The stock market had a dynamite start to the year, with the S&P 500 up 16% in the first half of 2023 and the Nasdaq returning roughly twice as much.
But what does the future hold? More good times for investors? Or fresh disappointment? Three expert MoneyShow contributors weigh in!
Alec Young, Mapsignals.com
They say that stocks climb a wall of worry. It’s true. Rarely is the march higher in equities a cakewalk.
The latest harbinger of equity doom is that weak breadth is a reason to be bearish. Those claims don’t hold water when you study the data. Here’s the deal: Narrow leadership means more pain for the bears. I’m sure you’ve heard this a lot.
“This market rally is way too narrow. A handful of overpriced tech behemoths are driving all the gains. Stocks are headed for a big drop as this shaky foundation inevitably crumbles.”
Sounds familiar right? So, are the bears onto something or just setting themselves up for more pain? Today, I’ll debunk Wall Street’s latest favorite bearish narrative and show you how to position your portfolio to take advantage of it.
Narrow Leadership Means More Pain for the Bears
The bears are right that market leadership has been narrower than usual this year. Only 28% of S&P 500 (SPX) stocks outperform the index vs. a long-term median of 48%. So far, 2023 reveals the lowest constituent outperformance in 15 years:
But here’s what the bears miss. Narrow market leadership is good because it boosts forward returns. This makes sense given that a majority of stocks in the index likely represent value.
Consider the following. Since 1928, the S&P 500 has posted 15.4% annual returns in the 12 months following periods of narrow market leadership vs. only 7.4% returns after very broad-based market rallies. Said another way, narrow leadership means more pain for the bears:
You may be wondering why strong breadth tends to result in weaker forward performance. Ultimately, when everything’s already run up, it makes sense that future performance would be weaker as fewer names are left to power additional upside.
Today’s narrow leadership means there are still plenty of stocks with lots of room to play catch up. Technology, communications and discretionary are the only sectors outperforming the S&P 500 YTD. Financials, energy, materials, industrials, real estate, staples, health care, and utilities still have plenty of upside, as do small and mid-cap stocks.
Jim Woods, The Deep Woods
The first half of 2023 just ended, and what a first half it was! The question now becomes: What’s going to happen in Q3?
While I’m tempted to borrow a line from the great Bob Dylan and say, “The answer, my friend, is blowin’ in the wind,” I will refrain from doing so and give you what I think you’ll find to be a much more substantive response.
After a very bearish 2022 that saw the S&P 500 lose some 19% of its value, stocks have made a rather robust rebound through the first six months of this year, with the benchmark domestic equity index turning in a near-16% move to the upside.
Now, last year stocks were down nearly across the board, but the declines were particularly deep in tech and other high-beta sectors. This year, we’ve seen a huge reversal of fortune in tech, and particularly mega-cap tech stocks such as Amazon
AMZN
AAPL
META
The heavy market-cap weighting in the Nasdaq Composite of these mega-cap techs, and of course their big moves higher, helped vault the index up more than 31% year to date. Below, the chart of the major domestic averages year to date tells the tale of a tech-fueled rally that looks to me like it wants to continue much higher.
The way I see it, as we begin the third quarter, the outlook for stocks and bonds is arguably the most positive it’s been since late 2021. Think about this: Inflation has just hit a two-year low, economic growth and the labor market remain impressively resilient, the Fed has temporarily paused its historic interest rate hiking campaign, the debt ceiling extension is resolved, and we’ve seen no significant contagion from the regional bank failures from earlier this year.
All of these positives augur well for a continued rally. And while clearly the past quarter brought positive developments in the economy and the markets, it’s important to remember that potentially significant risks remain.
Keep in mind that the economy has not yet felt the full impact of the Fed’s historically aggressive interest rate hikes. And while the economy has proven surprisingly resilient, we know from history that the impacts of interest rate hikes can take far longer than most expect to impact economic growth.
There’s also the fact that markets are trading at their highest valuation in over a year, and investor sentiment has become intensely optimistic. For example, the CNN Fear/Greed Index ended the second quarter at “Extreme Greed” levels, while the American Association for Individual Investors (AAII) Bullish/Bearish Sentiment Index hit its most bullish level since November 2021, right before the market collapse started in early 2022.
So, while clearly there have been positive macro developments in 2023 that have helped the stock market rebound, it’s important to remember that multiple and varied risks remain for the economy and markets.
Thomas Hayes, Hedge Fund Tips
There’s an old maxim, “The secret to happiness is low expectations.” This saying could not apply more directly than to what we are seeing coming into the Q2 earnings season. With consensus expectations looking as pessimistic as they were going into Q1 earnings season, the stage is set for another series of positive upside surprises.
While Q1 earnings expectations were for around -6.6% at the beginning of the season, they finished down only 2% by the end – shattering expectations to the upside and forcing analysts to begin modest upward revisions.
Q2 earnings season – which is just starting – may prove to be a replay of Q1. Set the expectations bar LOW (currently -6.8% estimated) and hop, skip and jump over the very low bar, forcing analysts to panic upgrade and portfolio managers to chase up with leverage.
There is one pocket of the market where expectations are currently set HIGH relative to the market in aggregate (where pessimism prevails). This group is the AI-related stocks and tech/“Magnificent Seven.” They have outperformed in 1H on the basis of these lofty expectations being fulfilled in the near term. But in our view, the likelihood is that this “new industry” emergence will take time.
That does not mean the earnings of the Magnificent Seven will be bad. It simply means we expect the relative outperformance of this group in 2H will pale in comparison to their relative outperformance in 1H.
It also doesn’t mean they will do poorly or “crash.” But it is our expectation that the remaining 93% of the S&P will start to catch a bid as managers who missed the gains in 1H start to play “catch up” by buying laggards they have NOT missed.
In Q2, analysts lowered estimates for the quarter by 2.9%. This is lower than the average intra-quarter lowering of 3.4% over the past five years.
The bottom-up target price for the S&P 500 is 4813.70, which is 9.5% above the recent closing price of 4396.44. At the sector level, the Energy (+22.0%) group is expected to see the largest price increase, as this sector has the largest upside difference between the bottom-up target price and the closing price.
On the other hand, the Consumer Discretionary (+4.4%) and Information Technology (+4.8%) sectors are expected to see the smallest price increases, as these two sectors have the smallest upside differences between the bottom-up target price and the closing price.
As we have stated in previous notes and media appearances, besides emerging markets being a major beneficiary of a resumption of the downtrend in the US dollar in 2H, multi-nationals with >50% of their revenues abroad will get have an enormous tailwind moving forward just as they had a headwind in the rear-view mirror.
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