There were several developments that contributed to risk sentiment and market performance in the second quarter of 2023. Resilience in the labor market and consumer spending contributed to inflationary pressures and weighed on fixed income markets as it kept the Federal Reserve (Fed) in play.
However, the resolution of the debt ceiling issue removed a potential headwind. Notably, the second quarter witnessed a narrow, yet powerful rally driven by AI, benefiting growth stocks, particularly in the technology sector.
As we look ahead to the next 12-18 months, economic factors will play a crucial role in shaping the market. Inflation and the strength of the labor market will significantly influence the Fed's policy decisions, which, in turn, will impact economic growth and corporate earnings.
Signs of consumer vulnerability, as evidenced by the increased usage of credit cards and other credit facilities, will also be essential in monitoring the direction of economic growth. Additionally, businesses dealing with loan rollovers at higher rates could also affect growth trajectories.
While signs of inflation moderating are clear, it remains uncomfortably high from the Fed's standpoint. The path to a lower inflation rate is expected to be gradual, as some components remain stubborn, however, we believe getting inflation down to 3% over the next year is feasible.
Video recorded on July 19, 2023
The biggest challenge for the Fed lies in the final stages of lowering inflation, hence the need for policymakers to continue their efforts to overcome this hurdle. By the end of 2024, inflation is projected to be closer to the Fed's 2% target.
We expect the Fed to hold rates in the 5.25% to 5.50% range for at least the next couple of quarters. As economic growth slows, rate cuts are anticipated to begin in Q2 2024, gradually bringing the Fed funds rate closer to 4% by the end of 2024.
Given this economic outlook, investors should approach the market with caution, particularly towards equities, as slowing economic growth could impact earnings. As a result, a selective approach to investing is recommended, with a focus on high quality companies in both the growth and value segments of the market.
On the other hand, fixed income is viewed more positively. We believe there are opportunities for investors to benefit from relatively high levels of interest income and potential capital gains should the Fed begin to cut rates in the future.
Looking ahead, key market developments to watch for include the potential broadening of the rally to other sectors, indicating increased market breadth and more diverse investment opportunities.
As investors plan for the rest of the year, they may wish to consider shifting away from cash and short-term investments. While cash has provided a safe haven during the Fed's rate hiking cycle, it now presents reinvestment risk as rates are likely to be lower in the future. Over the past five interest rate cycles, cash has underperformed most bonds and equities in the 2 years following the Fed's last rate hike. High quality fixed income currently offers investors an opportunity to lock in higher yields for longer.
In times of uncertainty and elevated market volatility, TD Wealth believes staying vigilant and prioritizing quality investments will be critical in navigating the market during the third quarter and beyond.
Although challenges may occur in the short-term, a mindful approach to risk management, portfolio diversification, and strategic investment decisions can help investors capitalize on the prevailing economic conditions and market opportunities.
Important Disclosures
TD Wealth® is brand of TD Bank N.A in the United States, member FDIC (TD Bank). Banking, investment management and trust services are available through TD Bank. Securities and investment advisory services are available through TD Private Client Wealth LLC (TDPCW), a US Securities and Exchange Commission registered investment adviser and broker-dealer and member FINRA/SIPC. Epoch Investment Partners, Inc. (Epoch) is a US Securities and Exchange Commission registered investment adviser that provides investment management services to TD Wealth. TD Bank, TDPCW and Epoch are affiliates.
The information contained herein is current as of August 8, 2023, and is sourced from FactSet, Morningstar Direct and Bloomberg among others. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve. Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice in reaction to shifting market conditions. Supporting documentation for any claims or statistical information is available upon request.
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To the extent that the information includes general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that the information provided here includes references to securities, those references do not constitute a recommendation to buy, sell or hold such security, and the information may not be current. It does not constitute a recommendation or investment advice and does not, and is not intended, to take into account the particular investment objectives, financial conditions, or needs of individual clients. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.
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Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.
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