Strong Market Returns Fueled by Economic Resilience…. and Hype

The stock market has experienced a notable upswing since October 2022, primarily driven by the strong performance of technology stocks such as Nvidia, Apple, and Microsoft. While some of the positive sentiment around these stocks is due to hype regarding AI-led innovation, underlying business fundamentals have held up well.  

In addition to the technology sector, the broader market has also shown signs of improvement since June 2nd. The Russell 2000 index, which measures the performance of small(er) companies, has outperformed both the Nasdaq and S&P 500, indicating a more balanced market performance. This is a healthy signal that could indicate the year-to-date rally in stocks is not a “bear market rally” but rather the start of a new bull market. The participation of cyclical sectors such as Industrials, Materials, Energy, and Financials in the market rally supports this thesis. 

On June 2nd, the May payroll report revealed job growth and wage increases remained strong, signaling that the economy is not in a recession and may potentially avoid one altogether. Other coincident economic indicators have displayed similar trends. Retail sales, industrial production, and construction spending are all trending up after pulling back earlier this year. This again, supports the view that the U.S. may have avoided a recession.

Despite this, there are some indicators we are monitoring closely. Tighter financial conditions, including rising interest rates, dampen economic growth over time, and thus we are actively assessing the economic horizon for signs of weakness.

Leading indicators, which give us a view of where the economy is headed versus where it is now, have indicated significant weakness for over a year. These indicators highlight the need for cautiousness in the face of strength. The best time for risk management is when markets are calm.

In terms of investment options, non-mega weight growth equities, defensive sectors, and Treasuries are currently preferred. These choices prioritize stability and protection against potential market downturns. Non-mega weight growth equities offer growth potential that does not rely on economic growth, while defensive sectors tend to perform relatively well during economic weakness. Lastly, Treasuries continue to offer attractive coupons while acting as a hedge against stock market volatility.

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