Weekly review

Weekly review

In the past week, the markets saw widespread gains across various sectors and indices. All 11 sectors of the S&P 500, as well as both value and growth stocks, ended the week higher. Notably, the Invesco S&P 500 Equal-Weight ETF (RSP) outperformed the mega-cap ETF, indicating broad-based buying interest. The S&P 500, which had broken out above key levels such as 4,200, 4,300, and 4,400 during the month, closed the quarter at 4,450. The Nasdaq Composite had its best first half since 1983 with a gain of 31.7%.

The week was eventful, featuring a reported coup attempt in Russia that quickly ended, positive economic data, indications from central bank leaders about the need for tightening to address inflation, a series of IPOs, and the release of the Federal Reserve's annual bank stress test results, which showed all banks passing. Earnings reports from companies like Carnival Corp., Walgreens Boots Alliance, General Mills, Micron, and Nike also influenced market sentiment. Throughout the week, there was a prevailing belief that the U.S. economy could avoid a recession and that the Federal Reserve was nearing the end of its rate hikes, which contributed to the overall buying interest.

In terms of sector performance, consumer staples, healthcare, and utilities were relatively weaker, while communication services faced pressure due to a downgrade of Alphabet by UBS and Bernstein. Real estate and energy emerged as the best-performing sectors, followed by materials, industrials, financials, information technology, and consumer discretionary.

On the other hand, the Treasury market had a different experience as it absorbed new supply and potentially witnessed some asset reallocation trades prompted by the stock market's bullish behavior. The yields on the 2-year and 10-year notes increased by 13 and 8 basis points, respectively, during the week.

The first half of 2023 was a strong start for the markets, although some investors may not have fully recognized the gains due to lingering effects from 2022. In comparison to last year's significant losses, with stocks down 20% and bonds down 10% at the midpoint, the first half of this year has been more rewarding. The favorable outlook for Federal Reserve policy and inflation, along with a resilient economy, have contributed to overall market gains. However, underlying trends indicate a balance of risk and opportunity, emphasizing the value of a diversified strategy. Here are some key observations from the first half and what they imply for the second half of the year.

The stock market experienced a solid start, continuing the rally that began in October 2022 after the bear-market lows. However, equities faced challenges along the way, including a strong jobs report in February and the bank crisis in March, resulting in an 8% pullback in the S&P 500. Despite these setbacks, the rally resumed due to expectations of the Fed's rate-hiking campaign nearing its end. The U.S. stock market has recovered about 23% since mid-October, reclaiming a substantial portion of last year's losses.

Market volatility has remained relatively low throughout 2023, except for the short-lived reaction to the bank turmoil. The VIX index, a measure of market volatility, has steadily declined, and there have been few significant market movements. However, it is advisable for investors to anticipate increased market fluctuations in the second half of the year.

Performance in the first half has been driven by relief in rising interest rates, benefiting technology and growth investments that were punished in 2022. The tech-heavy Nasdaq outperformed the Dow, and a few mega-cap names, such as Apple, Microsoft, and Tesla, experienced substantial gains. While the market's overall gains have been notable, the breadth of these gains has been narrow, indicating vulnerability if mega-cap tech encounters obstacles. Artificial Intelligence (AI) has played a significant role in fueling this year's rally, particularly in the semiconductor sector.

Longer-term interest rates have remained flat this year, reflecting declining inflation and a less robust economic growth outlook. Shorter-term rates have been slightly more buoyant due to positive economic data and signals from the Fed regarding potential rate hikes. The overall interest rate environment has been more favorable compared to 2022, with expectations that the Fed will conclude its rate hikes in the coming months.

The economy showed resilience in the first half, with better-than-expected first-quarter GDP growth primarily driven by increased personal consumption. However, estimates suggest slower growth in the second quarter, which is expected to continue throughout the year. Employment and spending growth are anticipated to soften, leading to a weakening of GDP in the coming quarters.

Small-cap equities, which are sensitive to domestic economic conditions, have shown signs of leveling off compared to large-caps after underperforming earlier in the year. This indicates emerging optimism in the domestic economic growth outlook, although a definitive upturn in small-cap performance has not yet been observed.

The S&P 500's 15% return in the first half of 2023 ranks as the fifth-best start since 1990. Historically, strong first halves have often led to further market gains in the second half of the year. While a repeat of the first half gains cannot be guaranteed, there are reasons for investors to be optimistic about the second half of 2023, despite potential economic weakness and challenges related to inflation and Fed policy.

Past week:

During this shortened trading week, both the S&P 500 and Nasdaq ended their winning streaks of five and eight weeks, respectively. The market had been showing signs of a possible pullback, leading to losses driven primarily by profit-taking after a significant period of growth. Interestingly, mega-cap stocks continued to outperform, defying expectations that consolidation efforts would primarily target them. Non-tech stocks saw more pronounced selling, as evidenced by the 2.7% loss in the Invesco S&P 500 Equal Weight ETF (RSP) compared to the 1.0% decline in the Vanguard Mega Cap Growth ETF (MGK). The market-cap weighted S&P 500 fell by 1.4%. By the end of the week, concerns emerged regarding global growth and the delayed impact of central bank rate hikes, influencing the market narrative. Federal Reserve Chair Jerome Powell, in his testimony before the House Financial Services Committee, stated that if the economy performs as expected, the Fed could implement two more rate hikes before year-end. Fed Governor Michelle Bowman also emphasized the need for additional rate increases to address inflation.

During Powell's testimony before the Senate Banking Committee, there were no surprises in terms of monetary policy views. However, concerns arose among committee members regarding capital requirements for banks, which affected bank stocks negatively. The SPDR S&P Bank ETF (KBE) fell 6.8%, while the SPDR Regional Banking ETF (KRE) declined by 8.1%. Weakness in regional bank components, coupled with growth concerns, contributed to the underperformance of the Russell 2000, which declined by 2.9%.

Several central banks worldwide, including the Bank of England, Norges Bank, Swiss National Bank, and Central Bank of Turkey, announced policy rate increases. These moves heightened concerns about global inflation and potential effects of rate hikes on global growth.

Adding to the growth concerns, preliminary manufacturing PMIs for Japan, Germany, the UK, the eurozone, and the U.S. all indicated contraction, falling below the threshold of 50 that separates expansion from contraction.

In the U.S., some economic data showed weakness during the week. Existing home sales declined by 20.4% year-over-year in May, and the Leading Economic Index experienced its 14th consecutive monthly decline. Additionally, weekly initial jobless claims remained elevated above 260,000.

However, housing starts exceeded expectations, with a significant surge of 21.7% month-over-month, reaching a seasonally adjusted annual rate of 1.631 million units—the highest level since April 2022. Total building permits also rose by 5.2% month-over-month, aided by a 4.8% increase in single-unit permits.

In response, homebuilders performed well during the week. The SPDR S&P Homebuilder ETF (XHB) rose by 0.5%, and the iShares U.S. Home Construction ETF (ITB) increased by 1.9%. Among the S&P 500 sectors, only the healthcare sector recorded a gain of 0.2%, while the real estate (-4.0%), energy (-3.5%), and utilities (-2.6%) sectors experienced the largest declines.

Trading volume was exceptionally high on Friday due to the reconstitution of the Russell Indexes.

Tuesday, the holiday-shortened week began with losses in the market. The broad-based selling was driven by the belief that a pullback was overdue following a recent period of strong growth. However, the major indices managed to recover from their session lows, thanks to a rebound in some mega-cap stocks.

The Vanguard Mega Cap Growth ETF (MGK) initially declined by as much as 0.9% but closed with a 0.1% loss. In contrast, the Invesco S&P 500 Equal Weight ETF (RSP) fell by 0.9%, and the market-cap weighted S&P 500 closed with a 0.5% loss, remaining below the 4,400 level.

Among the Dow components, 26 out of 30 registered losses, and ten of the 11 S&P 500 sectors declined. The energy sector was the worst performer, falling by a significant margin alongside declining oil prices.

Homebuilder ETFs, including the iShares U.S. Home Construction ETF (ITB) and the SPDR S&P Homebuilder ETF (XHB), saw gains in response to better-than-expected housing starts data for May. This positive economic data showed a surge in total housing starts and an increase in building permits, particularly for single-unit homes.

Overall, the strong housing data indicated positive prospects for homebuilders' sales and earnings in a supply-constrained housing market.

Wednesday's trading session saw the stock market closing on a softer note. While losses were observed in mega-cap stocks, the major indices held up relatively well. The market-cap weighted S&P 500 fell by 0.5%, while the Invesco S&P 500 Equal Weight ETF (RSP) experienced a modest decline of 0.1%. Investors were also digesting Federal Reserve Chair Jerome Powell's testimony before the House Financial Services Committee, where he reiterated the need for additional tightening measures to address inflation. Powell's comments did not bring any significant surprises, and as a result, they did not have a major impact on the market. In the afternoon trade, stocks made a rebound as Treasury yields fell in response to a successful $12 billion reopening of 20-year bonds. This led to a recovery in stock prices. However, selling pressure resurfaced in the final hour of trading, resulting in negative closes for the major indices. Regarding economic data, the weekly MBA Mortgage Applications Index showed a 0.5% increase, driven by a 2.0% rise in purchase applications but offset by a 2.0% decline in refinancing applications.

Thursday's trading session displayed a mixed performance in the stock market. Strong performance from mega-cap stocks provided support at the index level, driven by flight-to-safety trading due to concerns about global growth. However, the broader market exhibited weakness due to ongoing consolidation efforts and the aforementioned growth concerns. The Vanguard Mega Cap Growth ETF (MGK) recorded a gain of 1.1%, contributing to gains in the S&P 500 and Nasdaq, while the Dow Jones Industrial Average closed relatively flat. On the other hand, the Invesco S&P 500 Equal Weight ETF (RSP) declined by 0.4%, indicating negative market breadth. Underlying weakness in the market was influenced by several central banks, including the Bank of England, Norges Bank, Swiss National Bank, and Central Bank of Turkey, announcing rate hikes. These actions raised concerns about global inflation and the potential impact of rate hikes on global growth. Federal Reserve Governor Michelle Bowman also emphasized the need for additional rate increases to address inflation. Meanwhile, Fed Chair Powell's testimony before the Senate Banking Committee did not introduce any new surprises. However, concerns among committee members about capital requirements for banks, combined with growth concerns, led to declines in bank stocks. The SPDR S&P Bank ETF (KBE) fell by 3.2%, and the SPDR S&P Regional Banking ETF (KRE) declined by 2.7%. Regarding economic data on Thursday, the Q1 Current Account Balance was reported at -$219.3 billion, and initial jobless claims remained unchanged at 264,000. Existing home sales increased by 0.2% month-over-month in May, and the Leading Indicators fell by 0.7% in May. Additionally, natural gas inventories showed a build of 95 billion cubic feet, while crude oil inventories showed a draw of 3.83 million barrels.

Friday marked the end of the week with a downbeat performance in the stock market. The ongoing consolidation efforts and concerns about global growth prospects contributed to the weakness observed. Despite a brief rebound in the early afternoon, where some mega-cap stocks recovered from initial losses, selling pressure resumed, resulting in the major indices closing in negative territory. The losses ranged from 0.7% to 1.4%. The decline in stock prices was influenced by disappointing preliminary June manufacturing Purchasing Managers' Index (PMI) reports from various regions, including Japan, Germany, the UK, the eurozone, and the U.S. These reports indicated PMI values below 50, suggesting contraction in the manufacturing sector. The combination of these weak PMIs and the recent central bank rate hikes heightened concerns that the previous rate increases may be negatively impacting economic activity, particularly in the manufacturing industry. In terms of economic data released on Friday, the June IHS Markit Manufacturing PMI preliminary reading came in at 46.3, lower than the previous reading of 48.4. The June IHS Markit Services PMI preliminary reading was 54.1, a slight decline from the previous reading of 54.9.

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