The end of last year saw sentiment towards risk assets and in particular equities become very pessimistic. The bear market of 2022, which hit growth stocks hardest but also hit bond prices dramatically too, understandably led to broadly negative and pessimistic sentiment for market participants as we entered 2023.
The rises in interest rates by central banks around the world and continued high levels of inflation further led to economic forecasts predicting major slowdowns in the world’s largest economies.
Looking back, it is remarkable how strong equity prices have been through this period. The S&P 500 Index is up close to +17% so far in 2023, the MSCI World Index +15%. These would be strong moves for a 12-month period, so it is even more impressive to deliver this in just the first 6 months of the year.
For much of the first 6 months of 2023, the rally in equities has been led by a small number of stocks. Large cap technology stocks in the US have driven much of the performance for stock indices this year, with the news-flow around artificial intelligence (AI) and a starting point of below average valuations supporting a strong move up in share prices of these companies.
More recently, we have seen two things that make us think the rally in equities could continue through the remainder of the year.
First, we have seen a broadening in stock index performance. What does this mean?
The fact that much of the move up in stock indexes in the first half of 2023 was driven by a small number of stocks (Apple, Microsoft, Amazon, Nvidia, etc.) made that a ‘narrow’ market. When a rally broadens, we mean that more stocks in the stock market index are contributing to the overall index performance. This is typically a healthy sign for a market rally, as confidence from market participants spreads to other sectors and stocks in the index.
In the past two weeks, we have clearly seen a broadening in positive market index performance.
Second, the latest data from the United States show a major reduction in rates of inflation and evidence of disinflation coming into the system. Remember, higher interest rates and their associated negative impact on the economy are what have held back market sentiment and economic expectations. If inflation really is coming down quickly and surprises to the downside, this could be a major tailwind to the economy via: (i) lower prices which boosts demand, (ii) higher corporate profits which boosts share prices, (iii) the potential for interest rate rises to be paused and even (whisper it) reversed.
What is more, the hype around AI is no fairy tale. Large language models and generative AI are revolutionary and we see ChatGPT and other iterations of this technology as having the potential to transform entire industries and have a major positive impact on economic productivity.
Broadening in market performance, lower inflation, and a technological tailwind to the economy, could be the recipe for further upside surprises to equity prices this year.
Equity rallies of the past have been sustained by far less!
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
