June 2023 Commentary – The Rotten Tomatoes of the Stock Market
Have you ever been duped by a movie critic praising a new film only to watch it yourself and be less than impressed? How does this relate to the stock market?
In our June 2023 update, Beacon Wealth Consultants’ Chief Investment Officer Hillary Sunderland, CFA®, CKA® talks about the Rotten Tomatoes of the stock market!
Find out what the hype is all about, what’s going on in the markets, and our future expectations.
Watch the video to learn more!
Full transcript below.
Transcript
Hi, my name is Hillary Sunderland and I’m the Chief Investment Officer of Beacon Wealth Consultants and LightPoint Portfolios. Thank you for being a valued client of ours. Today I’m going to give you a brief update of the markets and the economy for the first half of 2023.
Well, the big story for the last 18 months has been inflation. The good news is that inflation has moderated and is now about half of what it was last summer. However, it’s still sitting above the fed’s target of about 2%. Because of this, we do expect one or two more interest rate hikes this year, likely starting in July.
Despite the backdrop of elevated inflation and interest rates, the US economy has continued to grow steadily. The reading on economic growth came in at a much faster pace in the first quarter than previously estimated. The slow but steady growth we are seeing has lowered the probability of a recession occurring this year. However, recessionary pressures still remain for 2024.
Both stocks and bonds have had a good first half due to a bounce back in profit margins and a resilient US economy. The only major asset class that fell in value was one of the best performing asset classes last year, The Bloomberg Commodity Index.
Bonds, once again offered positive returns to investors, but the story this year is really in the US large cap space. The S&P 500 index led the way in the first half, finishing up 16.89%. While initially this may seem like a reason to celebrate, the reality is that few investors have been able to keep pace with the gains as returns have been almost entirely driven by the market’s largest stocks. And so for this presentation, I decided to dub this the Rotten Tomatoes of the stock market.
If you’re like me, prior to watching a movie, I usually look at the movie ratings on Rotten Tomatoes to ascertain whether it is worth my time to watch it. What I’ve found is that if I look just at the critics reviews of a movie, the big loud voices of the movie industry, such as those shown here, I go into the movie with high expectations and sometimes I come out disappointed.
However, when I consider what the average person thought about the movie, which is the audience review outlined here, I tend to have a much better experience and expectations.
And for note, if you aren’t familiar with Rotten Tomatoes, anything below a 60% audience score indicates that the average person didn’t really like the movie, and that score causes me to question whether I should participate in watching it too.
So how does this relate to investing? Well, this year, a handful of mega cap names are carrying the performance of the S&P 500 index. This is because it is a market cap weighted index, meaning that the largest companies in the index, Apple, Microsoft, Amazon, Nvidia, et cetera, they have the loudest voices in the index. These companies are like the movie critics that are telling you what you should expect to see. When these companies perform well, they skew the performance of the entire index higher.
And why this is important to note is that according to JP Morgan, approximately 95% of the return of the S&P 500 index this year came from just the top 10 companies of the index, the other 494 stocks, (and yes, my mask correct there because there are more than 500 stocks in the index,) the other stocks in the index have not performed nearly that well.
If you took all of the stocks in the S&P 500 index and gave them equal weight or an equal voice in this case the audience review, if this were a movie review, the return for the first half was 7.03%, almost 10% below that of the index that is commonly quoted in the news. This is a very large spread that is largely due to excitement over advances in AI, which helped push a few of the biggest stocks in the index higher this year.
This has resulted in relatively few investors being able to keep pace with the gains and the market. According to Morningstar, the average large cap blend mutual fund has trailed the S&P 500 index by about three and a half percent year to date.
Under the surface sectors like healthcare, energy and financials, and from a diversified portfolio perspective, small cap stocks, emerging markets, international stocks, they have lagged the performance of the S&P 500 quite a bit.
So going back to that analogy of the Rotten Tomatoes movie reviews, the more the average person likes the movie, the more I’m able to trust the movie critics that they were correct, and I’m willing to go see the movie too. Similar to this, the more the average stock starts to participate in the stock market advance, the more willing investors are to believe that the market is on firm footing and put their capital to work.
Now the good news is that in the last week of the month, we saw the rally broadening out due to a string of economic reports that suggested that a recession is not imminent.
As we enter earning season shortly, we will gain more insight into how confident companies are about the second half of the year. I wouldn’t be surprised to see a bit of a pullback in the markets over the next few weeks given the strong advance higher in just a few companies. However, our expectation is that the rally should broaden out into other areas of the market over the next few months as the Federal Reserve provides clarity surrounding the path of interest rates.
As always, we’ll continue to assess the market outlook and make changes to the portfolios as warranted. We thank you for your continued confidence and please reach out to us with any questions you may have.
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