2023 Second Half Outlook

Will the bulls continue to dictate the market in the second half of 2023? Or will the bears come back with a vengeance? If history is to be our guide, the bulls are likely to maintain control for the rest of the year. You may have noticed that I typically spend a lot of time during these updates talking about the potential threats in the market. It’s important to know why the market may perform poorly in the future. This time however, I want to point out a few reasons that the market may continue moving higher.

Here are the facts:

1. When the market posts an above-average first half of the year following a down year, 86% of the time the second half of the year was also positive.

2. Under the previous circumstances, the average return of the second half of the year was 11.2%, which would take the market to new all-time highs by the end of the year.

These are the facts, but every market is different. We do still have a looming recession (although it has been looming for many months now). The Federal Reserve is likely not done raising rates, and the valuation of the S&P index is high based on earnings estimates. However, I will point out that if you remove the top 7 largest companies from the S&P, the remaining companies in the index have a P/E ratio around 15, which historically is on the low end. This tells us that many stocks in the index are not expensive based on their earnings and may have some catching up to do.

A key metric to watch for the second half of the year is the amount of money in money market funds. Money market funds are essentially cash that is sitting on the sidelines. They have become more attractive recently as interest rates have risen. You can also look at money market funds as dry powder waiting to be invested in the market. It is common for investors to park their money in money market funds while waiting for an opportunity to re-invest the funds into the stock market. The total balance of all money market funds is reported weekly by the Investment Company Institute. As of June 28th, there was $5.43 Trillion in money market funds, which is very close to a record all-time high. We believe that investors will deploy some of these funds when we get dips in the market during the second half of the year, which should support the market rally.

Key Items for the Second Half

Market Breadth Last month’s update focused a lot on market breadth, which is the number of stocks that are up vs. down for the day. Market breadth has improved since last month’s newsletter, which means that more stocks in the market are participating in the upward moves. This is absolutely key if

we are to see the market rally continue into the second half. The large stocks like Apple, Microsoft, Amazon, etc. have already made a big move up in the first half of the year. It is unlikely that they will have enough gas in the tank to drag the market higher all by themselves in the second half. We do see a large number of smaller companies that have great fundamentals, and when investors start looking at options aside from the mega-cap stocks, we believe they will focus in on companies like these.

Employment and Economy The market is still interpreting good economic and jobs data as a bad thing for the market. The reason for this is because the market assumes that good economic and employment data will lead to more Federal Reserve rate hikes. However, once the Federal Reserve indicates its willingness to pause rate hikes regardless of economic data then good news will be good news again. Economic data has been good so far this year and as long as that continues, it should be a tailwind for the market.

Inflation The next CPI reading is July 12th. We are (hopefully) getting very close to a point where the Federal Reserve can pause raising rates indefinitely. They paused at their last meeting, but with the caveat that they would likely not be done raising rates permanently. A low inflation number on the 12th would potentially allow the Federal Reserve to raise rates one more time and then be done. The market would almost certainly love that news.

Dry Powder As I mentioned earlier, there is $5.43T worth of dry powder in money market funds sitting on the sidelines just waiting to be deployed. Getting 4% return in a money market fund is definitely a welcome change from the .10% return money markets were paying a couple years ago, but to think that investors are going to be content with a 4% rate of return over the long term is absurd. For that reason, the huge amount of cash on the sidelines could be the fuel the market needs to move higher. As more people become convinced that the bear market may be over and we are actually in the early stages of a new bull market, a portion of those funds will likely be deployed, which would be another tailwind for the market.

Commercial Real Estate I promised only positivity in this update, but there is still a key negative issue on the horizon that may be difficult to avoid. Commercial real estate, specifically office space, is likely going to be a major issue over the next few years. Office space is simply not used to the extent it was pre-pandemic. Most companies have landed on a hybrid home/office work schedule. If this trend continues, it will likely mean companies will need less office space to accommodate their employees. This will be a slow motion trainwreck.

Office space is typically leased on a long-term basis. A lot of companies who want to reduce their office space are still stuck in their leases from prior to the pandemic. However, as those leases come due, that will be when we will likely start to see cracks in the market. We need to be very cautious when it comes to office real estate companies as well as banks who finance

office real estate companies. In our view, the question is not will the commercial office space industry experience an intense disruption, the question is how much will it affect the overall market? Our view at this point is that the sector disruption will likely be contained to specific sectors and have a minimal effect on the overall market. However, it is impossible to know the extent of the disruption at this point. We will be monitoring closely.

Overall

It is our belief that the most likely scenario for the second half of the year is that the market continues to trend higher. There will be dips in the market, like in every market, but we believe at this point those dips will be bought and the market will likely bounce back quickly. We also believe that the leaders of the market in the second half of the year will not be the top 7 mega cap companies that were the leaders during the first half of the year. We believe that smaller companies with strong earnings growth and attractive valuations will use the second half of this year to play catch-up to the mega-cap leaders of the first half. We continue to favor technology, industrials, consumer discretionary, and healthcare as sector leaders going into the second half.

The commentary in this article reflects the personal opinions, viewpoints and analyses of the Element Squared Private Wealth employees providing such comments and should not be regarded as a description of advisory services provided by Element Squared Private Wealth or performance returns of any Element Squared Private Wealth client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Element Squared Private Wealth manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

Sources: ● https://www.cnbc.com/ ● https://www.bloomberg.com/

● https://ici.org/