- The upcoming recession increasingly looks like it will be shallow. While recessions usually drag investment returns down, the severity of declines are driven by unemployment levels and the overall severity of the economic slowdown.
- Near-term risks remain elevated as stock market leadership is currently highly concentrated and valuations are above long-term averages.
After a historically poor 2022, this year’s financial markets are delivering positive returns as Wall Street believes inflation is under control and the bulk of U.S. Federal Reserve interest rate increases are behind us. The recent debt ceiling compromise removes an important uncertainty for the stock and bond markets, the economy, and the U.S.’s standing in the world.
The upcoming recession increasingly looks like it will be shallow. Our American economy remains resilient but is now clearly decelerating. While recessions usually drag investment returns down, the severity of declines are driven by unemployment levels and overall severity of the economic slowdown. Fortunately, today’s long-term outlook has improved. Economic cycles, by definition, ultimately transition back into expansion and growth. We expect this year’s primary driver of investment performance to parallel our central bank’s progress on getting inflation down to their 2% target.
One of the inherent risks in today’s stock market valuations is the S&P 500’s narrow breadth. The largest five corporations represent 25% of the index, the largest 10 U.S. stocks are around 35% of the index. Although it’s not uncommon for a group of select stocks to outperform the broader market, near-term risks become elevated when the remainder of the companies underperform by wide margins. Recently, however, overall stock market breadth has improved.
In the second half of 2023, we expect financial markets to endure a bumpy ride as recession looks more probable than not. Although many investors expect our central bank to cut interest rates toward year-end, we see inflation remaining sticky and interest rates staying elevated. Meanwhile, bonds are likely to generate stable returns in the near term.
Please let us know if you have any questions regarding your investments or the financial market’s news of the day. We look forward to speaking with you soon.