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Monday, July 15, 2024

Markets: April-June '23 review & outlook

Quarterly market review & outlook


Key takeaways

➡ During the quarter, the debt ceiling showdown was resolved more expediently than expected, and feared aftershocks from the Silicon Valley Bank failure generally failed to materialize. Those factors, combined with the absence of drama, were all enough to clear the way for stocks prices to move higher.

➡ Markets had been expecting the Fed to reverse course and enter a phase of rate cuts by late 2023 or early 2024. That no longer looks likely, in part because the job market has been resilient.

➡ The yield curve remains significantly inverted. Historically, inverted yield curves have been correlated with pending recessions in part because they discourage bank lending, but we are not seeing strong evidence of that so far this year.

➡ For the first half of this year, most market gains were largely isolated to the absolute most valuable companies. Some would like to believe these stocks are both growth and “safe,” but history has proven volatility cuts both ways. What goes up the fastest can just as easily fall the hardest.

➡ With many offices and stores empty, a potential series of bad commercial real estate loans is a common fear of many investors. As it relates to overall equity or bond prices, however, we expect the impact has already primarily been baked in.

➡ Recent events could very well mark entry to the next phase of profound change in the evolution from computers to the internet, to mobile, to cloud — and now to more advanced artificial intelligence (AI).

➡ The downward trend in inflation is good, and the Fed and other major central banks appear committed to containment. Meanwhile, higher interest rates have created volatility in stock prices, but the silver lining is that greater yields on bonds should provide more steady income from more conservative investment portfolios.

➡ We believe it is unlikely the U.S. dollar loses its global status any time soon. The U.S. dollar has a strong track record as an effective store of value, especially during times of crisis. Confidence is largely rooted in the robustness of U.S. financial markets and the economy along with macroeconomic policies promoting open markets, property rights, and rule of law.


The biggest financial story in the second quarter was the debt ceiling showdown, which was resolved more expediently than most expected.

It was a relatively quiet quarter, with feared aftershocks from the Silicon Valley Bank failure generally failing to materialize. Given a starting point of nearly universal pessimism regarding the economy, the absence of drama was enough to clear the way for stocks prices to move higher. Meanwhile, investors rapidly gained enthusiasm for the potential of developing artificial intelligence (AI) technologies, instinctively gravitating toward the biggest tech companies, and adding to overall returns.

The world has experienced significant change since the start of the pandemic just over three years ago. One thing that has been steady: Those who maintained a diversified investment approach and avoided emotional reactions typically have respectable gains to show for it. We believe that by avoiding big mistakes and remaining diversified, our clients remain well positioned for the next market cycle, regardless of whether we are truly in a new bull market or not. Along the way, small efficiencies from rebalancing and tax management tend to go unnoticed, but they compound and become material over time, which is why we are committed to both.

The Dow Jones U.S. Total Stock Market Index gained 8.3% in the quarter, led by the most valuable companies. The Russell 2000 Small Cap Index rose 5.3% and international stocks returned 2.9%. Aggregate U.S. Bonds lost 0.9%, with yields offsetting a good portion of the impact of rising rates.



➡ Consumer prices were reported 4% higher in May from the previous year, the lowest inflation reading since March 2021.

➡ Core prices excluding food and energy were 5.3% higher. These numbers mark progress in the fight against inflation but remain stubbornly high relative to the Fed’s 2% long-term target.

➡ The Fed increased short rates in May for a 10th consecutive time to 5.25%, then paused at its June meeting. However, Fed Chairman Powell indicated in comments following the meeting that inflation was still the priority and suggested additional hikes should be expected over the remainder of the year.

Market concentration

For the first half of this year, most of the market gains were isolated to the absolute most valuable companies — specifically Apple, Microsoft, Alphabet, Amazon, Meta Platforms, Nvidia, and Tesla. On average, these stocks are up 89%, while all remaining stocks in the S&P 500 are up on average just 8%.

Part of this is timing. Growth stocks in general had a horrible 2022, and while mega caps fared better than many of the more speculative names, they were still hit hard. A rebound started right at the beginning of 2023.

Another significant driver is heightened investor expectations for the business prospects of AI, allowing justification for multiples growing faster than earnings. This fervor accelerated with widespread exposure to ChatGPT and Nvidia’s announcement of increasing demand for the GPU chips driving more complicated AI processes. The result of this mega cap outperformance is that the U.S. stock market has become the most concentrated it has been in at least 50 years.

We generally believe in a diversified approach — both the asset class level and within equities.

Looking ahead, while we view these mega cap stocks as very strong companies, each with their own unique advantages, we believe capitalization weighted indexes face increased risk due to the historically outsized levels of concentration. Traditionally, large cap stocks are less volatile than small cap stocks, but recently the biggest stocks have seen the most extreme moves. Some would like to believe these stocks are both growth and "safe," but history has proven volatility cuts both ways. What goes up the fastest can just as easily fall the hardest.

Today’s mega cap tech leaders are likely to be challenged not only to support existing multiples, but to continue to defy the laws of large numbers. For example, a seemingly innocent 2% move in Apple or Microsoft represents more than a $50 billion change in valuation, or the equivalent of a Marriott or Fed-Ex. There are only so many dollars in the global economy to go around, and competition is fierce. Meanwhile, with so much investor enthusiasm focused on just a few companies, we believe it opens the door for many compelling opportunities elsewhere.

Valuations and sentiment

As of the end of May, the trailing PE of the MSCI All Country World Index was 18.2, implying an earnings yield of 5.5%.

With U.S. Treasury yields ranging from 3.8% to 5.5%, this is moderately unattractive, in our view. The earnings yield on international stocks is 7.0%, making a global approach more compelling on this basis. Growth stocks are again trading at historically high valuation multiples relative to value stocks. This suggests investor sentiment has returned to extreme levels favoring growth, and prices may be stretched.

Another quarter of positive returns has had a meaningful impact on overall sentiment.

Despite indications that more rate hikes are in store, widespread fear of recession seems to have waned. As a result, we are seeing increased signs of complacency and greed when it comes to equity investing. The VIX, sometimes referred to as the fear index, finished the quarter near a three-year low. Because it can be easier for markets to climb a wall of worry, we view overall sentiment as a slightly bearish factor, which is a change from its moderately bullish position last quarter.

Commercial real estate

In the U.S., there are about $1.4 trillion of commercial real estate loans due this year and next, according to the Mortgage Bankers Association.

With many offices and stores empty, a potential series of bad loans in this area is a common fear of many investors. Indeed, the situation in office space and retail is bleak, especially in certain cities like New York and San Francisco, and some owners are starting to walk away from their properties. As it relates to overall equity or bond prices, however, we expect the impact to be modest or already baked in.

First, the problem is widely known and all over the headlines, meaning losses are already anticipated. Second, while some properties will end up as a compete write-down, most retain significant value, and we expect recovery rates on defaults should be high. That said, the combination of additional rate hikes, an inverted yield curve, losses on commercial real estate, and bank caution following the Silicon Valley Bank implosion could come together to significantly tighten liquidity and create the deeper recession so many have been anticipating.

The bottom line

The low point of the bear market was in October. Since then, global stocks have rallied by about 25%. Technically, that meets the common definition of a new bull market and we could declare the bear history.

However, as of quarter end, global stock prices remain almost 8% below the peak of 18 months ago. And with central banks still tightening, we think it is premature to call this a new market cycle.

That does not mean stocks cannot break through to new highs. Stocks are one of the few things people tend to want more of after the price has already gone up. The fact that we have not reached new highs is a positive in our view. Valuations in the U.S. imply companies must perform well to justify higher prices, but for global investors, the bar is lower than it was. Meanwhile, the odds of a “soft-landing” seem to be increasing with every month that does not show a slowdown.

The U.S. market has become heavily concentrated. This creates some additional risk, but also opportunity for those willing to own areas of the market currently overlooked by many. Valuations in the mega class elite require strong execution but unlike much of the growth side of the market at the end of 2021, they do not strike us as unreasonable or as a cause for overall bearishness.

A word on AI

AI has captured our imaginations for decades. It has been in existence in various forms since the 1950s with the onset of computing, and we now seem to be entering a phase of accelerated development.

Recent events could very well mark entry to the next phase of profound change in the evolution from computers to the internet, to mobile to cloud — and now to more advanced AI. Along with the rapid adoption of ChatGPT, a blowout revenue forecast by Nvidia in May was meaningful because it showed that real-world demand for the most significant AI tools is accelerating in a big way.

Most of what gets called AI is really rules-based algorithms written by people. Recently, breakthroughs in generative AI are capturing much attention, and for good reason. Generative AI can write content, either in text or video. Large language models (LLM) like ChatGPT can consume massive amounts of information (effectively the open internet) and use it to create (usually) very good answers. Siri and Alexa do something similar but have more limited data sets and require more conservative constraints.

At present most LLM models tend to come up with “consensus” responses, making them more artificial research than artificial intelligence. Many leaders in the AI world talk often about the concept of AI “assistants” or “co-pilots,” which help us do things better. This is somewhat self-serving because it makes AI sound less scary but is also a useful perspective.

AI is getting better at helping write code, legal documents, and more. It can also imitate real people. New models will likely be able to combine text with images and video, and some tools can react differently based on how humans interact with them. There are many exciting potential applications, but there are also many things generative AI will not be able to help with. So far, much of the focus has been on how to do existing things cheaply, or how to replace people in various processes. Hopefully, this will transition to developing better products and services, not just cost-cutting.

Most of the current excitement relates to digital forms of AI. The physical world is perhaps even more interesting, but it has bigger development challenges for now. Things like autonomous driving and drones are happening. Truly advanced robotics are at least a few years away but may come sooner than many expect. The Tesla robot, which looks eerily similar to a Terminator minus the red eyes and menacing smile, can already do some sophisticated tasks. On that note, many prominent people in the field have expressed concern over the risks of AI, often in dramatic terms. Given their number and credentials, this should not be dismissed.

A few thoughts and observations related to AI and markets:

We believe the impact of AI will be dramatic and the rate of change in technology will accelerate beyond the recent pace. There is also a lot of hype, which probably overestimates the short-term impact. It is likely things will change less than most expect in the next five years and more than most expect in the next 10-20 years.

AI will benefit those who are most nimble at using it, which may turn out to be smaller companies. A faster rate of change could create greater risk for incumbents. For example, Google’s main search engine dominance may be threatened, or if Google or Microsoft or a new company create the breakthrough on personal digital assistants, it could threaten Apple. On the other hand, it is possible that one or two AI software or hardware companies pull ahead of the rest in some unimagined fashion, leading to unprecedented dominance and even greater wealth concentration.

Platform providers with the computing power to run advanced applications are likely to become even more important. Corporate tech budgets may increase incrementally to invest in AI; however, these trends are very well known and may already be fully reflected in stock prices of the mega tech companies.

There are suddenly a bunch of AI startups with multi-billion-dollar valuations. As with past boom-bust hype cycles such as dotcom, nanotech, clean energy, electric vehicles, cannabis, crypto, metaverse, etc., valuations for many companies will outpace reality and many people will lose money on them. A difference is that the impact of AI will likely be orders of magnitude more important than most of these.

AI will make companies more efficient in almost every industry. This should improve margins and at the same time may also help to reduce prices and contain inflation.

Many jobs will be replaced or greatly changed. Historically, with revolutionary technologies, companies found new and better roles for people, creating a net-positive overall. We expect mostly the same over the next decade or two, but things may move fast enough to cause periods of high unemployment along the way. More complex jobs are not immune. It is difficult to predict where breakthroughs will happen.

Ultimately, the societal impacts of improving technology will be profound.

It is debatable whether the internet and mobile devices have made our lives better or worse, but either way, the show will go on. Stocks do not measure the state of the world, or the happiness of people. For equity markets, what matters most is how much money companies make over time. There is a good chance that AI technologies will increase productivity, make life better, and make the money we have more valuable. On its own, they do not create more total money.

As in the early days of the internet, it is hard to predict which companies will end up winners and losers. The big winners may not even exist yet. In a world where the rate of change is likely to accelerate, and uncertainty with it, we believe a diversified investing approach remains as or more desirable than it has ever been.

Inflation update

While the latest reading of 4% in May was an improvement, it follows an 8.6% print last May, meaning prices are almost 13% higher than two years ago. Unlike many things in the financial news, this impacts all our daily lives. We can all feel it. An early 2023 survey by the Employee Benefit Research Institute showed that Americans’ retirement confidence has dropped meaningfully from a year ago.

Life is in many ways less stable than we wish. COVID has and continues to be a tragic health crisis. Government response, while potentially appropriate, has led to consequences that have supported equity markets and asset prices but has devalued our money. Additionally, the encouraging trends in the U.S. are not materializing everywhere — the U.K. just reported shop price inflation of 8.4% in June, with food prices up 14.6%.

Empower is committed to helping people meet retirement goals and achieve financial freedom. We urge individuals to take a rational and informed approach to dealing with inflation. The first step is understanding what it means to retirement plans. The Retirement Planner on your dash- board is a great place to start.

However, spending expectations may have changed. If you have aggregated credit cards and other spending accounts, now is a good time to see if retirement spending assumptions remain valid.

If you are already retired, current spending is relatively straightforward. If not, a good rule of thumb is that you will want 70-90% of current spending levels, if it is affordable. The unfortunate reality is that for many, recent inflation may mean targeting a somewhat lesser lifestyle than previously imagined. This does not necessarily mean drastic changes are immediately required, but it may be appropriate to make certain adjustments. This could mean spending less or delaying retirement age by a year or two.

As far as the future of inflation, we are cautiously optimistic. The trend is good, and the Fed and other major central banks appear committed to containment. Mort- gage rates are elevated for those who wish to buy a new home, but housing prices for buyers and renters have stabilized. Advances in technology are driving efficiencies and keeping a lid on prices. For example, a new Tesla Model 3 now lists for approximately $40,000, before a $7,500 tax credit. While still out of reach for many, this represents a deflationary pressure on a major segment. Rental prices dropped slightly in May for the first time in years, according to

Meanwhile, higher interest rates have created volatility in stock prices, but the silver lining is that greater yields on bonds should provide more steady income from more conservative investment portfolios. Near-zero interest rates were great for growth stocks, but they also created many challenges for retirees.

The U.S. dollar

Most recently, U.S. sanctions of Russia following the invasion of Ukraine have created concern that other countries may view this type of weaponization of the U.S. dollar as a potential threat, regardless of their stance on these sanctions. Therefore, other countries would look to reduce their risk by shifting away from the U.S. dollar. On a small scale, this behavior has already begun to take shape, especially among BRICS countries (Brazil, Russia, India, China), where a string of deals were made to settle trade in local currency over U.S. dollars. In Asia, the Association of Southeast Asian Nations also recently announced joint efforts to boost the use of member currencies for regional trade and investment. China has been a key orchestrator as part of its efforts to expand the use of its currency abroad.

Although these trends are concerning, the reality is it is unlikely the U.S. dollar loses its global status any time soon. The U.S. dollar has a strong track record as an effective store of value, especially during times of crisis. Confidence is largely rooted in the robustness of U.S. financial markets and the economy along with macroeconomic policies promoting open markets, property rights, and rule of law.

Economic research from the Federal Reserve shows the dollar’s international usage has not changed materially over the past five years and that dollar dominance has been stable for the last two decades.

In summary, the main reason the dollar is unlikely to be dethroned anytime soon is that there is no viable replacement.

The closest competitor is the euro, which as you can see still largely trails the dollar in dominance. Europe most closely resembles many of the factors contributing to USD dominance, but even with further fiscal integration, political differences will remain a challenge.

Evidence suggests that despite sanctions on Russia, this has not led to a material change in allocation of reserves and
is unlikely to. China faces significant challenges in its efforts to compete with the U.S. dollar in that its currency is not freely exchangeable, capital markets are restricted, the economy is tightly controlled, and there is an overall lack of confidence from investors in things like property rights. Digital currency and an overall evolving payment landscape could pose a threat to the dollar’s dominance, but this is far from certain, and just as likely could benefit the dollar.

Craig Birk, CFP®


Craig Birk is the Chief Investment Officer for Empower Personal Wealth. A CERTIFIED FINANCIAL PLANNER™ professional, he is responsible for Empower’s retail investment portfolio, providing strategic and executive direction to drive the optimal management of client assets.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No part of this blog, nor the links contained therein is a solicitation or offer to sell securities. Compensation for freelance contributions not to exceed $1,250. Third-party data is obtained from sources believed to be reliable; however, Empower cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third-party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Empower of the contents on such third-party websites.

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