Recession Canceled? S&P 500’s Record Half-Year Revives U.S. Stock Market

The S&P 500 index had a strong start to the year, making it the best first half since 2019. Despite concerns about a possible recession in the United States, it now appears that the likelihood of that happening is decreasing. Therefore, there is uncertainty about whether the stock market rally will continue for the remainder of 2023.

According to José Torres, a senior economist at Interactive Brokers, determining when the US government’s pandemic-related liquidity measures will run out is difficult. He specifically referred to the fiscal and monetary stimulus implemented from 2020 to 2021. Despite the Federal Reserve’s attempts to control inflation by raising interest rates since 2022, their intervention in March, which occurred after regional bank failures, added more liquidity to the financial system.

According to Torres, the stage was set for risky investments to flourish, leading to increased assets. Moreover, the current surge in artificial intelligence has further stimulated the upward movement of American stocks. Torres anticipates a subsequent decrease in the market from now on.

During the middle of March, the S&P 500 was trading at a comparable level to the start of 2023. However, the performance of stocks was adversely impacted by issues in regional banks until the Federal Reserve stepped in. On March 12, the central bank’s introduction of a program for funding terms for banks assisted and increased trust in the banking system. This alleviated the major strain on financial circumstances, marked by Torres.

Based on information from Dow Jones Market Data, the S&P 500 achieved its strongest performance in the first half of the year since 2019, with a notable 15.9% rise within the initial six months of 2023. In June, all 11 index sectors saw growth, a situation not observed since November.

Although the Federal Reserve raised interest rates quickly in 2022, aiming to reduce inflation and demand, the U.S. economy has proven to be resilient. Investors do not appear worried about a potential economic downturn because recent indicators have been positive.

On June 29, Bernard Baumohl, the chief global economist at the Economic Outlook Group, sent out an email declaring that the recession had come to an end effectively.

The writer highlights that despite the strong performance of the economy in the initial quarter, prices have continued to decline. The writer proposes that all inflation indicators have shown a decrease, and if inflation stays low, the Federal Reserve should maintain its current pause.

The Federal Reserve has decided to lower the frequency of raising interest rates this year. They temporarily stopped increasing rates during their meeting in June, but they have suggested that there might be more rate increases later on. Currently, traders predict that there will be a quarter-point increase in the Federal Reserve’s benchmark rate in July, based on the Federal-funds futures. This increase would result in a targeted range of 5.25% to 5.5%, according to the CME FedWatch Tool.

Numerous investors are satisfied with the Federal Reserve’s choice to halt temporarily, as they interpret it as an indication that the period of increasing interest rates is nearing its end. This particular period had previously inflicted substantial damages on stocks and bonds in the preceding year.

During the past week, several economic indicators in the United States brought pleasant surprises. The revised estimate for the country’s economic growth in the first quarter exceeded what was expected. Moreover, the orders for durable goods from manufacturers in May demonstrated increased strength compared to previous predictions. The sales of newly built homes in the same month exceeded economists’ forecasts. Additionally, consumer confidence reached its highest level in 17 months in June, based on a survey conducted by the Conference Board. Lastly, there was a decrease in the number of people filing for initial jobless claims for the week ending on June 24.

Investors were additionally satisfied to observe indications of a decline in inflation. As per a government report disclosed on Friday, inflation in the United States, as measured by the personal-consumption-expenditures price index, decreased to 3.8% in May compared to the corresponding period last year. This signifies the least rapid rate of growth since April 2021.

Nevertheless, Torres voiced worries about the possibility of the American economy growing too rapidly for the Federal Reserve to combat inflation effectively. This scenario may lead to the central bank taking a tougher approach by implementing tighter monetary measures.

‘Shocked’

The speaker states that there is a noticeable disparity between the current yield of two-year Treasury bonds, which is at 4.925%, and the rate that the Federal Reserve has indicated as their intended target after finishing their series of interest rate hikes. This discrepancy has emerged following a recent rise in two-year yields, which had previously decreased during a period of difficulty for regional banks.

The Federal Reserve recently published a report in June which outlined economic projections, suggesting that its policy rate may potentially reach a high of 5.6% by the year’s end. Presently, the targeted range lies between 5% and 5.25%.

Based on information from Dow Jones Market Data, the interest rate on the two-year Treasury note rose by 81.7 basis points in the second quarter, reaching 4.877% on Friday. This is the highest level seen since March 9, as indicated by data collected at 3 p.m. Eastern Time.

Torres was taken aback by how rapidly the market adapted to the rise in yields. He also thinks that there is room for yields to go even higher. Torres pointed out that the two-year Treasury rates are often used to gauge the Federal Reserve’s position on interest rates.

The stock market in the United States had a positive day on Friday, bringing the month of June to a close with overall gains for the week, month, and quarter.

According to information from Dow Jones Market Data, the S&P 500 and Nasdaq Composite have recently reached their highest closing levels since April 2022. Furthermore, both indexes have had their longest consecutive months of wins since 2021. In the first half of 2023, the Nasdaq, which primarily consists of technology stocks, saw a significant increase of 31.7%, marking its strongest performance for this period since 1983.

Liz Ann Sonders, the main investment strategist at Charles Schwab, shared worries about the stock market‘s overly optimistic sentiment, which puts equities at risk of declining. Despite the market’s impressive ability to bounce back, Sonders noted a noticeable focus on specific sectors.

She discovered a select few of well-established stocks, such as Apple Inc. (AAPL), Microsoft Corp. (MSFT), and Nvidia Corp. (NVDA), which have been instrumental in boosting the performance of the S&P 500 and Nasdaq.

Based on her perspective, at the start of the banking crisis in March, these stocks saw a substantial improvement in their performance. This was because investors were looking for companies with a solid financial status and the ability to generate cash.

According to Sonders, stocks belonging to the megacap group, encompassing sectors such as communication services, consumer discretionary, and information technology, have also experienced favorable outcomes due to their engagement with AI. Despite being labeled Big Tech, these stocks have profited from their connection to artificial intelligence.

Weakness, strength on the roll

Sonders thinks that the United States has faced several downturns in particular industries, such as housing and manufacturing, rather than experiencing a complete economic decline across all sectors. She argues that the ongoing debate about the occurrence of a recession overlooks the complexities of the current economic cycle.

In her statement, she mentioned that the economy had had times of being weak and strong instead of everything prospering or declining simultaneously. As a result, even though there might be problems in the services industry, the United States might still enjoy benefits in other fields, such as the recent progress in the housing market, which has already gone through a recession.

According to her, large companies with high market capitalization in the stock market have received a lot of attention for their impressive performance this year. However, she also pointed out that other areas, like the construction industry and the industrial sector of the S&P 500, have been doing well. Sonders specifically highlighted that industrial stocks have been especially notable because they offer a diverse range of satisfying choices.

From her point of view, making significant decisions regarding an entire industry in this particular environment is not suitable. Instead, Sonders favors the analysis of stocks based on characteristics such as “high quality” in order to identify potential investment opportunities.

Torres suggests that the uncertain economic conditions have made it harder to predict when the US might experience a recession. Nevertheless, he cautions that if interest rates continue to rise, regional banks could face a difficult situation. Moreover, he finds it difficult to imagine that the stock market, specifically the S&P 500, can continue to soar due to concerns about potential risks related to commercial real estate.

Charlie Ripley, a senior investment strategist at Allianz Investment Management, stated during a phone interview that the banks’ financial records will encounter greater strain as the Federal Reserve elevates interest rates. He further expressed concern about the potential scenario where a bank may witness an abrupt surge in customers withdrawing their money.

Investors will have access to the minutes of the Federal Reserve’s June policy meeting on Wednesday, after the U.S. Independence Day holiday on July 4.

Based on information from FactSet, the S&P 500 has shown considerable growth in the year 2023. On the other hand, the KRE, which is the SPDR S&P Regional Banking ETF, has faced a notable drop of 30.5% in the first half of the year. Similarly, the KBWB, or the Invesco KBW Bank ETF, has also experienced a decrease of 20.5% during the same timeframe.

Ripley observed that the market exhibits noteworthy discrepancies, with specific regions showing superior performance compared to others.