U.S. growth has remained resilient through the first half of the year despite tighter monetary conditions created by the Federal Reserve. Headline and core inflation continue to decline but remain elevated. Recent data is pointing to a further moderation in inflation thanks to easing supply constraints and gradual easing within the labor markets. After an interest rate pause in their June meeting, the Federal Reserve dot plot chart is indicating that additional interest rate hikes are on the table by year end.
There has been some debate about how the economy will perform in the future due to the numerous interest rate hikes over the past 16 months. Right now, it seems like the economy might be gently slowing down as some investors hoped, commonly referred to as a “soft landing”. However, we must keep in mind that the full impact of all the previous rate hikes might not be fully considered yet.
When interest rates are increased, it is crucial to bear in mind that the effect on the economy do not happen immediately. An insightful perspective from an FWM client who is a retired Economics Professor, Dr. Ken Galchus, aptly compares this phenomenon to turning a large ship - changes don't occur rapidly. Understanding this lag in economic response will be imperative for policymakers and investors alike as we head into the next year.
Equity markets have started the first half of the year strong despite the continued monetary tightening put in place by the Federal Reserve. It is important to note that even as equity markets move higher in this rising interest rate environment, they have overcome additional headwinds during the first half of the year including the debt ceiling and regional banking crisis.
In terms of performance, U.S. large-cap stocks led the way, with a notable increase of 15.5% in the first half of 2023. Of note is that this recent rally has been primarily driven by only a handful of stocks. The top 10 companies in the S&P 500 have accounted for over 95% of the index's year-to-date performance showing the lack of breadth. Furthermore, the tech heavy Nasdaq was up 32% through the first half of the year, its best first half performance in 40 years. U.S. small-cap stocks lagged because of greater exposure to cyclical sectors which have underperformed so far this year.
Both developed markets and emerging markets saw growth in the first half of 2023. Developed markets increased by 11.2% and emerging markets by 4.8%. This growth was supported by a weaker U.S. dollar and strong economic data in both regions. However, toward the end of the quarter, emerging market momentum slowed down due to disappointing economic data from China, falling short of expectations.
U.S. fixed income markets have continued to experience volatility this year, but overall, year to date returns have been positive. Longer duration fixed income outperformed shorter duration because of higher coupons and a slight moderation in interest rates. Shorter-term risk-free rates might seem great for now, but it is important to weigh reinvestment rate risk down the road.
As always, it is important to remain disciplined in your diversification approach and investment strategy. The stock market's narrow breadth and possibility of further interest rate hikes from the Federal Reserve could potentially weigh on the markets in the coming quarters.
About Rocklin Senavinin, CFP®
With over 20 years of experience in the financial planning industry, Roc has dedicated his career to helping individuals live comfortably in retirement and enjoy the assets they have spent their career building. He is co-founder of Fiduciary Wealth Management, a fee-only registered investment advisory firm in Little Rock, Arkansas. As a CERTIFIED FINANCIAL PLANNER™ professional, he has advanced training in the holistic process of creating a personal financial plan that addresses a person’s comprehensive needs for the short and long term. To learn more, connect with Roc on LinkedIn or visit www.fidwm.com. If you have questions, feel free to schedule a phone call using this link.
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