by Peter Jones, CFA Senior Vice President
Equity Research and Portfolio Management
The midpoint of 2023 coincides with the celebration of the 247th anniversary of our independence. Just like the Fourth of July fireworks we will see over the next week, the capital markets have begun the year with a bang. Last year was the worst year for the stock market since the Global Financial Crisis of 2008. At the same time, bonds suffered their worst return since 1781. It was only the second time in the last half-century that both stocks and bonds declined in the same year.
Incredibly enough, since October of 2022, stocks have recouped more than two-thirds of the decline seen last year. As depicted in the chart below, capital market strength has been broad-based. Bonds, on the other hand, will most likely take a couple more years to fully recover from 2022 losses.
At the start of the year, we expected the first half of 2023 to present stock market volatility and a slowing economy. It was our prediction that the market would tread water before rallying in the second half. Clearly, we underestimated the resilience of the labor market, corporate earnings and the overall economy. That said, we continue to expect the economy to slow from here and with the market no longer offering cheap valuation, we expect gains in the second half of the year to be harder to come by.
In other news, the Supreme Court rejected the Biden-Harris Administration’s student loan forgiveness plan. As a result, those with tuition liabilities will resume payments later this year. We have fielded many questions regarding the economic impact of student loan debt service. Of course, dollars funneled to pay down debt will slow the economy relative to dollars used to consume goods and services. However, the magnitude and impact on the broader U.S. economy is likely little more than rounding error. The student loan deferral program was saving debtors an annualized $60 billion dollars. This compares to U.S. GDP of nearly $30 trillion. Estimates from Morgan Stanley suggest that the drag on U.S. GDP growth is likely to be 0.10% or less.
The Passing of a Legend
On another note, Dr. Harry Markowitz (1927 – 2023) passed away this week. Markowitz was a Nobel prize winning economist best known for being the pioneer of “Modern Portfolio Theory”. Markowitz’s novel approach to portfolio construction continues to have a large influence on investment portfolios today. Without getting too far into the weeds, Markowitz could be described as the father of diversification. He introduced the idea that instead of individual stock selection, asset allocation decisions are the primary driver of long-term returns and that diversification, both within and across asset classes, reduces volatility and enhances the long-term predictability of portfolio returns. This approach has led investment advisors, ourselves included, to spend a lot of time with clients to determine the asset allocation most suitable for each unique client circumstance. The chart below is an illustration of the relative importance of each decision made within a portfolio. Our firm thanks Mr. Markowitz for his contribution to modern finance.
Takeaways for the Week:
We have been pleasantly surprised with the strength and resilience of the global economy and capital markets so far this year
The economy appears to be slowing and the market is no longer inexpensive. Our expectation is that capital market returns will be more muted in the second half of the year
The resumption of student loan payments later this year are unlikely to have a major impact on economic growth