US equities remain firmly in the lead for the major asset classes year-to-date, based on a set of ETF proxies through Friday’s (July 21) close. Markets generally post solid gains in 2023, but various risk factors will pose a resistance test for the bull run in the second half.
Year-to-date, however, the trend certainly looks rosy. All major slices of global markets, with the exception of commodities, posted positive returns. US equities continue to hold commanding height via the Vanguard Total US Stock Market Index Fund (VTI), which is ahead nearly 19% in 2023.
In second place: equities in developed markets outside the US (VEA). A surprise performance in third place so far in 2023: government bonds issued in emerging markets. VanEck JP Morgan EM Local Currency Bond ETF (EMLC) is up almost 10% this year, partly due to a stable/weak US dollar, which is reflected in higher prices of foreign assets after converting various currencies into greenbacks.
A large commodity metric (GCC) remains the only downside outlier with a modest 1.3% year-to-date loss.
The Global Market Index (GMI.F) has posted a solid 13.8% increase since the start of the year. This unmanaged benchmark holds all major asset classes (except cash) in market value weightings through ETFs and represents a competitive metric for multi-asset class portfolio strategies.
The rallies so far paint a bullish profile from a momentum perspective, but various macro threats lurk that could create new headwinds for the bulls. First, another interest rate hike is expected at the Federal Reserve’s policy announcement on Wednesday (July 26). Although inflation continues to show signs of easing, some economists warn that the end of the policy tightening game is still not imminent. In turn, it’s not clear that markets have priced in the possibility that interest rates may continue to rise beyond the Fed’s forecast hike on Wednesday.
“While things seem to be going in the right direction with inflation, we are only at the start of a long process,” said Karen Dynan, economist at Harvard University.
Markets are arguably pricing the odds high of a so-called soft landing. While there is support for this view, it’s not overwhelming. The publication on Thursday (July 27) of the government’s first estimate of US GDP for the second quarter could be a key figure in tipping the calculation one way or the other. Consensus forecast calls for production to decline to an increase of 1.5%, compared to 2.0% in the first quarter (seasonally adjusted annual rate), according to Econoday.com.
The disappointing rebound in China’s recovery this year after reopening its Covid lockdown is a headwind for the United States and the global economy. “Slow growth in China may have negative spillover effects for the United States,” warns Treasury Secretary Janet Yellen.
There is also the slowness of Russia’s war against Ukraine, which continues to reverberate around the world. Markets have generally learned to live with chaos and backlash, but the potential for negative surprises remains as both sides have increasing pressure to emerge from the currently prevailing war of attrition.
As of today, markets are climbing a wall of worry and appear to be peering through the various risks swirling around. It is to be assumed that the second half of the year will bring more of the same and prices will be stable to slightly higher. But with many markets now well above their 2022 lows, the margin for negative surprises has faded by more than an insignificant degree. In turn, the odds are perhaps higher that we see the markets consolidate their recent gains in the months ahead with some support and filler.
The big question is whether the resilience of US and global economic activity is weaker and less robust than it appears. July’s incoming numbers will serve as a stress test. In the meantime, it seems plausible that markets are more inclined to remain cautious before deciding that it is time to extend the recent uptrend. In short, economic numbers are likely to play a more decisive role in market sentiment going forward.
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