July 2023
Welcome summer! The Ratio Wealth Group Team hopes the first six months of the year were prosperous and wishes each of you an enjoyable remainder of 2023.
Investors had a lot to muddle through during the quarter. Geopolitical and economic risks continued to evoke strong emotional reactions – primarily fear. Add to the Russia/Ukraine headline, a US debt ceiling scare and the news outlets had plenty to focus on. Yet, global stocks rose 5.9% in the quarter, while US large-cap corporations rose 8.6% and US small-cap corporations rose 5.2%. While the bond markets were generally flat, year-to-date stabilization, slightly positive returns and healthy yields suggest the chaos from 2022 for fixed income is behind us. Add in a Denver Nuggets NBA Championship for those of us in the region and the last three months were not half bad.
In our last two communications, we highlighted our belief that a deep recession was likely avoidable. For several months, we have seen inflation trending downward at a healthy pace and the Federal Reserve in the later innings of increasing interest rates. We believe these factors will remain in the headlines throughout the year, with a more likely narrative as follows:
- A recession is coming but more of the “mild” version.
- The June 27, 2023, gross domestic product (GDP) forecast out of the Federal Reserve Bank of Atlanta for 2Q23 is a positive 1.8%.
- The June 27, 2023, gross domestic product (GDP) forecast out of the Federal Reserve Bank of Atlanta for 2Q23 is a positive 1.8%.
- Inflation is slowing but not fast enough.
- The Consumer Price Index (CPI) showed a June 2022 peak of 9.1%. The May 2023 CPI number was 4.0%. (U.S. Bureau of Labor Statistics) June 2023 numbers will be released on July 12, 2023.
- The Consumer Price Index (CPI) showed a June 2022 peak of 9.1%. The May 2023 CPI number was 4.0%. (U.S. Bureau of Labor Statistics) June 2023 numbers will be released on July 12, 2023.
- The Federal Reserve rate increases have had the desired effect but may have to be raised several more times to get the economy on a healthy footing.
- The median projection for year-end 2023 fed funds rate is in the 5.625%, up from the current range of 5.0%-5.25% (Federal Reserve Board “dot plot” forecast – July 6, 2023).
- The median projection for year-end 2023 fed funds rate is in the 5.625%, up from the current range of 5.0%-5.25% (Federal Reserve Board “dot plot” forecast – July 6, 2023).
While these macro topics will continue to dominate financial headlines, we believe that most market participants are acting under a general belief that the broader economy is stable. Attention is now rightly focused on market equilibrium and the prospects for realistic expansion.
Heading into the second quarter of 2023, our portfolios were positioned to be fully invested and diversified across major asset classes, with a tilt towards value-centric equity holdings and fixed income exposure that stayed shorter on the yield curve with a quality (investment grade) bias. Our investments reflected the belief (which was reinforced in late 2022) that valuations were “fair” across investable assets and that future gains would be derived from improving profits – always with a caveat that macro factors did not deteriorate drastically.
In the recent quarter, as in the first half of the year, aggregate performance across equities has been positive, but results have been extremely bifurcated. A heavily market cap weighted index like the S&P 500 saw the biggest returns from the largest names. The bulk of S&P 500 gains in the first half of 2023 were due to the positive reversals by Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVDIA and Tesla. These “Big 7” account for around 28% of the index and have returned 20% collectively. The rest of the S&P500 fell on average during the period. Note these Big 7 companies were down 34% on average in 2022. While the broad indexes show recent gains, a true “market” recovery has not materialized and some catch-up must be done between the economy and a larger representation of corporations that support global GDP.
For reference, broad year to date index performance as of 6/30/2023 is as follows:
- S&P 500 16.9%
- Dow Jones Industrial 4.9%
- Russell 2000 (US small-cap companies) 8.1%
- MSCI All – World Index 13.9%
- Aggregate Bond Index 2.1%
Our early 2023 notion that multiples were generally reasonable, and that stock performance would ultimately be dependent on rising profits, has been tested in the short term. For example, the valuations of US large cap indexes grew during the quarter, pushing multiples to the high end of their historical ranges. As indicated by the performance dispersion above, the top 10 market cap weighted stocks in the S&P 500 have a current multiple of 29x vs the remaining S&P 500 stocks of 18x. Relative growth rates can impact this spread but can also create greater downward pressure if high multiple stocks fall short on growth expectations.
We maintain that while certain segments of the market are extended, broad global growth, relative to prices and expectations, is reasonable. Non-US equites and US small-cap indexes are displaying a more reasonable historical relationship between valuations and modest growth. Our belief is that while extremes can last longer than the short-term fundamentals support, the equity markets are searching for a more equitable distribution of returns as indicated by July’s outperformance of stocks outside of the previously mentioned “Big 7”.
Year to date, some of the rebalancing we have done for client accounts has focused on increasing exposure to underperforming technology stocks as well as a slight increase in smaller US equities. Our intent is to position our clients in anticipation of a reversion to the mean from the outperforming, mega cap tilt, towards the underperforming, more attractively valued rest of the equity market. This might take some time, but we believe our changes will benefit returns as investors recalibrate for modest growth coming out of the 2022 correction and the momentum chase that has occurred in large cap technology stocks so far in 2023.
In fixed income and cash allocations, near term fundamentals still support a 5% plus yield in short- term treasuries. A balanced ladder of treasuries, municipal bonds and corporate bonds can produce a yield closer to 5.5% (noting the use of tax-equivalent yields for municipal bonds). For accounts that target balanced risk, relative to return, we did continue to raise fixed income allocations slightly. Remember, it was only two years ago that a similar strategy was yielding less than half what we see today.
Additionally, our Team has been spending a fair amount of time researching opportunities in the alternative investments space. These tend to have less liquidity and lower correlations to traditional assets like stocks and bonds. The design is to complement a diversified traditional allocation with opportunities for growth and income that are not dependent on the same factors for success. In evaluating these alternative investments, we seek to strike the right planning balance between liquidity and risk appropriate growth. Areas of interest specifically include opportunity zones for tax efficiency and an emerging need for private credit as lending standards continue to tighten.
We know this time of the year tends to get busy with travel, vacations and other summer activities. For those with kids going back to school, that summer fun feeds directly into a chaotic fall. Please know the entire Ratio Team is available for portfolio review and planning updates at any time. If your summer schedule is cumbersome, please anticipate a fall meeting to include a financial check-up and planning adjustments for 2024 and beyond.
With gratitude,
Derek
