While moving at a glacial pace, the U.S. economy seems to have stabilized somewhat after two years of significant turmoil. Whether or not that stabilization will mean avoiding recessionary icebergs in the second half of 2023 or early 2024 depends on myriad economic and financial factors. Those issues include inflation, lending and credit rates, job layoffs, and overall consumer sentiment.
The good news is the U.S. stock market is up 14% on a year-to-date basis through June 28 as measured by the S&P 500 index, and both housing and industrial production are swinging back into positive territory at the midpoint of 2023. Still, market watchers aren’t taking anything for granted.
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“It wouldn’t take much of a shock to send the market into a tailspin,” says Jason Mountford, trend analyst at Q.ai, an artificial-intelligence-powered investment platform. “Right now, I’m watching very closely for anything that could provide this shock, such as additional weakness in the banking sector or even macroeconomic or political events globally.”
With the stock market seemingly in balance for now, what are the biggest risk factors heading into the second half of the year, and what do those “swing factors” mean to investors?
Here’s an inside look at the seven most significant stock market factors in play right now:
— High inflation.
— Volatile housing and construction trends.
— Recessionary shadows.
— High interest rates.
— A “narrow” stock market.
— Election cycle.
— Technology stocks.
High Inflation
There’s no doubt the U.S. inflation rate is dropping. The larger problem is that inflation was too high to begin with, peaking at 9.1% in June 2022. By May 2023, the inflation rate slowed to a more manageable 4%. That’s good news for stocks, but money managers are still eyeballing key inflation indicators and the sectors affected by high inflation.
“Although currently somewhat under control, inflation has the potential to rise again,” says Craig Studnicky, CEO of ISG World, a real estate development firm. “Inflation negatively impacts both the U.S. and global economy, and it is ideal to maintain it within a range of 2% to 3%.”
The sustainability of the current Wall Street rally is closely tied to inflation reduction. “If inflation remains at high levels, there is a risk of the rally losing momentum, which would have a significant impact on overall stock market health,” Studnicky notes.
Volatile Housing and Construction Trends
The U.S. housing market seems to remain resilient, with U.S. home prices expected to grow by 4.6% in the 12 months starting in April 2023, according to CoreLogic. Meanwhile, housing starts climbed to an adjusted annual rate of 1.631 million units in May, an increase of 21.7% over April. That’s the highest housing-start hike since April 2022. While that’s good news for the economy and for stocks, the housing market is hardly out of the woods yet.
“Inflation has an impact on construction projects as high interest rates create difficulties in obtaining the required loans,” Studnicky says. “As a result, some projects may fail to materialize as initially planned if inflation doesn’t cooperate.”
Recessionary Shadows
It wasn’t too long ago that investment banking analysts were lining up to call for a significant U.S. recession in 2023 or 2024. Now, those calls are shifting toward a softer tone — but downside discussions aren’t going away altogether.
Take Goldman Sachs, which noted a consensus 65% chance of the U.S. falling into recession in January 2023. Since then, Goldman has recalibrated its recession odds, first to 35% and most recently to 25%, largely as the Silicon Valley Bank collapse and potential banking industry crisis are in the rear-view mirror.
“The looming risk of recession is still a threat, even if it is less likely to happen now,” says Jonathan Merry, CEO of Moneyzine.com, a financial and investing advice platform. “If a recession does happen, that would likely result in a bear market.”
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High Interest Rates
In June, the Federal Reserve decided to leave benchmark interest rates alone for now, and the key federal funds rate stands at 5% to 5.25%.
Yet in the same announcement, the Fed caught Wall Street off guard by indicating it would likely boost interest rates two more times in 2023. While that analysis from the Fed is only a projection and not a guarantee, the Fed is apparently still ever so cautious about inflation climbing again, and it’s sending a clear message conveying a hawkish outlook if inflation spikes upward again.
“The threat is consumers don’t have a lot of cash to spend,” Mountford says. “Borrowing has been dramatically dampened by high interest rates and the flow-on effect to mortgages, causing a stagnant housing market, and wages have grown but not at the rate of inflation. Consumers need to spend in order to create sustainable revenues that aid the stock market.”
A ‘Narrow’ Stock Market
Much has been made in the business press over the fact that 10 U.S. large-cap companies have generated the vast majority of stock market gains this year. Those stocks — Apple Inc. (ticker: AAPL), Alphabet Inc. (GOOG, GOOGL), Meta Platforms Inc. (META), Microsoft Corp. (MSFT), Nvidia Corp. (NVDA), Amazon.com Inc. (AMZN), Tesla Inc. (TSLA), Broadcom Inc. (AVGO), Advanced Micro Devices Inc. (AMD) and Salesforce Inc. (CRM) — have accounted for approximately 90% of all stock market returns in 2023, and that’s not a healthy indicator for the broader stock sector.
“The S&P 500 has been driven by a handful of the largest-cap tech stocks, and without them, the S&P 500 index is barely positive,” says Scott Pederson, owner and wealth manager at Harmony Wealth Management. For this rally to continue, it has to broaden out to include more than just the biggest tech stocks, Pederson notes. “Bob Farrell, the former chief stock market analyst and senior investment advisor at Merrill Lynch, has an investing rule that markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names,” Pederson adds. “The market rally would be stronger if value and smaller-cap names began to rally.”
Election Cycle
The best year of the four-year presidential cycle is usually the third year, which is where the U.S. stands in 2023. “Based on the historical composite for the S&P 500, the market tends to rally into mid-July, then (move) sideways until a rally late in the year,” Pederson says. “Historically, if the S&P 500 is up more than 10% through June, it continues to move higher the second half of the year.”
Technology Stocks
The benchmark Nasdaq-100 index is in full flight in 2023, gaining 36.8% through June 28. Can technology stocks continue their winning ways? Investment experts think so.
“The technology sector, particularly companies involved in artificial intelligence, is showing promise despite high overall market volatility,” says James Allen, founder at Billpin, a money management services platform. “Major risk factors include the potential for a difficult pricing environment for electric vehicles, which could impact companies like Tesla. Additionally, increased competition and potential headwinds for generative AI could pose challenges for companies like Alphabet.”
Technology stocks can be expensive based on valuation, but it’s a sector where investors can find growth if the economy slows. “The large-cap tech companies don’t need help financing their business based on the cash flow they have coming in,” Pederson says. “Consequently, look to add to technology stocks on sector pullbacks.”
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Update 06/29/23: This story was previously published at an earlier date and has been updated with new information.
