After a painful experience for investors last year, the stock market has gotten off to a strong start in 2023. Entering July, the S&P 500 is up 16.9%, a far cry from the -20% drop stocks endured by this time in 2022. After such a strong start to the year, what should investors expect moving forward?

As the table below illustrates, the stock market tends to exhibit a degree of positive momentum. In the 97 full years going back to 1926, there have been 27 instances where the S&P 500 was up between 10-20% during the first six months. Stocks would go on to deliver additional gains during the second half of those 27 periods 93% of the time. Additionally, when the market began the year in that 10-20% range, it delivered a positive return over the full calendar year 96% of the time. Only during the onset of the Great Depression (1929) did the market deliver a strong first half, only to end up negative on the year.

US Stock Market Returns Following Strong First-Half Performance

Source: Morningstar Direct. Data is from 1/1/1926 to 6/30/2023. Stocks are represented by the S&P 500, returns are cumulative.

It’s worth highlighting the fact that capping the first-half return at 20% in this analysis made the data look a little better. For example, of the four times in history that the S&P 500 started the first half with a 25%+ gain, it has never managed to deliver additional gains during the second half. This provides some evidence that the market can get a little ahead of itself and appreciate too quickly. We don’t necessarily appear to be there yet, at least solely based on the return during the first half of this year.

Importantly, we must insert the standard disclaimer here: past performance is not indicative of future results. Returns from decades past have no direct causal relationship with how stocks will behave in the future. Market movement is driven by an endless array of variables, and no two periods will ever look identical.

The consensus view entering the year was that the economy was barreling toward a recession and that the stock market would continue to struggle. Such an outcome has yet to materialize. Many economists and forecasters still project a recession on the horizon, but in typical fashion, it always seems to be about a year away. Clearly, investors are facing some mixed signals:

Reasons to be Negative:

• There are signs the economy is slowing
• Stock earnings are expected to decline
• The valuation of large US stocks is stretched
• The market has been driven by a handful of large stocks
• Potential for a flare-up in banking turmoil
• Potential for other unforeseen risks.

Reasons to be Positive:

• We have avoided a recession so far
• The labor market remains strong
• Inflation is trending lower
• The Fed may soon be done hiking rates
• Market momentum
• Relatively attractive valuation in small-value and international stocks

Unfortunately, the historical return data is nowhere near dependable enough to use as a basis for allocation decisions. Still, understanding market tendencies can help establish reasonable expectations and allow investors to mentally prepare for what may come next. The historical data suggests it’s not unreasonable to expect continued gains in the market. A diversified portfolio and a long-term financial plan can set investors up for success regardless of what happens in the near term. 

Week in Review

• Headlining the economic data from last week was the June Consumer Price Index (CPI) reading on inflation. While June inflation was expected to fall, partly the result of base effects (headline inflation peaked in June of 2022), the data came out lower than expected. Headline CPI rose 0.2% (3.0% YoY). Core CPI, which excludes the volatile food and energy components, rose 0.2% (4.8% YoY). Shelter, which makes up 1/3 of the headline data, slowed to 0.4% MoM (7.8% YTD), notably below its YTD avg MoM increase of 0.6%.
• Despite the cooler-than-expected reading on inflation, the market still expects the Federal Reserve to move forward with another rate hike when the next monetary policy meeting concludes on July 26
• Last week earnings season kicked off with a handful of the nation’s largest banks reporting Q2 results, which generally exceeded expectations. Coming into the quarter, analysts were forecasting a YoY earnings decline of -7.1%, according to FactSet. Wall Street analysts are known to lower their forecasts as earnings season approaches, which makes it easier for companies to deliver a positive earnings surprise. A substantial portion of the earnings decline is expected to come from the Energy sector, which is contending with falling energy prices. We will need to see some largest positive surprises for the overall market to overcome the expected weakness from the energy sector. Earnings growth is the fuel that powers stock prices higher over time. We will need to see a return to positive earnings growth at some point for continued stock market gains to be sustainable.

Hot Reads

Markets

• Inflation Rose Just 0.2% In June, Less Than Expected As Consumers Get a Break From Price Increases (CNBC)
• The War Against Inflation Is A Long Way Away From Being Won (CNBC)
• Pay Raises Are Finally Beating Inflation After Two Years of Falling Behind (WSJ)

Investing

• Smart Things Smart People Said (Morgan Housel)
• Bear Markets Are Transitory (Ben Carlson)
• How Will Artificial Intelligence Affect Investing (Morningstar)                                      

Other

• Lots of Tap Water Contains ‘Forever Chemicals.’ Take These Steps to Reduce Your Risk (WSJ)
• 7 Tips For Becoming a Smarter Golfer, According to Collin Morikawa (Golf Digest)
• The 42 Best Movies on Netflix This Week (Wired)

Markets at a Glance

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Economic Calendar

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION