All data and commentary as of July 12, 2023.
Only when the tide goes out do you discover who’s been swimming naked.
This quote from legendary investor Warren Buffet seems more relevant than ever in the current market environment. After the dismal returns we saw across nearly every asset class last year, it seems a new bull market may be emerging (at first glance) with the S&P 500 staging a noticeable comeback so far in 2023. However, the vast majority of these returns can be attributed to only a handful of large tech constituents within the index. While seeing technology and AI stocks take off this quarter has brought some much needed optimism to the market, the outstanding year to date returns of companies like Nvidia, Apple, and Meta seem to be the outliers rather than the norm. As a matter of fact, over 200 of the constituents of the S&P 500 still have a negative or flat return for the year as of quarter end.
The melt up of tech stocks seems to make little fundamental sense given a backdrop of rising interest rates, stricter lending from banks, and the ever-looming possibility of an impending recession – but speculative investors have piled into companies that may be positioned to benefit from the explosion in popularity of AI tools like ChatGPT. While there is no doubt that these tools have potential to change the landscape of various industries in the near future, AI is still very early in development and adoption. Like we saw in the 2000 Dot Com bubble, many early adopters of this technology will likely fail before the successful long term market leaders emerge (Pets.com was one of the most well-known casualties of the internet bubble, and 20 years later companies like Chewy are thriving with similar business models). Given the speculative nature of this space, we feel it is important to be cautious around the hype for the time being and maintain a focus on quality companies with the stability to withstand the economic un- certainty that will likely persist through the remainder of the year.
On the economic side of the financial landscape, the Fed left rates unchanged in their June meeting for the first time since January 2022. However, it seems clear that they have not declared victory over inflation with 2/3 of the FOMC members seeing rates going up by at least an additional 0.50% by year end. This forecast has drawn controversy from the investing community, as it suggests 2 additional rate increases which many see as too aggressive. Fed rate increases have a notorious long and variable lag in their impact on the economy, so it is difficult to determine when monetary policy has reached a point that is sufficiently restrictive to slow the economy without sending the US into a recession. While tamping down inflation is the Fed’s main priority right now, further rate increases could put additional pressure on the consumer and businesses as the cost of borrowing increases.
As it relates to your portfolio, we are focused on maintaining healthy diversification across asset classes and favoring holdings with mature, stable companies with high and sustainable free cash flow rather than chasing the speculative tech/growth trade that has gained some buzz over the course of 2023. On the fixed income side, we are planning to extend the duration of bond portfolios this quarter to better position those assets as we finally approach the end of the Fed’s restrictive campaign. We have also started to implement new alternative investments like structured notes and interval funds where appropriate in an effort to bring additional diversification, stability, and income to portfolios.
Please don’t hesitate to reach out if you have any questions or concerns related to your portfolio, and we look forward to meeting with you soon!
Jake Fromm | Lead Investment Analyst, CFS® | It is our mission to help you think differently about your wealth so you can LIVE WELLthy™ today and tomorrow.