Quarterly Market Performance Commentary

Despite months of a widespread prediction for a recession throughout 2022 and into 2023, markets have defied expectations with major indices surging into a fresh bull market during the continued rally though the second quarter of 2023 (See Figure 1, below). Seeing its best results since the 1980s, the NASDAQ composite is up 32% YTD through June while the S&P 500 is up 16%, and the Dow gained 3.8% (1). Many account this continued rise in markets due to some major market movers failing to materialize this year, such as the U.S. defaulting on its debt, an impending recession, and a systemic credit crunch.

Figure 1: Various market indices performance through 2023

Leading contributors to both quarterly and YTD market gains were primarily driven by familiar tech giants such as Apple, Microsoft, Nvidia, and Amazon and with the top 10 stocks being responsible for 97% of the U.S. market’s overall gain through May 2023 (2). Furthermore these growth-oriented stocks have far outpaced their value-oriented counterparts with the Morningstar US Growth Index ending up +28% YTD through Q2 2023 versus a modest +4.1% gain for the Morningstar US Value Index through the same period.

Economic Fundamentals – Q2 2023

Despite aggressive interest rate hikes by the U.S. Federal Reserve to combat inflation (which were recently paused in June), many core economic fundamentals have remained strong in the first two quarters of the year. The U.S. Department of Commerce revised their estimate of Gross Domestic Product (“GDP”), a measure of the value of final goods and services produced in a country, to a 2% annual growth rate through the first quarter – 0.7% higher than previously estimated (3). Additionally, labor markets have shown resiliency with employers adding another 339,000 seasonally adjusted jobs in May and maintaining consistently higher hiring metrics compared to the 2019 pre-pandemic average (See Figure 2, right) (4).

Figure 2: Nonfarm payrolls, monthly change

Consumer spending, another primary indicator of economic growth, rose 0.8% in April and home prices appear to be potentially stabilizing, as prices increased for a second straight month through March (5,6).

Another indicator of investor confidence in the economy and broader markets can be found in the fixed income markets. As reported in our Q1 2023 Retirement Plan Newsletter, bond prices had been rallying through the first quarter of 2023. This was primarily the result of uncertainty around numerous banking collapses and the lasting implications of these events. However in the second quarter of 2023, yields rose, and inversely, prices fell, indicating investor optimism in the economy (7). Despite these indicators, some analysts warn that the Fed’s rate increases may start to set in and visibly work against growth in the months ahead.

Market Sentiment – Recession or No Recession?

Over the past year, analysts have been forecasting an impending recession that has yet to materialize. As time has passed, conflicting viewpoints have emerged, and the question remains—Will this predicted recession indeed come to fruition?

Some economists believe that one of the primary reasons we have managed to avoid a recession thus far is the strength of the labor market.8 Additionally, American spending has continued to rise, albeit at a slower pace (5). Furthermore, major domestic market indices have demonstrated overall growth this quarter, although opinions differ regarding the future trajectory of the markets, with some foreseeing resiliency while others foresee some cooling. Despite these positive indicators, there remain some key factors pointing to an impending recession. The still inverted yield curve is one such indicator, and the Federal Reserve’s intentions to raise interest rates twice more in 2023 further fuel concerns (9). Additionally, economists often refer to what is known as the “Anxious Index”, which tracks the likelihood of GDP decline in the next quarter as polled by the Federal Reserve Bank of Philadelphia, as a reliable indicator of an impending recession as well. The recessionary threshold benchmark for this index is around 20%. In recent times, this threshold has been surpassed multiple times, even exceeding 40% in the fourth quarter of 2022 (4).

Given these conflicting signals, there is no definitive consensus regarding the direction in which the economy is heading. However, we know that most retirement plan savers will live through seven to eight recessions in their retirement saving journey. This is normal! When advising employees, Forest Capital Management reviews participant investment goals and strategies to ensure they are set up for long-term success. So long as a participant is invested appropriately, generally the best course of action during a recessionary period and volatile market is to stay the course!

Environmental, Social, and Governance (“ESG”) Funds

ESG funds represent a distinct category of mutual funds that uphold a set of rigorous standards in their investment practices, which ultimately assess the holdings within the portfolio to ensure they meet the necessary criteria. The set of criteria is far reaching but may include practices such as excluding holdings in oil and gas or selecting holdings with companies that score well on ESG issues.

The screening process employed by ESG funds has made them increasingly appealing to investors who prioritize environmental and social responsibility while seeking to avoid risky or unethical investments. The growing popularity of ESG investing is evident in the significant fund flows depicted in Figure 3 below (10). However, this surge in popularity has also sparked debates concerning the effectiveness, value, and potential political influences associated with ESG funds (11).

Notably, this year, President Biden exercised his veto power to reject an attempt by Republican members of the House and Senate to overturn the DOL’s recent ESG rule. This rule now allows plan fiduciaries to include ESG factors in the risk/return analysis of retirement fund options, thereby enabling the inclusion of ESG funds in retirement plan lineups. This development opens up new possibilities for plan sponsors (12).

At Forest Capital Management, we aim to sup-port plan sponsors by providing comprehensive analysis of the pros and cons, specific fund philosophies, and performance of ESG funds. Our goal is to equip sponsors with the necessary insights to fully understand the intricacies of these relatively new and complex investment vehicles.

Figure 3: Quarterly global sustainable fund flows (USD)
  1. Otani, Akane. “Markets’ Monster 2023 Rally Defied All Expectations.” The Wall Street Journal, 30 June 2023, https://www.wsj.com/articles/markets-monster-2023-rally-defied-all-expectations-705bc313
  2. Solberg, Lauren. “14 Charts On New Bull Market for Stocks, Mixed Returns for Bonds in Q2” Morningstar, 3 July 2023, https://www.morningstar.com/markets/14-charts-new-bull-stocks-mixed-market-bonds-q2?utm_source=eloqua&utm_medium=email&utm_campaign=newsletter_morningdigest&utm_content=46129
  3. “Gross Domestic Product (Third Estimate), Corporate Profits (Revised Estimate), and GDP by Industry, First Quarter 2023” U.S. Department of Commerce, 29 June 2023, https://www.bea.gov/news/2023/gross-domestic-product-third-estimate-corporate-profits-revised-estimate-and-gdp-industry
  4. Lahart, Justin. “Is This ‘Recession’ in the Room With Us Now?.” The Wall Street Journal, 7 June 2023, https://www.wsj.com/articles/is-this-recession-in-the-room-with-us-now-b18d669b
  5. Torry, Harriet & Timiraos, Nick. “U.S. Consumer Spending Jumped in April and Inflation Accelerated” The Wall Street Journal, 26 May 2023, https://www.wsj.com/articles/consumer-spending-personal-income-april-2023-b1b57c31
  6. Friedan, Nicole. “Home Prices Rose in March for Second Straight Month” The Wall Street Journal, 30 May 2023, https://www.wsj.com/articles/home-prices-rose-in-march-for-second-straight-month-dbc1553a
  7. Grossman, Matt. “Treasury Yields Resume Climb as Investors Bet on Growth” The Wall Street Journal, 30 June 2023, https://www.wsj.com/articles/treasury-yields-resume-climb-as-investors-bet-on-growth-5d157f69
  8. Mackintosh, James. “Where’s the Recession We Were Promised” The Wall Street Journal, 23 June 2023, https://www.wsj.com/articles/wheres-the-recession-we-were-promised-cd68a992
  9. “After brief pause, Federal Reserve looks poised to raise interest rates again.” CBS News, 5 July 2023, https://www.cbsnews.com/news/federal-reserve-interest-rate-hike-imminent-fomc-minutes-2023-07-05/
  10. “Global Sustainable Fund Flows: Q1 2023 in Review” Morningstar. 25 April 2023, https://www.morningstar.com/lp/global-esg-flows
  11. Coburn, Jonathan. “What Is ESG Investing Good For?” The Wall Street Journal. 21 June 2023, https://www.wsj.com/articles/esg-investing-fiduciary-standards-blacklist-7a2a8360https://www.morningstar.com/lp/global-esg-flows
  12. Latham & Watkins. “DOL Final Rule on ESG Factors to Take Effect February 1, 2023” Latham & Watkins, 24 January 2023, https://www.lw.com/admin/upload/SiteAttachments/Alert%203058.pdf