The first half of 2023 has proven to be the best half year for the markets since 2018, which of course, predates the economic, social, and political disruptions brought about by the pandemic. The economic forces at work in the US and around the world have produced an inflationary environment unlike any we have seen in modern times. This environment has also prompted the Federal Reserve and other central banks around the world to raise rates more quickly than any other time in history. Under normal circumstances this would have plunged the US and world economies into a deep recession, but this has not happened. There may well be a technical recession later this year or early next, but likely it would be “unfelt” in the sense that most households still have excess savings, leftover from the stimulus packages passed by Congress and two Presidential Administrations. In addition, the labor market remains strong, despite a growing pessimism by small and medium-sized businesses. Some of this pessimism ironically persists since it still is very difficult to find qualified workers to fill even the most basic job openings. Currently, there are more than 10 million unfilled positions in the American economy. This hardly seems like a recession so far.
What might be happening in the economy is what is known as a “reordering” of the old economy (pre-pandemic) to a new economy (post-pandemic). In other times of reordering, like the 1920s, emergent technologies like electricity, aviation, automobiles, the telephone, and medical innovations catapulted the economy and society forward. None of those technologies were invented at the time but became mainstream in the economy as moved forward after the First World War and recovery from the global pandemic of the Spanish Flu of 1917. There is an eerie parallel between now and then. As we have seen in recent years, technologies like video conferencing, artificial intelligence, machine learning, and the widespread adoption of the electric vehicle (EV) have captured the attention of society in general, the economy, and certainly the markets. Like the “Roaring Twenties” of the 20th Century, we are seeing our current decade of the 21st Century off to a quick start with the adoption of new technologies hitting the mainstream.
In addition to the technological influences, we are also seeing a sociological transformation in how we work. This has happened several times in history, with generally a good result after a period change which proved painful for some. For example, when industrialization swept through the world and the US in the 19th Century, there was a mass domestic migration from the rural agrarian economy to an urban industrial economy. There was pain involved in the process, but the standard of living for almost everyone rose quickly over that of previous generations. In the 1920’s in particular, automobiles and air travel displaced the horse and buggy and the telephone revolutionized communication. Many jobs were destroyed, but many more new ones were created, resulting in overall economic progress for the masses. Today’s work-from-home or hybrid environment is likely here to stay. Prompted by the COVID-19 pandemic, work-from-home was previously ambient, but now is firmly established in today’s workplace environment. Try as they might, one large company after another has tried to force their employees back to the traditional in-office model, with little-to-no success.
I think the sociological changes that are largely permanent at this point have rewarded many technology companies like Apple, Microsoft, and others, with multiple trillion dollar valuations. The demand for decentralized (work-from-home) technologies have also challenged some professions that at one time appeared invulnerable to automation, but now too may be vulnerable to artificial intelligence (AI). Companies like Nvidia that have invested heavily in AI in the last decade are now being rewarded by a trillion dollar valuation. To give you a sense of just how much money that is, here is a real life example. If one second equals one dollar, it would take 32,709 years to reach the trillion dollar mark! Companies are quickly adjusting to this new environment, either by growing or failing. Suffice it to say, the reordering is well underway.
Importantly, the current market rally that has given us this good first half of 2023 is not limited to just a handful of high flying stocks, but in recent weeks has begun to broaden out in the market, with small cap stocks finally beating the big players with very strong results. This broadening of the rally is encouraging as the smaller companies are not being left behind. A potential reason for this might be smaller companies are more agile and adaptable than their larger competitors. Perhaps in this time of reordering the money advantage of the big company is trumped by the agility of the small company.
With a degree of optimism, several areas of concern seem to be less concerning in the last month or two. Inflation, while still persistent, has probably peaked and is heading lower over time. The potential of more bank failures seems less today than a few months ago, although surprises could easily come when they are least expected. Geopolitical tensions seem less now than when brinksmanship characterized the US/China relationship and the Russian aggression in Ukraine will likely not go nuclear. Lastly, the market does not take political sides when it comes to domestic politics. In fact, the market does better when there is a divided government, meaning one political party does not control both the presidency and Congress at the same time.
What is the expectation for the second half of 2023? With leftover savings from the $6T infusion of cash from fiscal and monetary stimulus of the past few years, the consumer will likely keep on spending and hence fuel economic expansion. The strength of the labor market is such that wages will remain strong even with persistent inflation. Consequently, the market will probably continue to melt-up if nothing unexpected happens. The market does expect the Federal Reserve to continue to raise interest rates at a moderate pace, but the sense is they are nearing the end of the tightening cycle. Remember, the market trades today at what it thinks will take place nine months to a year in the future – it trades on anticipation, not realization. Currently, we are well under record highs and could see in the second half of the year a continuation of this positive trend.
As good as things might appear at the present time, the wise investor should always expect the unexpected. Since no one can consistently predict the future, evaluating your risk is always important in good times as well as bad. The longer time horizon a person has the better, because over time the market always adjusts and prospers. Today’s reordering is a perfect example of the market adjusting to the unexpected, but time is a critical factor, which is an important factor in your long-term success with your retirement savings.
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