Investment Update

“Artificial Intelligence (AI)”, there, we said it. Now to be clear, nothing in this 2nd Quarter Investment Update was generated using ChatGPT or any other Large Language Model (LLM), although we did consult a few.

Another Quarter of Positive Stock Market Returns

Stocks continued their impressive rebound from the lows of last fall. Last quarter we highlighted the positive returns with significant help from the mega-cap tech stocks. In many respects this quarter was much of the same with even stronger outperformance from this narrow, albeit influential group of stocks. This led the NASDAQ Composite to a stunning 2nd quarter and year-to-date return of 13.1% and 32.3%, respectively, for the best first half since 1983. On the other end, the Dow Jones Industrials generated 2nd quarter and year-to-date returns of 4.7% and 4.9%, while the S&P 500 gained 8.7% and 16.9% for the quarter and year-to date.

All told, we are sitting in a better place through six months than most expected. We recall a year ago at this time the markets had just put in their worst first-half performance since 1970. We indicated at the end of last quarter we found some compelling investments in both the equity and fixed income markets, yet at the same time sounded a somewhat cautious tone. With this quarter’s gains, we see recent developments as better than feared – the bar was relatively low. Specifically, here are a few things that happened.

  • Interest rates continue to rise, but markets were encouraged by the Fed’s decision to skip the opportunity to hike at its June meeting, leaving rates at 5.25%. While the Fed plans to make two more 25 basis point increases, the stock market seems to be more focused on a tightening process nearing its end.
  • Headline Inflation at 4% is down meaningfully from its 9% peak last June, but still well above the Federal Reserve target of 2%.  Goods inflation has fallen precipitously; service inflation less so.
  • Markets bypassed two potential obstacles by way of no additional fallout from the banking mini-crisis and the passing of a debt-ceiling agreement.
  • The equity market got even more excited about AI. In the 2nd quarter, shares of Apple Microsoft, NVIDIA, Meta, Alphabet, Tesla, and Netflix had an average gain of 31%.
  • Despite all the fears of recession, corporate earnings generally exceeded their targets, bolstered by a more sanguine outlook from management than many anticipated, ourselves included.
  • The unemployment rate remained historically low at 3.7% and consumers continue to spend. Is everybody travelling to Europe this summer?
  • The housing market has continued to surprise positively, in spite of mortgage rates doubling. Inventory remains tight keeping prices firm, while new construction is strong. Homebuilder stocks outperform.
  • Despite all the geopolitical upheaval, namely rising tensions with China and the war in Ukraine, for most of us, it is business as usual for now.


Looking back at our outlook commentary last quarter and at year-end, most of the opportunities and concerns we highlighted then still remain. Our macroeconomic research work continues to suggest caution is warranted despite the continued market strength and the lack of any obvious negative developments from the perspective of a rising stock market and service driven economy that appears quite strong. Underneath this lies a consumer who is increasingly feeling the pain of higher interest rates and persistent inflation. Yes, the rate of change has slowed but absolute levels remain high.

We believe the downside risk to the economy and the stock market has become more elevated. Almost all of the recent market strength has come from investors’ willingness to pay a higher multiple on earnings, not from actual improved earnings growth.

While we can see some effect of higher interest rates on the economy and businesses, we believe its most significant impact is likely in front of us. Keep in mind that due to the Pandemic, some five trillion dollars of liquidity, mostly courtesy of the Federal Reserve, was injected into the economy with a lot of that liquidity still sloshing about and inflating asset prices. As an aside, this liquidity is increasingly concentrated while many are feeling the intended effects of the Fed induced decline in the overall money supply –   comments that seem rather in conflict but actually highlight some of the growing income disparities in our nation.

We see the major focus over the balance of the year as the tug of war between the economy’s resilience, especially here in the U.S., and the Fed’s determination to rein in inflation. Investors have cheered recent data that shows strength in manufacturing, upward GDP revisions, and the weakest jobless claims report in almost 2 years. Seemingly good news about the economy, but not the Fed’s prescription of what will bring inflation down to 2%. The stronger the economy is, the more emboldened the Fed will likely be about keeping interest rates higher for longer.

The risk in avoiding a near-term recession increases the odds of a more consequential economic downturn later on. For now, the markets are more optimistic that this outcome can be avoided all together. That places a lot of faith in the Fed to get their policy changes right. History has shown this faith has often been misplaced.

In the end, what will matter to investors is how all this impacts growth, especially in corporate earnings. We are often reminded that the stock market and the economy follow two different paths. We will soon hear companies report on Q2 earnings and provide guidance on what they see ahead.  We don’t discount that corporations may continue to successfully navigate a challenging environment. Still, we observe that the gain of the past six months makes it more difficult to support meaningfully higher prices from here without better visibility in the 2nd half and 2024.

Recall we spoke of constant change and heightened volatility being with us for some time to come. And that does not mean it is all bad. Our proprietary quantitative process continues to identify attractive equity investments in each of our distinct strategies that are poised to flourish – individual stocks that have strong financial underpinnings, adept managements, and more reasonable valuations. There are a number of things we are quite excited about. Some specific examples:

  • Energy – we see challenges to traditional oil supply and we expect alternative sources of energy and energy storage will continue to grow – liquified natural gas (LNG), nuclear, solar, wind, batteries, to name a few. Studies clearly show that carbon-based fuels – oil and gas – will provide the major share of fuels necessary to enable the positive growth needed to power strong economics around the world, hence, our overweight position in the sector.
  • Climate change, El Niño, call it what you will, the fact is we are and will continue to experience more extremes, particularly in precipitation and temperature. Semiconductor companies and industrial companies involved in precision agriculture and process control help to better manage scarce resources, operate remotely and autonomously to help counter these effects.
  • Healthcare – we have increased our exposure here as some of the most exciting developments are in front of us. Not just efforts to combat obesity, but gene therapy, broader applications on mRNA technology to include such things as cancer vaccines, the deployment of AI to accelerate drug development and faster and more accurate diagnoses and treatments.

The fixed income team continues with their recommendation to remain shorter in maturities and duration given the economic outlook and shape of the yield curve. We are finding value in shorter Treasuries, high quality corporates, and of recent, the municipal market for tax-exempt portfolios. As long as this current inverted yield curve rate structure lasts (now longer than expected) it is a welcome change to see conservative fixed income strategies benefit from the most attractive yields.