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Mid-Year Update: What Happened? What's Next?

Mid-Year Update: What Happened? What's Next?

July 13, 2023

We’ve reached the halfway mark for 2023, after what can only be described as one of the most confounding six-month periods in recent history. We entered the year awaiting a widely predicted recession, which has yet to arrive. We also witnessed the failures of First Republic, Silicon Valley, and Signature Banks, were the second, third, and fourth largest bank failures in U.S. history.

Those failures instilled panic and caused a run on deposits at several banks across the country as savers sought to ensure FDIC coverage on their money and avoid the possibility of being part of another banking crisis. Luckily, the issues were isolated to just a few banks, and did not cause wide-spread losses in the markets.

Despite the fears of recession and bank failures, the S&P500 and Nasdaq gained 15.91% and 31.73% respectively. That performance was driven primarily by the so called “Magnificent Seven” tech stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta) which rallied a combined 90%+ in the first 6 months of the year. The surge was primarily due to optimism spurred by the emergence of Artificial Intelligence and speculation that the Federal Reserve might be near the end of their interest rate hikes.

The strong performance resulted in Microsoft, Apple, Nvidia, Amazon, and Tesla reaching a staggering 43.8% of the NASDAQ index. To reduce the concentration and resulting distortion of the index, NASDAQ, Inc. announced a “special rebalance” which will reduce the companies’ concentration to 38.5%. A special rebalance has only occurred twice in history; once in 1998, and again in 2011.

While the strong performance during the first half is noteworthy, it is important to remember that it is unlikely to be repeated in the second half of the year.

The Federal Reserve is committed to continued rate increases, possible two more times by December to slow the economy in the fight against inflation and to cool the labor markets (a nice way to say cause layoffs and a possible recession).

The questions on our minds now are:

  • Will positive returns continue, or will we see a correction?
  • Will there be a recession? If so, how severe?
  • Where are the opportunities?

Unfortunately, we don’t know the answers to the first two questions. Neither does anyone else, despite what you hear on T.V. or read on the internet. Future performance cannot be predicted, and neither can recessions. No one has predictive abilities.

We can, however, look at emerging trends, current sector, and corporate valuations, as well as historical performance in similar periods to find attractive areas to invest.

As you may recall, in 2022 we made several changes to our portfolios.

  1. We replaced our Large Cap Growth manager, moving away from technology and economically sensitive industries, with a strategy focused on high-quality, cash-rich companies with resilient business models.
  2. We reduced our overall equity exposure by decreasing Mid and Small Cap stocks, which enabled us to add a second market-neutral strategy, further reducing our market risk.
  3. We decreased our allocation to international markets and replaced our growth-oriented manager with two dividend-focused strategies. The focus on dividends helped offset downside risk and added a consistent return stream from those dividends to help offset the volatility.
  4. We increased the quality of our bonds, and reduced bond duration (a measure of how sensitive bonds are to changes in interest rates).
  5. We added a second market neutral strategy to the models.

Subsequently, we significantly outperformed the indices, and many of our peers, during 2022.

Some of those changes that led to our significant outperformance in 2022 caused us to lag the markets in the first half 2023. Namely, our focus on high quality Large Cap stocks left us underweight technology, specifically the names associated with the AI driven rally. Additionally, our overweight to market-neutral strategies prevented us from fully participating in upside returns.

As our clients know, we are primarily focused on minimizing downside risk and believe that a diversified, long-term investment philosophy focused on owning quality companies and proven managers, will help investors reach their long-term goals. We also employ a tactical overlay to adjust allocations to help reduce detrimental emotional reactions caused by behavioral biases.

Given the current environment, and what we believe is likely to be a challenging second half of the year, we plan to maintain our focus on quality, but make some adjustments to portfolios.

  1. In June, we reduced our market-neutral allocation by half.
  2. Also in June, we re-initiated half of our expected allocation to Mid Cap stocks, utilizing a manager with an emphasis on high quality companies across the U.S. We made this investment because of discounted valuations in the Mid Cap space and the emergence of a positive trend in the broad Mid Cap universe.
  3. In July we expect to replace our Large Cap Growth manager, which no longer meets our stringent criteria for inclusion, with one focused on “Wide Moat” companies trading at attractive valuations. A “wide moat” is defined as a company with a sustainable competitive advantage over its peers that is expected to last at least 20 years.
  4. Also in July, we will be reallocating away from short duration U.S. Government bonds to more diversified intermediate duration bonds. Duration is a measure of a bond’s sensitivity to interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates. We will be making this move because we believe we are close to the end of the rate hiking cycle, and because we are currently earning close to 5% in our current allocation to Money Market mutual funds.
  5. We are watching the Small Cap universe for an opportunity to begin reinitiating our position as well, likely beginning with half of the allocation and adding on pull backs.

We believe these adjustments will position portfolios to better participate in the recovery if it persists through the second half without exposing investors to excessive risk if volatility does materialize.

The possibility of a recession and market correction in 2023 is not zero. As of June 30, 2023, the two-year minus ten-year yield curve is still inverted by -1.06%2, a reliable indicator of recessions. Additionally, the U.S. consumer is starting to show signs of reduced willingness to spend on non-essential goods and services as savings decline and inflation, while moderating, remains persistent.

As always, we will continue to monitor events around the world, and keep a keen eye on both policy and risks here in the U.S. Our goal is always to be prepared for whatever unfolds, and to be proactive rather than reactive. We firmly believe that we are well positioned for whatever comes next.

As always, if you have any questions or concerns, please reach out to our team.

  1. Ycharts
  2. FRED database

Important Information

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks, including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

All data is provided as of December 30, 2022.

The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Past performance does not guarantee future results.

Asset allocation does not ensure a profit or protect against a loss.

Due to the volatility of the markets mentioned, opinions are subject to change without notice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the author only and do not necessarily reflect the views of LPL Financial. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results.

No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Past performance is no guarantee of future results.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Please note that individual situations can vary, and therefore, this information should only be relied upon when coordinated with individual professional advice.)

For a list of descriptions of the indexes and economic terms referenced, please visit our website at