As 2023 unfolds, the mood of investors in the US stock market is shifting. Although initial bearishness fueled significant gains in risk assets throughout the first half of the year, the story seems to be taking a different turn. Several indicators that previously signaled growth are now projecting a more neutral outlook, potentially leaving equities vulnerable to a variety of factors such as a recent surge in bond yields and concerns over China’s economy.
At the start of the year, with a brutal 2022 selloff fresh in mind, extreme pessimism prevailed. Investors were bracing for a recession predicted to hit the latter half of this year. However, signs of economic resilience coupled with cooling inflation quickly turned the tide. Optimism returned, risk appetite increased and investors drew off the sidelines resulting in a nearly 14% rise in the S&P 500 this year.
But this climate of optimism faces a stern test. Market strategists at BofA Global Research warned that the ‘strong tailwind’ for risk assets seen in the first half of 2023 is no longer present moving forward. Market dynamics, nevertheless, are hard to predict. Several economic events looming large on the horizon have investors watching closely, including the Federal Reserve’s annual symposium in Jackson Hole, Wyoming, where pundits hope for insights into the future course of interest rates.
Another source of anxiety rattling investor sentiment is the deteriorating property market in China. The ripple effects of China Evergrande Group, a beleaguered property giant, filing for US bankruptcy protection earlier this week has heightened fears over the impact on China’s flagging economy.
Steve Chiavarone, a senior portfolio manager at Federated Hermes, suggests that the market might still not be bullish enough in the short to medium term, taking comfort from signs that the US economy will sidestep a recession this year. He noted that there is historical precedent for the S&P 500 to gain an average of 14% during pauses to Federal Reserve tightening.
However, not everyone shares this optimism. Quincy Krosby, Chief Global Strategist at LPL Financial, highlighted the market’s vulnerability due to the surge in bond yields and concerns over the Chinese property sector. He argued that the time to get bearish might be looming.
Meanwhile, the 10-year Treasury yields are at their highest since October, exceeding the S&P 500 which is down by over 5% since its peak in late July. As higher yields on Treasuries make stocks less appealing to investors, especially with high equity valuations when compared to history, analysts are beginning to predict volatility ahead.
In the face of these unpredictabilities, investors are employing a wait-and-see tactic until companies start announcing third-quarter earnings in October. Depending on the stability of the market at that time, they will likely adjust cash allocations.
The market holds its breath as we head into the final quarter of this rollercoaster year. While optimism endures, it’s measured and far from extreme. Yet despite all these moving parts and the twists and turns they bring, it’s important to remember a simple tenant: Look for the silver linings, because sometimes perceived threats can turn out to be enormous opportunities.
