Mickey Kim
The following is an excerpt from Kirr, Marbach & Co.’s second quarter client letter, available at kirrmar.com.
What a difference a year makes, thank goodness! The S&P 500 had a total return of 8.7% in the second quarter (Q2-2023) and 16.9% in the first-half of 2023 (H1-2023). Further, though past performance is no guarantee of future results, history can be a useful guide and CFRA Research tells us following an H1 gain in excess of 10%, the S&P 500’s H2 return typically nearly doubled its normal 77-year average H2 return (8.0% vs. 4.5%) and delivered a 12-percentage point improvement in its frequency of positive H2 returns (83% vs. 71%).
Taking a walk down “Memory Lane” sometimes brings back painful memories, but can also reinforce important lessons. 2022 was the worst year for stocks since the depths of the Global Financial Crisis/Great Recession in 2008 (fourth worst for the S&P 500 since 1945) and worst year for bonds ever.
The year was so bad, Bloomberg said, “one bad year in the stock market has turned Wall Street strategists into bears after two decades of bullishness.” In fact, the average forecast for the 17 firms Bloomberg tracked called for the S&P 500 to decline in 2023, “the first time the aggregate prediction has been negative since at least 1999.”
In summing up 2022, we said:
The pain is real. Pessimism is high. Fear is extreme and understandable. We’re heavily invested alongside you and feel the same emotions. Still, while there are undoubtedly more shoes to drop in 2023 that could cause stocks and bonds to drop further, we believe 1) much of the bad news has already been priced into the market, 2) the regime change from 0% interest rates will finally force investors to focus on company fundamentals and stock valuations and 3) it is difficult times like these that present opportunities for long-term investors in a world obsessed with short-term results.
In May 2020, “headline” inflation as measured by the Consumer Price Index (CPI) was barely positive at 0.1% (year-over-year increase). Just over two years later (June 2022), CPI peaked at 9.1%, the largest yearly increase since the early 1980s. Who knew the CPI would decline in each of the next eleven months to 4.0% in May 2023? According to Bespoke Investment Group, the 5.1% decline in the CPI was the largest trailing 12-month fall since the Global Financial Crisis/Great Recession.
If we told you in March of 2022 the Fed would aggressively increase short-term interest rates from 0% to 5% over the next 14-months, the conventional wisdom would be stocks and the economy would both be pummeled. As is often the case, conventional wisdom would be wrong. In fact, the S&P 500 had a total return of 4.3% from the start of the Fed’s campaign to fight inflation by raising interest rates (March 16, 2022) through June 30, 2023. In addition, the U.S. economy continues to show surprising vigor, with the labor market remaining robust and first quarter of 2023 gross domestic product (GDP) growth recently revised to 2% (from a previously reported 1.3%).
As we’ve stated time and again, the financial markets and economy are impossible to predict due to literally thousands of interrelated factors, even if you have perfect insight into some of the primary inputs like interest rates.
The S&P 500 had a very strong H1-2023, but it was actually a case of a small handful of mega-capitalization technology stocks doing exceptionally well. According to Bespoke just 30 of the S&P 500 stocks accounted for more than 95% of the H1-2023 gain (meaning the other 470 stocks accounted for less than 5% of the H1-2023 gain). Apple alone (market cap $3 trillion) accounted for about 18% of the H1-2023 gain and adding Microsoft (14%), NVIDIA (13%), Amazon (8%), Tesla (7%), Meta Platforms (7%) and Alphabet (7%), this group of seven mega-capitalization technology stocks (1.4% of the stocks in the index) accounted for about three-quarters of gain in H1-2023.
Three Investment Lessons Reinforced in H1-2023
1. “Experts” are lousy forecasters about the economy and financial markets.
2. Surprises happen. Silicon Valley Bank failed on March 10, 2023, the third largest bank failure in U.S. history. Many “experts” predicted a global banking crisis, but the S&P 500 had a total return of 15.8% between March 10, 2023 and June 30, 2023 (meaning almost all of the H1-2023 gain for the S&P 500 occurred after Silicon Valley Bank failed).
3. It’s best to focus on your plan. Whether it was the panics related to the failure of Silicon Valley Bank or the “Sword of Damocles” gamesmanship regarding raising the debt ceiling to prevent a U.S. default, speculators (not investors) had very good reasons to move to cash “until the dust settles.” True to form, these speculators would have missed out on the significant returns earned by investors who stayed the course and stuck to their plans. Remember, your investment decisions and reactions to market events will have a significant impact on your personal investment return.
Kim is Kirr Marbach & Co.’s chief operating officer and chief compliance officer. He can be reached at 812-376-9444 or [email protected].
