As summer gets into full swing, investors have enjoyed a strong June rally in stocks to cap off a surprisingly good first half of 2023. The current bull market has pushed up equity prices globally by 13% for the year – an incredible feat in the wake of multiple bank collapses this Spring, and despite the recent U.S. debt ceiling standoff that threatened a government default. Economic data has also surprised to the upside, including May’s employment report of 339,000 newly created jobs, adding to year-to-date job growth totals of 1.5 million. These strong hiring trends can be observed in most developed economies around the world and have led economists to increase their forecasts for global GDP growth to 2.7% for 2023.
With a few exceptions, global financial markets and most asset classes have performed well year-to-date, in the face of coordinated and restrictive monetary policy from the Federal Reserve and its international central bank counterparts. Notably, the rapid rise in interest rates orchestrated by Fed Chair Jay Powell has been the most hawkish monetary policy in 40 years. Even so, the Fed still can’t claim victory in its fight against inflation, although the May Consumer Price Index (CPI) reading of 4% was much improved from the 9.1% recorded in June of 2022. Consequently, the market is anticipating a further increase in the Fed Funds interest rate to 5.3% by the July Federal Open Market Committee (FOMC) meeting.
There are, however, diverging trends emerging in the global economy as business activity has accelerated in China and Europe but slowed in the U.S. While the Eurozone couldn’t avoid a recession last winter nor dodge the ill effects of high energy prices related to the war in Ukraine, the region has recovered swiftly thanks to record low unemployment and rising wages. In China, removing the “Zero COVID Policy” has led to a quick recovery in their economy, while boosting the prospects of their major trading partners in Asia and Europe. But geopolitical disagreements between China and the U.S. loom large, posing new risks for investors and prompting the largest companies in the world to reconsider their supply chains and overall exposure to the region.
The second half of the year is expected to be more challenging for stocks with analysts forecasting a 6.4% profit decline for S&P 500 companies in the recently completed quarter. While investor sentiment is broadly positive thanks to the recent performance of financial markets, share prices within the S&P 500 are now trading at a lofty valuation multiple of 18x earnings, and, therefore, are vulnerable to a possible year-end recession. A precursor to upcoming economic stress could be recent readings from the Conference Board’s Leading Economic Index (LEI), which reported a 13th straight monthly decline, thus confirming softness in manufacturing, housing activity, and weakening consumer credit conditions. Upcoming Fed policy will have a lot to say about the prospects for corporate America, with a soft landing for the U.S. economy being the desired outcome sought by stock investors and owners of risk assets.
