare lagged the overall market while the energy and utility sector experienced negative returns. Financial companies grappled with multiple bank failures, while energy companies dealt with falling oil prices after significant gains in the previous year. 

This increase in stock prices came as corporate earnings stabilized and valuations grew. The price-to-earnings ratio of the S&P 500 now sits at about 20x estimated earnings for the next 12 months, above the average since 2000 of 16x, meaning many stocks are more expensive than is typical.

Bonds continued to confront additional rate hikes by the Federal Reserve. Though corporate bankruptcies have ticked up, credit spreads on high-yield bonds remain at tight levels. 

What Does This Mean for the Second Half of 2023? 

The economic backdrop combined with above-average valuations makes us modestly cautious on risk assets. Though we continue to expect economic growth to slow as high-interest rates filter through the economy, stronger consumer and corporate balance sheets remain healthy. Bonds offer attractive yields and a likely near-term end to interest-rate hikes.  

This year's dramatic shifts in the market are a helpful reminder that markets can shift swiftly and without warning. As such, a properly diversified portfolio tailored to your unique goals and objectives is the best strategy to build wealth over time.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Investment Services, LLC, Bluespring Wealth Partners, LLC, and Grove Point Financial, LLC. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by any entity for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was created to provide accurate and reliable information on the subjects covered but should not be regarded as a complete analysis of these subjects. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. Kestra Advisor Services Holdings C, Inc., d/b/a Kestra Holdings, and its subsidiaries, including, but not limited to, Kestra Advisory Services, LLC, Kestra Investment Services, LLC, Bluespring Wealth Partners, LLC, and Grove Point Financial, LLC. Does not offer tax or legal advice.