Expectation Vs Reality - Holdun

What a difference a year makes

June 2022

  • U.S. inflation hits over 9% for the highest inflation reading since 1981.
  • The Federal Reserve started the fastest rate hiking cycle in history with four 75bp rate hikes in a row.
  • The U.S. stock market was entering into a bear market with the S&P 500 eventually falling 25% from its highs as tech stocks cratered.

June 2023

  • Headline CPI falls to under 3% as inflation takes a long-awaited tumble.
  • The Fed pauses rate hikes following 10 consecutive interest rate increases.
  • The U.S. stock market approaches bull market territory with the S&P 500 up 17% as tech stocks rally.

Yes – despite slowing economic indicators, a banking crisis, falling earnings, sticky inflation, and the fastest rate hiking cycle in history, both the S&P 500 and Nasdaq now sit within touching distance of their all-time highs.

S&P 500 – Total % Off Highs

Holdun Market Insights 19-07-2023 S&P 500 - Total % Of Highs

Source: Ycharts

Needless to say, this melt-up has been a difficult square to circle for investors.

While it may seem irrational given the negative economic news at every turn, the same pattern has happened again and again in markets. As a forward-looking machine, the markets will move higher long before the coast is clear.

Investing is a relative game. It’s never about whether things are good or bad but whether things are better or worse than expected.

Yes, we are facing the lagging impacts of higher for longer interest rates while leading indicators point to a slowing economy. Still, inflation has tempered, we are approaching the end of the hiking cycle, labour markets remain resilient, and the earnings recession appears shallow thus far.

Put simply, the outlook is far from perfect, but it has improved relative to the start of the year, and the market has responded accordingly.

Performance Breakdown (to end June 2023)

  • U.S. equities led the way in Q2 thanks to a surge in the major tech names. The unrelenting performance of the ‘magnificent 7’ mega caps has now pushed US indexes back toward all-time high.
  • Of the U.S. indexes, the tech-heavy Nasdaq led the way with its strongest start to the year since 1983.
  • Emerging markets lagged their developed market counterparts despite a weakening in the U.S. dollar but still generated a small positive performance.
  • Elsewhere, Japan saw positive gains as relative value vs. U.S. stocks attracted foreign investor flows. In contrast, the China reopening trade lost steam in Q2 with Chinese consumer spending coming in lower than expected and questions persisting over the current state of property market with credit spreads remaining elevated.

Holdun Market Insights 19-07-2023 - Performance Breakdown (to end June 2023)

Sector Breakdown

  • In a repeat of last quarter, big tech led the way as A.I. mania took hold, driving Information Technology names higher.
  • Communication Services strength was driven by Alphabet and Meta who have recorded YTD returns of 33% and 150%, respectively.
  • The trend of mega-caps leading the way continued as Amazon and Tesla drove the Consumer Discretionary sector higher.
  • Performance drops off rapidly once you strip out the ‘Magnificant 7’. To put their dominance into context, the average YTD return on Amazon, Apple, Google, Meta, Microsoft, NVIDIA and Tesla was 84%. Meanwhile, the average YTD return for the rest of the S&P 500 was just 3.7%. This skew is evident when you look at the YTD returns of the other 7 sectors within the index.

A tale of two markets
S&P 500 Index performance by sector in 2023

Holdun Market Insights - 19-07-2023 A tale of two markets S&P Index Performance by sector in 2023

Source: Refinitiv

Cautious Optimism

In just nine months, we have gone from a ‘guaranteed’ hard landing recession to a Goldilocks narrative where inflation neatly falls into place while an A.I. fueled boom sparks the latest bull run.

In our view, the market will always operate in extremes, and the truth sits somewhere in the middle.

In investing, as in life, it bears to remember nothing is ever as good or as bad as it seems.

Even when things are good, there are ominous signs about impending doom.

And even when things are bad, there may be promising signs of improvement.

We see these conflicting signals everywhere in markets at the moment.

Forward-looking recession indicators such as the inverted yield curve and weak manufacturing activity are all flashing warning signs. Meanwhile, measures of real economic activity, such as labour market strength and consumer spending, remain resilient.

But which signals are most important, and do they offer insights into what to expect from markets for the rest of the year?

Interpreting the Data


The Consumer Price Index (CPI) in June was up 3.0% from a year ago, the lowest level since March 2021. Adjusted for food and energy prices, core CPI was up 4.8%, the lowest since October 2021.

Holdun Market Insights 19-07-2023 U.S. YOY Inflation Rates Since 2021

If you annualize the three-month trend in the data, CPI is rising at a 2.2% rate and core CPI is climbing at a 3.5% rate.

Holdun Market Insights 19-07-2023 PCE-equivalent CPI Inflation for June 2023, Annual Rate

Source: Jason Furman

Undeniably, there are disinflationary signs in the data, which aligns with our view that inflation would be below 3% by the end of summer.

From here, the main barrier to inflation returning to the Fed’s 2% target is wage growth and a reversal in energy prices. While any oil price reversal is harder to predict, wage growth should continue to trend lower as the heat comes out of the labour market.

Positive signals – but still too early to declare victory.

Consumer spending

It’s fair to say, the resilience of the US consumer is something we underestimated coming into the year.

Personal consumption expenditures increased 0.1% month-over-month in May to a record annual rate of $18.3 trillion.

Holdun Market Insights 19-07-2023 - FRED Personal Consumption Expenditures

Source: St Louis Fed

The cash pill of excess savings following the pandemic functioned to mitigate the negative effects of higher rates and kept the party going. Now, as excess savings dwindle, consumption rates may finally drop off.

If excess savings data is to be believed, a reduction in consumer spending can be expected as we move towards the end of the year.

However, it’s tough to time any slowdown in spending because the data for excess savings varies widely.

  • Federal Reserve researchers found that household excess savings in the U.S. may be fully depleted.

Stock of excess savings across advanced economies

Holdun Market Insights 19-07-2023 Stock of excess savings across advanced economies

Source: Federal Reserve

  • A separate San Francisco Fed study estimated excess savings have fallen from $2.1 Trillion but $500 billion remains vs. pre-pandemic levels.
Holdun Market Insights 19-07-2023 Accumulated and drawdowns of excess savings

Source: Federal Reserve

While the exact numbers vary, the trend is clear. Excess savings have largely been spent down, which will function as a headwind for the economy as we move forward.

With that said, until we see a more pronounced drop off in the labour market, any pull-back in spending should be minimal.

Labour Market

Slowing, slower than expect, is the general consensus here.

Initial claims for unemployment benefits fell to 239,000 during the week ending June 24, down from 265,000 the week prior. While numbers have ticked up since the September low of 182,000, the current levels are still in line with levels associated with economic growth.

Seasonally Adjusted Initial Claims
June 25, 2022 0 June 24, 2023

Holdun Market Insights 19-07-2023 Seasonally Adjusted Initial Claims

Source: Department of Labour

Regardless of what way you cut the data, it’s clear the labour market remains secularly tight despite some slowing growth in June.

The US economy added 209,000 jobs in June.
Unemployment rate
drops to 3.6%

Holdun Market Insights 19-07-2023 US economy added 209,000 jobs in June. Unemployment rate drops to 3.6%

Source: CNN

While a resilient labour market is an undeniable plus for the economy, this remains a classic ‘good news is bad news scenario’.

Unless we see a drop off in wage growth, the Fed could be forced to resume their rate-hiking in the fight against inflation, which will function as a negative surprise for markets.

Higher for longer

One major headwind for markets is the growing impact of higher interest rates as credit and liquidity reduce over time.

The impact (or lack thereof) of the fastest rate hiking cycle in history has surprised many. Labour markets and consumer spending have remained resilient despite rapid monetary tightening.

But we’re not out of the woods just yet; In fact we may not even be in the woods yet.

Interest rate adjustments take time to fully impact the economy.

From an economic data standpoint, rate hikes have historically functioned with a significant lag of up to 18 months, and it’s currently only 12 months since the first rate hike. To say that we are seeing the full effects of last year’s hiking cycle is premature.

One reason for this extensive time lag is credit has already been locked in at low rates, and it takes time for this debt to roll over.

Cheap borrowing rates were locked in for longer period by U.S. companies who went on a credit binge when rates were on the floor in 2020-2021.

The same can be said for the US households, who locked in record low rates in 2020-2021. This has helped keep their debt servicing levels near record lows despite the rising rate environment.

Holdun Market Insights 19-07-2023 FRED Household Debt Service Payments of Disposable Personal Income

Source: St. Louis Fed

Even with some long maturity walls, if rates stay high for long enough, U.S. businesses and households will eventually be forced to refinance at far less favourable conditions.

While only one example, it highlights how the negative effects of higher rates take time to fully play out, but this higher-for-longer narrative will ensure we feel the squeeze at some point in the future.

But for now, the can will be kicked down the road as we bask in the residual glory of the 0% rate environment.

Earnings Hold Up

Another positive for stocks is the ‘major’ earnings recession narrative that drove stocks lower last year has not played out thus far.

Holdun Market Insights 19-07-2023 Predicted Collapse in 2023 EPS Has Not Materialized with Investors Now Looking to 2024

Source: BMO Investment Strategy Group, FactSet, IBES.

Q1 earnings fell just 2%, better than the 5% projected. Current estimates expect Q2 earnings to fall 6.5% year-over-year, resulting in the 3rd consecutive quarter of negative earnings. But with expectations on the floor (-6.5%), there is room for a positive earnings surprise, which could push stocks higher over the short term. As they say, nobody ever got injured falling out a basement window.

Looking ahead, consensus estimates that S&P 500 earnings will bottom in Q3 2023 before rebounding in 2024.

Of course, many things can go wrong between now and when those future earnings are realised, but as things stand, this shallow earnings decline narrative is positive news for investors.

With the 2024 earnings recovery now being priced in, any hit to margins between now and then will pull markets lower.

A Handful of Winners

‘ Do we have a strong stock market and economy, or are a handful of outperformers just papering over the cracks?’

The current narrow market breadth has been well-documented.

Just seven companies have provided over 80% of the gains we have seen in S&P 500 this year.

A Handful of Companies are Driving the Bus

Holdun Market Insights 19-07-2023 - S&P 500 Magnificent 7 Tech Megacaps

Source: Russel Investments

Driven by a thirst for A.I., these stocks have seen a staggering turnaround in less than 12 months. A reminder of how fast the narrative can change.

2022 returns:

Apple -27%
Microsoft -29%
Google -39%
Facebook -65%
Tesla -65%
Nvidia -51%

2023 returns:

Apple +49%
Microsoft +44%
Google +41%
Facebook +155%
Tesla +133%
Nvidia +213%

The question from here is, ‘Will the rest of the field start playing catch-up, or will the magnificent 7 simply fall back in with the rest of the pack?’

With the exception of Meta and Nvidia, most of the outperformance in these names has come from multiple expansion as opposed to increased earnings, making their current growth rate all the more difficult to maintain. We believe this runaway train is losing steam, but those expecting these names to fall to the multiples seen in the rest of the market will be left waiting. You don’t get amazing companies at average prices.

(We expect some turbulence next week while the Nasdaq 100 ‘special rebalancing’ takes place, but this will be short-lived.)

Yes, structurally speaking, massive divergence is not a good character trait of any market, but it doesn’t necessarily guarantee disaster in our view.

In a scenario where all other names have fallen, and a handful of companies are propping up the market, this ‘last domino to fall’ narrative becomes a far more pressing issue, but that is not the situation we are in.

In fact, in June, we saw early signs of a market rotation as lagging sectors such as industrial and materials led the way ahead of IT and communication services, and the equally weighted S&P 500 outperformed the market cap-weighted S&P 500.

While it’s still too early to call this a true inflection point, this market rotation could represent the next leg up for markets as the underperforming names start to play catch-up.

Putting It All Together

There are a lot of positives to take out of the first half of 2023. Consumer balance sheets remain healthy, and consumer spending has held up. Labour markets have softened somewhat, but job growth remains strong as inflation falls closer to the magical 2%.

That being said, there are still salient risks on the horizon. The excess savings cash buffer has taken a significant hit. Quantitative tightening is set to resume at a rate we have never seen before, and interest rates look set to remain high for the foreseeable.

As we look ahead, the market appears to be flirting with overconfidence. Investors have taken a decidedly positive view on the ultimate resolution of multiple macroeconomic unknowns. With several rate cuts expected next year and strong earnings growth projections now priced in for stocks, a lot needs to go right just to meet current expectations at a time when outcomes remain uncertain.

And now, thanks to the strong year-to-date rally in equities, markets no longer have a valuation buffer to protect if things don’t go to plan.

Over the near term, positive momentum will remain as old sources of uncertainty fade, which could push markets higher, but the reality is, we are yet to feel the full effects of the Fed’s rate hiking cycle. While the economy has proved surprisingly resilient, we know from history that the impacts of rate hikes can take much longer than most expect to impact economic growth.

While we express caution, it is worth noting that we do not expect a major drawdown in the stock market. Price corrections due to slowing economic data are expected over time, but the current money on the sidelines will put a floor under how far markets will fall. Any significant pullbacks will function as buying opportunities for those waiting for a more attractive entry point.

Some positive steps have been made, but inflation won’t be fully unwound without some discomfort along the way.


  • Despite a decade of being significantly overweight U.S. vs. international equities, this year, we repositioned to take a more ‘balanced’ approach. While we don’t have bullish conviction in Europe, U.S. dollar weakness and relative value opportunities call for a more regional balance across equity portfolios.
  • Japan offers some potential. Equities could continue outperforming as the country moves out of deflation and transitions to a mildly inflationary economy • Given the multiple expansions in the first half of the year, the risk-reward trade in equities is less attractive, increasing the need to focus on quality. Consumer staples, financials, and healthcare remain a focus.
  • The yield curve inversion is paying us to stay at the short end of the curve for now. The scope for longer-duration exposure increases as we move towards the end of the year. • We remain underweight corporate bonds as the narrow credit spreads fail to compensate for the added credit risk on offer.
  • We remain underweight corporate bonds as the narrow credit spreads fail to compensate for the added credit risk on offer.
To learn how we can help you protect your wealth from the volatility ahead, simply reach out to us using the link below.