Mana’s 2nd Quarter Economic and Market Update

Asset Class Performance

US Stocks continued their strong surge into the second quarter of 2023. The Nasdaq Composite led the way with a 13.1% increase, the S&P 500 advanced 8.6%, and the Dow Jones Industrial Average rose 4%. S&P Sector divergence continued, with technology and consumer discretionary sectors leading the way with 15.4% and 13.8% returns, respectively. Utilities were deepest in the red, finishing down -2.5% for the quarter. Global markets also rallied, but lagged the US. The MSCI World Ex USA posted a 5.9% gain in Q2. All fixed income indices were lower in Q2, due to rising yields with the exception of high-yield B and CCC bonds. Commodities were the biggest laggard, -2.6% in Q2. 

Extensive research has shown that, if you have a diversified portfolio, a whopping 88% of your experience (the volatility you encounter and the returns you earn) can be traced back to your asset allocation. - Vanguard.

Investing Commentary + Outlook

The Fed in Focus

Over the last 18 months, the Federal Reserve (Fed) has been at the center of every market conversation, dramatically reshaping the interest rate landscape compared to the beginning of 2022. The central bank's rapid hike of its key Fed Funds Rate from 0% to 5.5% was a response to combat inflation levels not seen in over four decades. This comes shortly after the Fed slashed the Fed Funds Rate to 0% for the first time ever, made no raises for seven years, and quickly cut it following a rate hike cycle to 0% again in 2020.

As the Fed has hiked rates, short term bonds are yielding higher returns than long-term bonds, what’s commonly known as an inverted yield curve.  Normally, long-term bonds yield more than short-term bonds due to the higher risks associated with lending money for extended periods. Over the years, inverted yield curves have been reliable predictors of economic downturns. When short-term interest rates exceed long-term rates, it indicates that investors are seeking safety in long-term bonds, possibly because they anticipate economic challenges ahead. This behavior reflects a lack of confidence in the near-term economic outlook, which can lead to reduced spending, investments, and overall economic activity. Historical data shows that inverted yield curves typically precede recessions by several months to a couple of years. It is essential to note that while it has shown remarkable accuracy as a recession indicator, it is not foolproof, and there can be exceptions.

We believe we are towards the end of this rate hiking cycle, and based on studies completed by YCharts over past rate cycles, there is no historic consistency with which certain asset classes outperform during these times. The chart below shows the asset class performance over each of the last four rate hiking cycles, showing how difficult it is to predict outperforming asset classes. 

History has shown that each rate hike cycle produces different best and worst performing asset classes, and it is virtually impossible to predict the ultimate winner. However, by maintaining a diversified portfolio (in the above example, the 60/40 portfolio), investors can mitigate risks and position themselves to capitalize on opportunities, regardless of the market conditions.

The Magnificent Seven

Despite the economic headwinds, the stock market has had a solid year, and S&P 500 operating earnings-per-share rose 6.4% from a year earlier and 4.3% from the fourth quarter. Profit margins also rose to 11.7%, indicating that companies have had success in defending margins. 

The main issue is that the performance is highly concentrated in a select group of names. Seven mega-cap companies - NVIDIA (NVDA), Tesla (TSLA), Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL, GOOG), Meta (META), and Amazon (AMZN) - drove 73% of the S&P 500’s YTD gain!  These stocks are now being called the Magnificent Seven, with YTD performance ranging from +38% for Alphabet to +213% for NVIDIA! 

Expectations that the Fed will slow down its hiking cycle - in combination with the influence and possibilities of alternative intelligence that have entered the market with the rise of Chat GPT and other AI - have driven these stock prices up. We believe in investing in these stocks, as they represent a large portion of the US stock market - Apple is now a $3 trillion company! However, we continue to create balance in your portfolio through diversification into companies of all sizes, and from regions around the world. It’s important to remember that these same stocks experienced tremendous downside during the market decline in 2022, with drawdowns ranging from -27% to -65%!

Where do we go from here?

The US economy has remained resilient, but economic momentum is slowing based on a number of factors. Business spending appears to be at most risk, but experts expect it will vary among sectors. Investments in AI will continue, given the productivity output that can be generated, but further cuts in manufacturing and employment could arise. This could be exacerbated by tightening lending standards, which we believe would have the greatest impact on small companies. Because there is less fiscal stimulus than during the pandemic, personal debt has risen, and the personal savings rate has fallen to 4.2% - well below the average of 8%. Student loan payments resuming in Q4 2023 will also reduce consumer spending.  

While the US economy is slowing, and US stock valuations are more closely aligned with long term averages, we see two areas of opportunity: the global economy appears to be gaining steam, and fixed income continues to look attractive. Below is a chart from JP Morgan showing current valuations versus historical 25-year averages.

Currently consumer sentiment is low, and the increased risk of recession could keep consumer sentiment depressed. While the natural tendency is to sell, history suggests trying to time consumer sentiment is a mistake. On average, buying during the peak consumer confidence resulted in 3.5% subsequent 12-month returns, while buying during the trough of consumer confidence (i.e., buying when consumer sentiment is depressed) resulted in 12-month returns of 24%. We aren’t anticipating these kinds of returns, but it reiterates our philosophy that it’s important to stay the course. 

Follow our Instagram for personal finance tips and inspiration.

Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.