Six months ago markets were falling, inflation was rising, the Federal Reserve was hiking interest rates, and it looked as though a recession was right around the corner. Since then, we’ve had a banking crisis and the threat of a U.S. default. Fast forward to today and the stock market has defied gravity with the S&P 500 gaining 16%. While investors’ worst-case scenarios never materialized and the markets rallied, the first half of the year is a reminder that the stock market is not the economy, but a leading indicator of where investors think the economy will go.
The S&P 500 is up over 20% from its October 2022 lows and we’ve technically entered a new bull market, but before breaking out the champagne, investors may want to consider the concentrated and inequitable nature of this performance. According to S&P Global, seven of the S&P 500’s constituents have provided more than 100% of the gains in the index while the remaining 493 companies are essentially flat for the year. Just five of those seven companies represent nearly a quarter of the market cap of the entire index. The largest constituent, Apple, has surpassed the $3 trillion valuation mark, making it worth more than the combined market capitalization of the entire Russell 2000 index.
The extreme concentration and inequality in performance has been driven by investors going “all-in” on the rise of artificial intelligence and the possibility of it bringing a future boom in productivity. In addition, when the U.S. hit its debt ceiling in January followed by the failure of Silicon Valley Bank in March it led to a meaningful liquidity injection into the financial system. According to Strategas, the size of the Fed’s Balance Sheet jumped by $300 billion in March while the Treasury Department’s General Account fell from roughly $580 billion in January to $23 billion by early June. Since the debt ceiling was increased in June, the Treasury has begun replenishing funds in the General Account which should drain liquidity from the financial system.
Though the annual rate has decreased from 5.4% to 4.6%, inflation remains higher than normal. According to a report on the Economic Well-Being of U.S. Households, over 23% of adults reported that their spending had increased but their income had not. Packaged goods company General Mills recently issued a profit warning due to consumers substituting from their branded products into generic alternatives because they are no longer able to stomach (pun intended) the company’s price increases. The U.S. economy is dependent on consumer spending which makes up 70% of its GDP but consumers now need 18% more today to buy the same set of goods as they did in January 2020. Households will keep spending as long as they have jobs and access to credit, but inflation continues to erode their purchasing power.
Cracks in the economy are beginning to show. From the start of the year through May, 286 U.S. companies filed for bankruptcy protection, including Bed Bath & Beyond and Vice Media. According to the Wall Street Journal, that is the highest number during the first five months of a year since 2010. Banks have become more strict with their underwriting and data on the manufacturing sector has been deteriorating for months. Commercial real estate continues to be a major area of concern, especially offices. In the U.S. alone, about $1.4 trillion of commercial real estate loans are due this year and next, according to the Mortgage Bankers Association. Americans continue to say they are concerned with the economy and believe it’s in bad shape; in one poll 83% of Americans think the economy is fair to poor and 72% expect it to get worse.
In spite of this negativity, not all things are bad and the American consumer has remained resilient. Compared to all other G7 countries, the U.S. is growing the fastest and has the lowest rate of inflation. The labor market is still strong, unemployment remains at record lows, and jobless claims decreased in May. People are back to traveling; the number of people flying in the U.S. recently rose above pre-Covid levels according to the Transportation Security Administration. Mortgage rates are undoubtedly high at 7%, but housing starts unexpectedly surged 21.7% in May and new building applications increased, suggesting residential construction is on track to help fuel economic growth.
As amazing as this market rally has been, it can be humbling to take a step back and view it with a wider lens. Most of 2023’s year-to-date gains represent only a partial recovery from 2022’s declines. We may now technically be in a bull market, but last year’s bear market has not yet gone completely into hibernation.
Mackenzie Edwards – July 2023
IMPORTANT DISCLAIMER: Inlet Private Wealth®, LLC (“Inlet Private Wealth®” or the “Firm”) is a SEC registered investment adviser with its principal place of business in Jupiter, Florida. Unless otherwise noted, all data has been obtained via Bloomberg®. Inlet Private Wealth and its representatives are in compliance with the current registration and notice filing requirements imposed upon SEC registered investment advisers by those states in which Inlet Private Wealth maintains clients. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. The data contained in this report was gathered from what we believe to be reliable sources, but we cannot guarantee its accuracy. For information about Inlet Private Wealth’s registration status and business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).