Each quarter, Collective Wealth Planning, with the help of our investment partner First Ascent Asset Management, provides transparency and seeks to clearly communicate what is driving performance for portfolios. The First Ascent Asset Management investment team has put together the following commentary for Q2, 2023.
Highlights
After a choppy start to the second quarter, stocks gained meaningfully in June. This marks the third straight quarter of positive returns for stocks, both in the US and internationally. Reversing the trend from last quarter, the US stock market led, followed by developed international, with emerging markets trailing. While fixed-income markets pulled back modestly, overall portfolio results were generally positive for investors.
The Federal Reserve held two meetings during the quarter, raising the federal funds rate by 0.25% at the first, and holding at their 5-5.25% target at their second, taking a pause after 15 months of consecutive increases. While this pause was certainly welcomed by investors, expectations are that more hikes are likely before the end of the year, albeit at a more measured pace than we experienced in 2022. While certainly there is no guarantee, market expectations and Federal Open Market Committee (FOMC) forecasts indicate one to two more 0.25% hikes this year, with the potential to see reductions in the federal funds rate during 2024.
Corporate earnings held up better than expectations during the quarter and the economy, while showing signs of slowing, has continued to expand. The unemployment rate remains at very low levels and the employment market tight. The Fed is certainly looking for some cooling on the employment front as they seek to balance their dual mandate of stable prices and maximum employment.
US Stocks
US markets posted a strong quarter, gaining over 8%. For both the quarter and the last year, large caps outperformed small caps, while real estate lagged.
After a strong 2022, value-oriented equities have been outpaced by growth stocks as they returned to favor so far in 2023. Returns for the total market over the past year have been nearly 19%, surprising many market pundits who believed rising rates and political challenges would create headwinds for markets.
International Stocks
Reversing the recent trend, international stocks trailed US markets during the second quarter. Over the past year, returns for developed international and US stock markets have been virtually identical (MSCI EAFE +18.77 / CRSP US Total Market +18.94). Emerging markets, weighed heavily by weakness in Chinese stocks, were still modestly positive over the quarter and year.
Fixed Income
Against the backdrop of the pause by the Federal Reserve, but with the potential for additional rate hikes coming, bond markets were flat to modestly negative for the quarter. The Bloomberg Barclays Aggregate Bond Index was down just under 1%, while hedged international bonds eked out a small gain.
For investors in tax-sensitive portfolios, municipal bonds have been one of the strongest sectors over the last year, with even stronger relative results when compared on an after-tax basis.
Parting Thoughts
As we do each quarter, we share illustrations or ideas that we hope can provide value and perspective for our investors. The illustrations we wanted to share this quarter come from JPMorgan’s Guide to the Markets.
Despite major geopolitical headlines, bank failures, debt ceiling tensions and more throughout this year, if you are feeling like things have settled down a little bit and volatility has declined, you would be right.
This first illustration simply shows how many days each year the S&P 500 moved more than 1% (up or down).
So far this year, we are on pace to experience less than half of the number of big daily moves that occurred last year. Given that we have roughly 250 trading days in a year, looking back to 2022 meant that, on average, the market moved by more than 1% every other day.
A key takeaway here is one you have heard from us many times, which is that the path of the markets is far from smooth. Large daily swings often trigger emotional reactions if you are watching the markets too closely. During a period of relative calm, it is useful to reflect and remember that short-term moves are common and that as long-term investors we must acknowledge that fact, and do our best to tune out the short-term movement and noise in the markets.
The next two illustrations relate to valuations across global equity markets. We are strong believers in the importance of broad, global diversification. Over time, US and international markets have shown cyclicality, with one outperforming for a while, then the other. We are currently in a period where the US has outperformed international markets for quite some time, and investors may second guess the importance of not concentrating all their investments in the US markets.
The illustration and table above quantify the valuation differences among major countries and geographies. The grey bars, purple diamonds, and black bands represent the valuation relative to an area’s own history. The overall high/low position on the graph represents whether it is expensive or cheap relative to the world market.
One thing you will notice is that the US tends to trade at a premium to the rest of the world. There are good reasons for this, including our legal and regulatory environment, our history of innovation and efficiency, and generally higher economic growth rates. However, you will also notice that US stocks are as expensive as they have been over the last 15 years while many other areas are offering more compelling valuations. Research has shown that valuations are one of the few if any indicators that are correlated with future returns (you know how the old saying goes, the secret is to buy low and sell high).
This next chart takes it a step further, comparing valuations by sector between the US and Europe. You can see that the current discount is significantly larger than historical averages across nearly all sectors.
It is impossible to know when the market leadership cycle will switch between US and international stocks. While we believe diversifying across the world is always important, now, as much as ever, the price disparity among regions provides a compelling case for ensuring that a well-constructed portfolio contains a meaningful allocation to non-US investments.
Each quarter, Collective Wealth Planning, with the help of our investment partner First Ascent Asset Management, provides transparency and seeks to clearly communicate what is driving performance for portfolios. However, as long-term investors we believe it is important to note that any single period (especially a period as short as a quarter) can be skewed or limited in informational value and stress the importance of the longer-term perspective on portfolio positions.
Investments are not guaranteed and are subject to investment risk, including possible loss of the principal amount invested. Past performance is no guarantee of future results. All allocations and opinions expressed are as of the date of this presentation and subject to change. The information contained herein does not constitute investment advice or a solicitation. Information obtained from 3rd parties is believed to be accurate, but has not been independently verified.
