Market Commentary June 30, 2023
As we roll in to summer the hot start to the year in equities continued in the second quarter. The S&P 500 continued its rally, finishing the quarter up 8.3% and 15.9% year-to-date (YTD). The equal weighted S&P 500, which weighs each company’s contribution to the index equally was up 3.5% for the quarter and 6.0% YTD.
Additionally, international stocks rallied in the quarter as the MSCI EAFE was up 3.2% and 10.1% YTD. Bonds were more muted in the quarter with a slight pullback. The Bloomberg US Intermediate Term Corporate Bond Index decreased 0.2% for the quarter, while still up 2.3% YTD.
Similar to last quarter, market breadth has remained very narrow in stocks. At the end of the quarter, the 10 largest companies in the index accounted for over 29% of the index. That concentration increased to roughly 34% at the end of the second quarter. The largest company in the index, Apple, closed the quarter with a market capitalization of over $3 trillion dollars, or roughly 8% of the total index. This is an exceptionally high weighting for a single company.
What this means for the market overall is that a very small number of companies can have a very large impact on the direction of overall market returns. For example, if two company’s return 20% next quarter and one of them has a 5% weight in the S&P 500 and the other a 0.5% weight (which would still make it one of the 35 largest companies in the index) the 5% weighted company would contribute 1% to the index’s return for that quarter, while the smaller company would only contribute 0.1%.
As we noted above, the S&P 500 has returned 15.9% YTD. The S&P 500 weighs the companies in the index based on their market capitalization, or in other words, how large they are. An alternative way to look at the market is an index that takes each of its constituents and weighs them equally. In this case Apple would have the same weight as a company much smaller, like Advanced Auto Parts. In contrast to the 15.9% returned by the S&P 500, the equal weighted S&P 500 is up significantly less at 6.0%, almost a full 10% difference in returns.
While the current concentration of large companies in the S&P is larger than normal, many of the biggest of the big companies have exposure to one of the best performing themes so far this year, Artificial Intelligence (AI). Out of the top 10 largest S&P constituents, 7 have businesses that could be impacted by accelerating developments in AI. If this sounds similar to past recent market trends like the “Metaverse,” “Cloud Computing,” or even “Cryptocurrencies” you might be right. Significant sales growth or profitability related to AI development may or may not materialize the way these companies anticipate, but there is no doubt the market has baked in a significant premium in share prices.
On the heels of bank turmoil last quarter and continued fallout this quarter with the seizure and sale of First Republic Bank to JP Morgan, the Federal Reserve held its short-term interest rate targets stable in June for the first time since beginning the current rate hike cycle in March of 2022. The current rate hike pause was described by the Fed as an opportunity for the central bank to assess the economy and strain in the banking system. However, it would appear the Federal Reserve Board of Governors is prepared to continue with one or more hikes before the year’s end.
In rate markets, Q2 was defined by bond prices continuing to adjust to the Federal Reserve’s reiterated commitment to keeping credit conditions tight to control inflationary pressures in the economy. Rates trended broadly higher through the quarter, incrementally returning closer and closer to 2022 levels. As such, US dollar denominated bond indexes were broadly lower in the quarter – and approaching flat levels on a year-to-date basis.
As always, if you have questions regarding your portfolio, please consult your financial advisor. We appreciate your continued trust in SG Long Financial and look forward to working with you in the future.
Rob Richardson, CFA
Chief Investment Officer
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