Like a Bridge Over Troubled Waters
Dear Clients and Friends,
I am feeling a bit nostalgic today. There is a sense of satisfaction in experiencing over 35 years of financial markets (Dad has 57 years) and to still love what I do. I do not believe that there are many careers that not only provide daily feedback (is the market up or down today?), but also measures our success over the very long term. Being part of a team that originated in 1966 gives me the distinct view of the positive impact sound financial planning can have on multiple generations. As dad recently remarked to a retiring doctor, “I remember when you just started college”.
Two neighbors from Queens, New York hit number one on the charts in 1970 with their seminal hit “Like a Bridge Over Troubled Water.” It was meant to be a metaphor for people living through a trying time in their lives. I find it an interesting starting point to help show that here and now in 2023 that we are in fact, in the good all days.
Human memory tends to filter out bad experiences. The past is fear free. The future is unknown, and this is what frightens us. In most people’s minds 1970 probably reminds us of a kinder gentler world, especially when compared to the chaos and bedlam of the last few years.
1970 was the era of bellbottom jeans, free love and tie-dye shirts, $.36 gasoline and bread was $.25 a loaf (Staying Alive by Gene Baumgaertner). According to Macrotrends 100 year historical chart, the Dow Jones industrial index was at 753.12. But 1970 was also the year of 379,000** deaths worldwide from war, over 2 billion people living in poverty,*** the life expectancy for a man was 67.1**** and the Beatles broke up.
Fast forward to today. I will issue the challenge here and now. Go ahead and tune into any news outlet for an hour and attempt to find more than one positive story that leaves you feeling optimistic. It might seem hopeless and even make you want to shout, “It wasn’t like this in my day!”
But things are better. Death from armed conflicts has dropped by more than 75% since 1970 (84,000),** worldwide poverty has dropped by 68% (648 million)***, the life expectancy for a male is now 73.5 (women 79.3)**** and while we have no comparison to the Beatles, the Dow Jones is now at 34,496 (Macrotrends 100 year historical chart) or simply put, $10,000 invested in the DOW 30 years ago in 1970 would be worth $450,000 today’
So, like a Bridge over Troubled Water when you are feeling weary or when times get rough_ please remember that the world has never been a better place to live in. To paraphrase from one of my favorite books, The Rational Optimist by Matt Ridley: Compared to 50 years ago, when I was just 7 years old “the average human now earns 3 times as much money (corrected for inflation), eats one third more calories, use less energy, buries two thirds fewer children and can expect to live one third years longer.”
Pessimists can have all the headlines, but the optimists have been the ones on the right side of history. We are a problem-solving species, so be hopeful my friends as according to the National Academy of Sciences, optimists live 15% longer than their pessimistic counterparts.
Now onto our regularly scheduled Quarterly report:
Declining Inflation and Resilient Growth Push Stocks Higher in Q2
The S&P 500 ended the second quarter and first half of 2023 at a 14-month high and most major stock indices logged solid gains in the second quarter following a pause in the Fed’s rate hike campaign, stronger-than-expected corporate earnings (especially in the tech sector) and the relatively drama-free resolution of the debt ceiling.
The second quarter began with markets still in the throes of the regional bank crisis following the March failures of Silicon Valley Bank and Signature Bank, and investors started the month of April wary of contagion risks. Those concerns proved mostly overdone, however, as throughout most of the month regional banks were stable. That stability allowed investors to re-focus on corporate earnings, and the results were much better than feared as 78% of S&P 500 companies reported better-than-expected Q1 earnings, a number solidly above the 66% long-term average. Additionally, 75% of reporting companies beat revenue estimates for the first quarter, also well above the long-term average, according to FactSet KeyMetrics on June 2023. That solid corporate performance was a welcome sight for investors and coupled with general macroeconomic calm, allowed stocks to drift steadily higher throughout most of April. However, following an underwhelming earnings report, concerns about the solvency of First Republic Bank weighed on markets late in the month and the S&P 500 declined into the end of April to finish with a modest gain.
Fears of a First Republic Bank failure were realized on May 1st, as the bank was seized by regulators and the FDIC was appointed its receiver. However, that same day, JPMorgan announced it was acquiring the bank from the FDIC, and that move helped to calm investor anxiety about financial contagion risks. The Federal Reserve also helped to distract investors from the First Republic failure, as the Fed hiked rates at the May 2nd FOMC meeting, but importantly altered language in the statement to imply it would pause rate hikes at the next meeting. That change was expected by investors, however, and as such it failed to ignite a meaningful rally in stocks. Instead, the tech sector helped push the S&P 500 higher in mid-May, thanks to an explosion of investor and financial media enthusiasm around Artificial Intelligence (AI), which was highlighted by a massive rally in Nvidia (NVDA) following a strong earnings report. However, like in April, the end of the month saw an increase in volatility. This time it was thanks to the lack of progress on a U.S. debt ceiling extension and rising fears of a debt ceiling breach and possible U.S. debt default. However, a two-year debt ceiling extension was agreed to by Speaker McCarthy and President Biden on May 28th and was signed into law a few days later, avoiding a financial calamity. The S&P 500 finished May with a slight gain.
With the debt ceiling resolved, a Fed pause in rate hikes expected and continued stability in regional banks, the rally in stocks resumed in early June and was aided by several potentially positive developments. First, inflation declined as the Consumer Price Index (CPI) hit the lowest level in two years. Second, economic data remained impressively resilient, reducing fears of a near-term recession. Finally, in mid-June, the Federal Reserve confirmed market expectations by pausing rate hikes and that helped fuel a broad rally in stocks that saw the S&P 500 move through 4,400 and hit the highest levels since April 2022. The last two weeks of the month saw some consolidation of that rally thanks to mixed economic data, political turmoil in Russia and hawkish rhetoric from global central bankers, but the S&P 500 still finished June with strong gains.
In sum, markets were impressively resilient in the second quarter and throughout the first half of 2023, as better-than-feared earnings, expectations for less-aggressive central bank rate hikes, more evidence of a “soft” economic landing and relative stability in the regional banks pushed the S&P 500 to a 14-month high.
Second Quarter Performance Review
The second quarter of 2023 saw an acceleration of the tech sector outperformance witnessed in the first quarter, as “AI” enthusiasm drove several mega-cap tech stocks sharply higher. Those strong gains resulted in large rallies in the tech-focused Nasdaq and, to a lesser extent, the S&P 500 as the tech sector is the largest weighted sector in that index. Also like in the first quarter, the less-tech-focused Russell 2000 and Dow Industrials logged more modest, but still solidly positive, quarterly returns.
By market capitalization, large caps outperformed small caps, as they did in the first quarter of 2023. Regional bank concerns and higher interest rates still weighed on small caps as smaller companies are historically more dependent on financing to maintain operations and fuel growth.
From an investment style standpoint, growth handily outperformed value again in the second quarter, continuing the sharp reversal from 2022. Tech-heavy growth funds benefited from the aforementioned “AI” enthusiasm. Value funds, which have larger weightings towards financials and industrials, relatively underperformed growth funds, as the performance of non-tech sectors more reflected the broad economic reality of mostly stable, but unspectacular, economic growth.
On a sector level, eight of the 11 S&P 500 sectors finished the second quarter with positive returns. As was the case in the first quarter, the Consumer Discretionary, Technology, and Communication Services sectors were the best performers for the quarter. The surge in many mega-cap tech stocks such as Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Meta Platforms (META), and Nvidia (NVDA) drove the gains in those three sectors, and they handily outperformed the remaining eight S&P 500 sectors. Industrials, Financials, and Materials saw moderate gains over the past three months, thanks to rising optimism regarding a “soft” economic landing.
Turning to the laggards, traditional defensive sectors such as Consumer Staples and Utilities declined slightly over the past three months, as resilient economic data caused investors to rotate to sectors that would benefit from stronger than expected economic growth. Energy also posted a slightly negative return for the second quarter, thanks to weakness in oil prices.
| US Equity Indexes | Q2 Return | YTD |
|---|---|---|
| S&P 500 | 10.32% | 16.89% |
| DJ Industrial Average | 5.28% | 4.94% |
| NASDAQ 100 | 17.33% | 39.35% |
| S&P MidCap 400 | 6.70% | 8.84% |
| Russell 2000 | 7.24% | 8.09% |
Source: YCharts
Internationally, foreign markets lagged the S&P 500 thanks mostly to the relative lack of large-cap “AI” exposed stocks in major foreign indices, combined with some late-quarter worries about the EU economy and pace of Bank of England rate hikes, although foreign markets did finish the second quarter with a modestly positive return. Foreign developed markets outperformed emerging markets thanks to a lack of significant economic stimulus in China, which weighed on emerging markets late in the quarter.
| International Equity Indexes | Q2 Return | YTD |
|---|---|---|
| MSCI EAFE TR USD (Foreign Developed) | 3.63% | 12.13% |
| MSCI EM TR USD (Emerging Markets) | 1.50% | 5.10% |
| MSCI ACWI Ex USA TR USD (Foreign Dev & EM) | 3.13% | 9.86% |
Source: YCharts
Commodities saw modest losses in the second quarter as most major commodities declined over the past three months. Oil prices witnessed a moderate drop despite a surprise production cut from Saudi Arabia and an increase in geopolitical tensions in Russia, as concerns about future economic growth and oversupply weighed on oil. Gold, meanwhile, posted a modestly negative return as inflation declined while the dollar failed to meaningfully drop.
| Commodity Indexes | Q2 Return | YTD |
|---|---|---|
| S&P GSCI (Broad-Based Commodities) | -1.45% | -7.54% |
| S&P GSCI Crude Oil | -5.21% | -12.40% |
| GLD Gold Price | -3.08% | 5.23% |
Source: YCharts
Switching to fixed income markets, the leading benchmark for bonds (Bloomberg Barclays US Aggregate Bond Index) realized a slightly negative return for the second quarter of 2023, as the resilient economy and hope of a near-term end to Fed rate hikes led investors to embrace riskier assets.
Looking deeper into the fixed income markets, shorter-duration bonds outperformed those with longer durations in the second quarter, as bond investors priced in a near-term end to the Fed’s rate hike campaign, while optimism regarding economic growth caused investors to rotate out of the safety of longer-dated fixed income.
Turning to the corporate bond market, lower-quality, but higher-yielding “junk” bonds rose modestly in the second quarter while higher-rated, investment-grade debt logged only a slight gain. That performance gap reflected investor optimism on the economy, which led to taking more risk in exchange for a higher return.
| US Bond Indexes | Q2 Return | YTD |
|---|---|---|
| BBgBarc US Agg Bond | -0.38% | 2.09% |
| BBgBarc US T-Bill 1-3 Mon | 1.23% | 2.33% |
| ICE US T-Bond 7-10 Year | -1.32% | 1.62% |
| BBgBarc US MBS (Mortgage-backed) | -0.41% | 1.87% |
| BBgBarc Municipal | 0.04% | 2.67% |
| BBgBarc US Corporate Invest Grade | 0.40% | 3.21% |
| BBgBarc US Corporate High Yield | 2.60% | 5.38% |
Source: YCharts
Third Quarter Market Outlook
As we begin the third quarter of 2023, the outlook for stocks and bonds is arguably the most positive it’s been since late 2021, as inflation hit a two-year low, economic growth and the labor market remain impressively resilient, the Fed has temporarily paused its historic rate hiking campaign, the debt ceiling extension is resolved, and we’ve seen no significant contagion from the regional bank failures from earlier this year.
That improvement in the fundamental outlook has been reflected in both stock and bond prices so far this year, as the S&P 500 hit the best levels since last April and more cyclically focused sectors led markets higher late in the quarter on rising hopes for a broad economic expansion.
However, while clearly the past quarter brought positive developments in the economy and the markets, leading the financial media to proclaim a “new bull market” has started, it’s important to remember that potentially significant risks remain to the economy and markets. Put more bluntly, the market has taken a decidedly positive view on the ultimate resolution of multiple macroeconomic unknowns, but their outcomes remain very uncertain and thanks to the strong year to date rally in stocks, there is now little room for disappointment.
First, the economy has not yet felt the full impact of the Fed’s historically aggressive hike campaign, and while the economy has proved surprisingly resilient so far, we know from history that the impacts of rate hikes can take far longer than most expect to impact economic growth. Put in plain language, it’s premature to think the economy is “in the clear” from recession risks, and we should all expect the economy to slow more as we move into the second half of 2023. The key for markets will be the intensity of that slowing, as at these valuation levels stocks are not pricing in a significant economic slowdown.
On inflation, clearly there’s been progress in bringing inflation down, as year-over-year CPI has fallen from over 9% in 2022 to 4% in less than a year’s time. However, even at 4%, CPI remains far above the Fed’s 2% target. If inflation bounces back, or fails to continue to decline, then the Fed could easily hike rates further, like the Bank of Canada and Reserve Bank of Australia did in the second quarter, following pauses of their own. Those higher rates would weigh further on economic growth.
Turning to banks, markets have taken the regional bank failures in stride, as the collapse of First Republic Bank caused minimal volatility in the second quarter. However, it’s likely premature to consider the crisis “over” and at a minimum, reduced lending by regional banks poses an additional threat to the commercial real estate market and small businesses more broadly. Bottom line, measures taken by the Fed in March have “ringfenced” the regional bank stress for now, but this remains a risk to the economy.
Finally, markets are trading at their highest valuation in over a year, and investor sentiment has turned suddenly, and intensely, optimistic. The CNN Fear/Greed Index ended the second quarter at “Extreme Greed” levels, while the American Association for Individual Investors (AAII) Bullish/Bearish Sentiment Index hit the most bullish level since November 2021, right before the market collapse started in early 2022. Positive sentiment does not automatically mean markets will decline, but the sudden burst of enthusiasm needs to be considered in the context of what is a still uncertain macroeconomic environment and markets no longer have the protection of low expectations and valuations to cushion declines.
In sum, clearly there have been positive macro developments so far in 2023 that have helped the stock market rebound. However, it’s important to remember that multiple and varied risks remain for the economy and markets.
As such, while we are happy with the market’s performance, we remain vigilant towards economic and market risks and are focused on managing both risk and return potential. We understand that a well-planned, long-term-focused, and diversified financial plan can withstand virtually any market surprise and related bout of volatility, including bank failures, multi-decade highs in inflation, high interest rates, geopolitical tensions, and rising recession risks.
At Cohen & Son Wealth Management, we understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. Successful investing is a marathon, not a sprint, and even intense volatility is unlikely to alter a diversified approach set up to meet your long-term investment goals.
Therefore, it’s critical for you to stay invested, remain patient, and stick to the plan, as we’ve worked with you to establish a unique, personal allocation target based on your financial position, risk tolerance, and investment timeline.
We remain focused on both opportunities and risks in the markets, and we thank you for your ongoing confidence and trust. Please rest assured that our entire team will remain dedicated to helping you successfully navigate this market environment.
Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review.
Sincerely,
JONATHAN COHEN, AWMA
Managing Director, Investments / Branch Manager
Raymond James & Associates / Jupiter Branch
Any opinions are those of Jonathan Cohen and the Sevens Report and may not necessarily express the opinions of Raymond James. The information contained in this article does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
The Dow Jones Industrial Average (DJIA), commonly known as "The Dow" is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal.
The NASDAQ Composite Index is an unmanaged index of securities traded on the NASDAQ system.
The S&P MidCap 400® provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500, measures the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.
Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index.
The S&P GSCI is a composite index of commodities that measures the performance of the commodity market.
S&P GSCI Gold is an index tracking changes in the spot price for gold bullion.
S&P GSCI Crude Oil is an index tracking changes in the spot price for crude oil.
GLD is a gold index fund based on gold and holds gold and/or cash as its only assets, but shareholders are not guaranteed to receive physical gold in exchange for their shares.
The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations.
The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index's three largest industries are materials, energy, and banks.
The MSCI ACWI (All Country World Index) is a free floating-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets.
The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
The Barclays US T -Bill index measures the performance of public obligations of the U.S. Treasury that have a remaining maturity of greater than or equal to 1 month and less than 3 months.
The ICE U.S. Treasury 7-10 Year Bond Index is market value weighted and is designed to include U.S. dollar denominated, fixed rate securities with minimum term to maturity greater than or equal to seven years and less than ten years.
Barclays Capital U.S. MBS Index measures the performance of investment grade fixed-rate mortgage-backed pass-through securities of GNMA, FNMA, and FHLMC.
The Barclays Capital Municipal Bond is an unmanaged index of all investment grade municipal securities with at least 1 year to maturity.
The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
The Bloomberg Barclays U.S. Corporate High Yield Bond Index is composed of fixed-rate, publicly issued, non-investment grade debt, is unmanaged, with dividends reinvested, and is not available for purchase. The index includes both corporate and non-corporate sectors. The corporate sectors are Industrial,
Utility and Finance, which include both U.S. and non-U.S. corporations.
Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Diversification and asset allocation do not ensure profit or protect against loss. Holding investments for the long term does not insure a profitable outcome. Investing involves risk and you may incur a profit or loss regardless of the strategy selected.
**OurWorldInData.Org Data charts in War and Peace after 1945
*** Worldvision.Org/Global Poverty
**** CDC.gov/
-Table 15 Life expectancy in the United States 1900-2016
-National Center of Health Statistics