Outperforming in 4Q23 Likely Will Require Getting Out of 1H23’s Comfort Zone
It’s no secret to active investors that the 10 largest US stocks dominated market returns in 1H23. The following chart provided by AllianceBernstein with data assists from FactSet and Standard & Poor’s, details exactly to what degree these 10 companies drove the S&P 500’s 16.9% 1H23 total return. Notably, six of the 10 are Tech stocks while Amazon and Tesla fall into Consumer Discretionary and Alphabet and Meta reside in the Communication Services sector. Outperformance in 4Q23 and in 2024 probably will require investors to add some breadth to their holdings beyond these companies and sectors, possibly well beyond them.
Predictably, in our view, equity market behavior in 3Q23 largely follows a consolidation pattern consistent with investors – including us – processing disparate data on:
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Money flows thus far in 3Q23, though, convinced us of one thing: the same 10 stocks will not lead equity markets in 2H23 that drove performance in the first half of this year. For the balance of this year, we anticipate significant broadening of equity market positive performance. Such action would be part and parcel with our expectation for 2024 evolving into a stockpicker’s market vis-à-vis the substantially limited momentum-based drivers that defined 1H23. The value propositions, as reflected by price-to-earnings ratios, along with post-2Q23 earnings season trading patterns support this view. For instance as conveyed in the following graph, small caps over the past 50 years rarely traded as inexpensively as they recently traded.
The fact that a monumental magnitude of cash remains on the sidelines buoys our belief that the balance of 2023 will provide a positive backdrop for risk assets. Based on Capital Group’s chart below, entering 2H23 money market fund assets amounted to over $5.4 trillion, or about 14.7% of the recent S&P 500 market cap. Certainly the rapid run-up in short-term interest rates related to the Fed’s actions warrant investors holding heightened cash balances. However, as the Fed nears the end of its tightening cycle we expect the clarity offered for interest rates will lead much of this cash balance back to risk asset and equity markets.
The combination of expectations for increasing market breadth and compelling valuations lead us to favor stocks in the Industrials and Materials sectors vis-à-vis S&P 500 sector weightings. Industrials companies we favor include Lockheed Martin (LMT), Rockwell (ROK), Delta (DAL), Honeywell (HON), Chart Industries (GTLS), and Wesco (WCC). The Materials side we retain in investor accounts Eastman (EMN) and Sociedad de Quimica y Minera (SQM). Outside of these sectors, we recently added Halliburton (HAL) and Tyson (TSN) to client holdings as well.
Exiting 2Q23 earnings season Solyco Wealth commenced pivoted client portfolios to take advantage of higher bond yields with less susceptibility to equity volatility and credit risk. While it increasingly appears that the US will forego a recession in 2023 – the Atlanta Fed’s recent GDPNow estimate pointed to 5.8% 3Q23 GDP growth! (see below) – we harbor no expectation that equity markets will reward such lofty economic performance. Rather, we anticipate that any incremental economic strength will be met, at least, with hawkish Fed rhetoric and, more likely, future increases in the Fed Fund Rate. With real yields of 2%+ now available with little duration risk, we choose to increase by a combined 10% short-term Treasury and corporate debt exposure while reducing stock ownership by 10% for our three more aggressive model portfolios.
Benefiting from rising equity values in 2Q23, Solyco Wealth’s four Model Portfolios posted an average return for the past quarter of +4.78%, ranging from +3.14% for the Conservative Model Portfolio to +6.68% for the Aggressive Model Portfolio. Alas, as each of our four portfolios not only retained fixed income and cash allocations but also substantially diversified equity holdings across the eleven S&P sectors, each of the Model Portfolios failed to keep pace with the S&P 500’s blistering 8.70% 2Q23 return.
The stratospheric rise of the stock price for graphics chipset pioneer NVIDIA (NVDA) and other artificial intelligence (AI) participants invokes more than a few thoughts of asset-price bubbles. As Wharton Professor Jeremy Siegel recently noted in commentary on the subject, “momentum can carry stocks far higher than their fundamental value, and no one can predict how high they might go.” We argue that price appreciation far above a company’s fundamental value hardly warrants being labeled a “bubble.” Appreciation of 160% in less than six months, however, warrants heightened scrutiny. 
Outside of the shockingly fast failures of Silicon Valley and Signature Banks, the strength with which the Technology and Communication Services sectors finished 1Q23 undoubtedly defines the biggest surprise for equity markets for the first three months of the year. Led by a meteoric 81.9% rise from Meta (aka Facebook) to start the year, the Communication Services Select Sector SPDR (XLC) exchange traded fund (ETF) moved 23.1% higher for 2023 through April 17th. Similarly, NVIDIA’s (NVDA) artificial intelligence chip-driven investor fury led to an 84.8% rise in its shares and a 19.8% appreciation for the Vanguard Information Technology (VGT) ETF. 
A 1Q23 rebound in risk-asset markets resulted in each of Solyco Wealth’s four model portfolios posting positive returns for the past quarter. Net of fees this drove the average outperformance for the portfolios versus their respective benchmarks to 4.55% for the prior year and to 9.85% since their 9/8/21 inception, as shown in the following graphs. Alas, the particularly strong equity market performance in 1Q23 translated to modest after-fee average underperformance for the four portfolios of -0.36% versus benchmark and 2.03% vs. the S&P 500. Notably, each of the four model portfolios also retains a fixed income weighting, ranging from 65% for the Conservative Model Portfolio to 5% for the Aggressive Model Portfolio, that typically hampers performance in strong equity markets. For the quarter the portfolios’ fixed income holdings underperformed their Bloomberg US Aggregate Bond Index (AGG) benchmark by an average of 0.45% while equities in the portfolios lagged performance of the S&P 500 for 1Q23 by 0.47%.
We at Solyco Wealth anticipate the U.S. entering the most forecasted and discussed recession in economic history some time in 3Q23. One need do little more than scan Bloomberg, CNBC, or any other financial press headlines to discover the all-too-numerous drivers of this impending economic downturn. In short, recessionary drivers encompass various degrees of impacts from the U.S. Federal Reserve escalating the prevailing interest rate environment to counteract inflationary forces that resulted from aggressive acceleration of demand for goods and services, the satisfaction of which labor, logistics, and policy issues complicated, as the country and the world recovered from the worst of the COVID-19 pandemic. Oh yeah, and there was an energy price-spike brought on by Russia invading Ukraine right as that inflation component really started to take root and accelerate. Uhm, I’m forgetting something else, too, that consumers and, thus, economies dislike…bank failures! Thankfully, no one expects anything from the U.S. Congress for another couple months until the Debt Showdown: the fun just never stops!
Covered call options and cash-secured put options represent key components of valuation and volatility management at Solyco Wealth. We remained very active in the options markets in response to the heightened volatility in equity markets that characterized the close of 2022 and the beginning of 2023. Substantial moves higher and lower for well-held stocks such as NVIDIA, Amazon, Netflix, Tesla, and Meta, among many others provide motivation for having a well thought out strategy to roll contracts prior to engaging in an initial options trade.
The April 15, 2023, deadline for filing 2022 taxes or extensions fast approaches. Rather than commencing the filing of your taxes haphazardly, searching for statements and information on an as-needed basis, Solyco Wealth highly recommends that you spend some front-end time devising or downloading a Tax Preparation Checklist. Doing so likely will not only save time, but also reduce the probability of you or your preparer committing errors. 
Reinvesting dividends paid on shares of common stock frequently represents an outstanding way in which to benefit from the long-term compounding effect of common stock ownership. Investing website The Motley Fool calculated that the value of $10,000 invested in the S&P 500 in 1960 – with dividends reinvested through 2021– would have compounded to a cool $4.95 million. The value of the reinvested dividends accounted for $4.16 million, or 84%, of the gain, while simple share price appreciation made up only $795,800 of the increase. 