Capital markets are responding to several encouraging developments.  Inflation is coming down.  The Federal Reserve is close to wrapping up its dramatic program of raising interest rates.  The stock market has officially ended its most recent “bear market.”  Employment remains strong, and overall economic activity has proved resilient against some daunting challenges faced in the first half of the year.  Investors who endured a difficult 2022 received some welcome recovery in the first half of this year.

At the top of the list, inflation is on the wane.  The latest report from the U.S. Bureau of Labor Statistics shows the Consumer Price Index (CPI) rising by four percent.  Inflation has been on a slow, steady descent from its peak of roughly nine percent last summer, and the current report gave the Federal Reserve a moment of pause in their program of raising interest rates.  Commentary by the Fed leaves open the possibility of one or two more minor bumps in rates during the second half of the year, although they appear to have now completed the majority of the planned tightening of monetary policy designed to bring inflation down to their target level of two percent.  This is good news for capital markets, but consumers probably feel only limited relief.  While the rate of price increases has slowed, overall prices remain elevated.  

June 8 was the official end of the longest bear market in 75 years, as stock prices have now rebounded by more than 20 percent from their October 2022 lows.  This bear hung around for 248 days, nearly twice the length of an average market downturn.  Not all investors feel the same level of relief, however, as market gains have been dominated by a handful of super-sized technology companies.  The largest five stocks in the S&P 500 Index represent more than 20 percent of the market weight for that index, and they are all technology names.  Interest in commercial applications for Artificial Intelligence (AI) has focused on a small number of leading competitors, helping the NASDAQ benchmark to surge by more than 32 percent this year.

One of the most important metrics that help us gauge the health of our economy is employment.  People with jobs are better able to pay their bills.  Employment has remained strong throughout the Fed’s year-long campaign to raise rates.  The official unemployment rate remains very low at 3.7 percent.  Economic activity continues to surprise on the upside, making gains in spite of a banking crisis that led to the failure of three regional banks and threat of a U.S. default that was narrowly avoided by a late May agreement on government spending. 

Risks to the second half of the year include the continued possibility of recession, especially with tighter bank lending conditions.  Along with higher interest rates, banks are facing a difficult environment for commercial property loans.  Remote work has caused a precipitous decline in occupancy rates for downtown office buildings in major cities.  In some cases, the loans on those properties will go into default.  In San Francisco, for example, a prominent building in the Financial District that was valued at $300 million before the pandemic recently sold for around $60 million.  The 22-story office building was vacated by a large tenant, which notably impaired the valuation.  Ongoing weakness in the market for shopping centers and office buildings will cause banks to be more cautious in their lending activity to those sectors.  Declining commercial property values pose risks for lienholders and municipal budgets that rely on property taxes.  

Investors have been rewarded for their patience this year.  We are not completely out of the woods, but the bear has left the area and there are encouraging signs that the Fed is winning their battle with inflation.  We hope you enjoy a wonderful summer of fun activities with family and friends.  Please contact us if you have any questions.