Key takeaways:
- Holding tight. Persistent inflation means central banks may keep interest rates higher for longer. We prefer quality in this regime: investment grade bonds with attractive yields and resilient equities that can weather slowing growth.
- Pivoting to new opportunities. Fast-moving markets create opportunities for investors willing to get more granular. We also see durable opportunities in quality companies, resilient sectors such as healthcare, private credit, and local currency emerging market debt.
- Harnessing mega forces. Artificial intelligence and automation could revolutionize industries beyond technology, potentially improving productivity and reducing costs.
As we enter the second half of the year, we have started to see economic data surprise to the upside, a welcome change from what had seemed like a near-certain recession in the first half. The year began with markets focused on the potential impact of rapidly rising interest rates -- fears confirmed when Silicon Valley Bank catalyzed a set of regional bank failures in Q1. As the year progressed, however, the likelihood of a soft landing moved from being a highly held hope to a plausible reality, driving cautious optimism amongst investors.
Inflation has been coming down: the June 2023 CPI print came in at 3%, down from its 9.1% peak in June 2022. Core CPI has also been coming down, albeit not as dramatically: June saw a reading of 4.8%. With inflation approaching target, the Fed may too be approaching the conclusion of this rate hiking cycle, though we expect it to keep rates high as long as it takes to get inflation down further.
While manufacturing slowdowns, tighter credit conditions, and declining savings rates indicate a slowing economy, a robust labor market, low unemployment rates, and strong consumer – alongside enthusiasm about AI technology – have driven markets higher.
Beyond the mega-tech names, we have started to see market breadth widen out and valuations outside of those seven names still look reasonable relative to history. Complementing this theme, Q2 earnings largely came in better than expected, with a larger share of SPX companies beating EPS estimates than recent historical averages. However, richer valuations and profit taking likely contributed to many stocks selling off even after these strong earnings announcements.
Looking forward, we prefer balancing the upside potential of a continued market rally with downside protection against the risk posed by restrictive central bank policy via quality equities, investment grade fixed income, and diversifying alternatives that can capture high cash rates and deliver additional alpha beyond traditional asset classes.
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