The first half of 2023 has been better than investors had any right to expect, given the scale of last year's stock market meltdown.
The war in Ukraine, runaway inflation, post-coronavirus supply shortages and continued lockdowns in China sent the S&P 500 spiralling 20 per cent and into an official bear market.
Apple, Amazon, Facebook, Tesla and the other technology companies finally came unstuck after a decade of dominance, resulting in the Nasdaq crashing by a third.
Politically and economically, this year has been even bumpier. The war in Ukraine is continuing, inflation is sticky and interest rates have soared (with more to come).
We have also suffered a banking crisis, a US debt ceiling stand-off, a disappointing Chinese reopening and there are now growing fears of a global recession.
Watch: What is the US debt ceiling?
Yet, despite all the grim news, investors have something to celebrate with the S&P 500 index jumping 20 per cent since last October, marking an official bull market.
So, can markets climb higher or have investors got carried away?
Many are wary about the bull run, with Morgan Stanley strategist Michael Wilson struggling to “get on board with the current excitement” as fiscal support, market liquidity and company revenue look set to fade.
“If second-half growth re-accelerates as expected, then the bullish narrative being used to support equity prices will be proven correct. If not, many may be in for a rude awakening,” Mr Wilson says.
There is a path ahead for stocks in the second half of the year but it is a narrow one, says Mark Haefele, chief investment officer for global wealth management at Swiss private bank UBS.
For markets to rally further, three things need to happen. First, interest rates must peak, with the US Federal Reserve raising its funds rate no more than twice from today’s 5.25 per cent, after June’s pause.
There are grounds for optimism here, Mr Haefele says.
“Lower headline and core inflation, alongside challenges faced by US regional banks, have boosted market conviction that the Fed is close to the end of its hiking cycle.”
For markets to continue rising, the widely predicted US recession also has to be cancelled.
Hopes are rising as economic growth and corporate earnings prove sturdier than expected, as consumers continue to spend while the jobs market holds up, Mr Haefele says.
“Confidence that a recession can be avoided could increase if real income growth continues to improve, companies start restocking inventories and the labour market remains robust,” he says.
Finally, we need the buzz surrounding artificial intelligence, which has largely driven this year’s growth, to prove justified, rather than driven by hype and a fear of missing out.
The “surging seven” US mega-cap growth stocks – Apple, Microsoft, Nvidia, Amazon, Meta, Tesla and Alphabet – have risen by an average of 86 per cent this year amid optimism about the effect of AI on their long-term prospects, Mr Haefele says.
“These seven stocks account for 80 per cent of the gains in the S&P 500, so a positive market outlook is contingent on these stocks holding on to or extending their gains.”
Yet it may not be possible for all three wishes to come true at the same time. If the economy continues to grow, interest rates may have to climb even higher.
After a strong run, the upside to stocks is now limited, Mr Haefele says.
“Risks to the US growth outlook remain, and increasingly bullish equity market sentiment speaks against chasing the S&P 500 higher.”
Rather than piling into tech shares at today’s highs, he suggests investors focus on cheaper parts of the market that have lagged in the rally, and diversify into bonds, infrastructure and gold.
Although Fed Chairman Jerome Powell is making a case for two more interest rate increases, with US inflation falling to 4.1 per cent in May, we are close to the end of the tightening cycle, says Vijay Valecha, chief investment officer at Century Financial.
Jobs growth, resilient consumers and a historically low unemployment rate mean “the bull case remains strong”, he says.
Mr Valecha is also wary of the AI frenzy, which has pushed valuations close to bubble territory.
“The AI rally is partly driven by genuine advances in technology and partly by investor euphoria. The benefits of AI are likely to manifest over the long-term and are not yet showing up in the fundamentals of AI stocks.”
As the lagged impact of monetary tightening slows the economy further, a correction cannot be ruled out, he adds.
chief investment officer at Century Financial
After all the first-half excitement, investors may need to settle down and be patient.
Broker Charles Schwab says weak leading indicators, rising unemployment, the top-heavy rally, AI hype and frothy markets suggest that the year’s “second half may be marked by less drama, but milder returns for investors”.
Amundi Asset Management reckons the global economy faces a “narrow and uncertain path” as growth slows and bottoms out in the second half of 2023 year, but with a potential recovery due next year.
Group chief investment officer Vincent Mortier urges caution after recent excitement as the slowdown in inflation will only be gradual, with price growth remaining above central banks' targets until the middle of next year.
Emerging markets are expected to fare best as the Fed stops tightening and the US dollar starts to depreciate, he says.
History suggests that 2023 could still end on a positive note. Research from Sam Stovall, chief investment strategist at financial analyst CFRA, shows that since 1945, a strong first half of the year is also highly correlated with gains in the second half.
That is a positive sign, but hardly concrete. Mr Stovall warns that historical performance is never a guarantee when it comes to the stock market.
If the analysts are correct, investors should be happy with their first-half gains, but not set their sights too high for the second half.
The real action will arrive in 2024.
