2023 Halftime Report and Latest Fed Minutes

Heading into 2023, most investors would have embraced any first-half report that didn’t bring more red, let alone double-digit positive returns.  As of June 30, the S&P500 was up 15.91% for its best first half since 2019, and the tech-heavy Nasdaq led the way with a 31.73% return, a rally not seen since 1983.  Gold, often a haven in times of volatility, brought a modest 5.27% return.  Oil, the only real winner amid 2022’s punishing duo of Russian hostility and Fed rate hikes, closed out the first half down -12.47%.  

For the stock pickers out there, trash became treasure as beaten down companies like Nvidia, Meta, Tesla, Carnival, and Royal Caribbean all boasted over 100% returns in the first six months of 2023.  Apple has continued its epic clime as its market cap eclipsed $3 trillion at the end of June.  Bringing up the rear in the S&P500 is Advance Auto Parts, down 54% year-to-date.

Arguably the most frightening economic news of the year thus far relates to the banking sector.  Silicon Valley Bank (SVB), Signature Bank, and First Republic all closed, victims of bank runs spurred by social media panic and capital reserves ill-prepared for the Fed’s rapid rate hikes.  However, the Federal Reserve released its annual stress test of the 23 largest banks on June 28 and all passed.  This shows the large banks are well positioned to weather a recession and can continue lending to businesses and households even in a severe recession.  The Fed also included an exploratory market shock involving inflation and rising interest rates, which all the banks withstood.

Markets have largely moved right in line with the Fed’s commands.  Aggressive rate hikes in 2022 battered the stock market, especially growth stocks, but a softer tone and their June pause was certainly tied to the strong returns investors have enjoyed in 2023.  Therefore, in looking forward to the second half of the year, the Fed’s minutes released July 05 might provide a glimpse into the economic future.  Bear in mind though, this information is from their June 13-14 meeting.  

The June meeting occurred amid persistently high core inflation, resolution of the US debt limit, increasing wage growth, and rising equity prices led by mega-cap stocks.  The Open Market Desk’s Surveys of Primary Dealers and Market Participants showed a higher peak policy rate than the May meeting and respondents assigned a 60% probability for the peak being higher than the current rate; in other words, more rate hikes are expected later this year.  They still saw a recession as likely but neither deep nor prolonged.  Real gross domestic product (GDP) expanded at a modest pace in the second quarter and labor markets remained tight (unemployment was just 3.7% in May).  The Fed unanimously agreed to pursue their target inflation rate of 2%.  

It’s worth noting the novelty of this goal in the modern economy, as prior to the end of 2021, the annual CPI never reached 4% in the 21st century.  Many of the supply chain issues that initially contributed to inflation have subsided as China has reopened their economy and energy prices have fallen.  But the trillions of dollars of stimulus that sparked runaway inflation have yet to fully wear away, and the Fed can’t ask Americans to outright pay it back.

Investors know how painful rapid-fire high interest rate hikes of .50% and .75% can be from last year.  The question on investors’ minds for the second half of 2023 may be:  are sporadic modest rate hikes of .25% enough to slow down a rallying stock market?  The fear of a recession and its impact on the markets has largely subsided.  If the economy were to slow down further, and unemployment ever to increase, the Fed would likely see its mission as complete and retreat as the market’s recent enemy.

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