The first half of 2023 has seen unprecedented success for megacap tech stocks. However, it would be a mistake to compare this year to the iconic 1999, despite the desire to party like it’s that time. In fact, a more relevant comparison might be the events of 1987, a year that may seem like ancient history to some. Regardless of the perspective, it’s clear that the current market conditions, with stretched equity valuations and rising interest rates, call for a cautious approach.
The Strategas technical and macro research team, led by Chris Verrone, took a closer look at the performance of the Invesco QQQ exchange-traded fund (ticker: QQQ). This fund tracks the Nasdaq 100 index, which comprises the largest nonfinancial stocks on the Nasdaq and is dominated by technology giants.
Their findings revealed that the QQQ saw an astounding 38.8% increase in the first half of this year, surpassing even the best-performing years of the 1990s. To put it in context, even the dot-com frenzy of 1998 only saw a 35% surge in the first half. The first half of 1995 came close with a 33.1% jump.
Historically, staying invested in winners has been the winning strategy. In the second half of 1998, the QQQ outperformed with a 37.3% gain. However, in 1995, the second half only saw a modest 7.1% advance following the strong first-half performance. The legendary year of 1999 witnessed a 25.1% rally in the first half, which was overshadowed by a remarkable surge of 61.4% in the final six months.
As we look ahead to the rest of 2023, it’s crucial to consider these historical precedents. While the first half has been remarkable, it remains to be seen how the second half will unfold. With equity valuations stretched and interest rates on the rise, investors need to maintain a cautious approach and carefully evaluate their investment strategies.
Remember, as much as we might want to party like it’s 1999, the present circumstances call for a more measured and thoughtful approach.
The Year That Shifted the Market: 1987
The year 1987 holds a significant place in the history of the stock market. It began with a remarkable 33.8% gain in the Nasdaq 100 during the first half, only to be followed by a 17.4% decline in the second half of the year. However, the most memorable event of 1987 was Black Monday, which occurred on October 19th. On that dreadful day, the Dow Jones industrials plummeted by a staggering 22%, setting a one-day record that still stands today. Following this crash, circuit breakers were implemented to prevent a similar occurrence in the future.
What sets apart the years of impressive equity returns are the different interest-rate environments they exist within. As pointed out by the Strategas team in a client note, “Yields fell sharply in 2H ’95 and ’98, and equities continued to forge ahead, while rates skyrocketed in the summer of ’87, signaling troubles ahead.”
In recent times, long-term Treasury yields have experienced a significant surge, breaking through key technical levels on Strategas’ charts. Notably, the benchmark 10-year note yield surpassed the 4% mark on Thursday, surpassing both a prominent downtrend line and the highs seen in early March. Simultaneously, the two-year note—the maturity that most closely aligns with the Federal Reserve’s predicted rate movements—reached 5%, falling just short of its peak before the 2008-09 financial crisis and the bank failures that were brought to light by Silicon Valley Bank. It is crucial to note that these rising yields have been observed in real terms, adjusted for inflation. The real yield on five-year Treasury inflation-protected securities has more than doubled from its low point in early April and now sits above 2%.
Surprisingly, the increased borrowing costs have had a relatively minimal impact on the sectors of the real economy that are most sensitive to interest rates.
Housing Market Dynamics
The housing market is currently experiencing constraints in the supply of available homes for sale, rather than a decrease in demand due to rising mortgage interest rates. Many homeowners are hesitant to give up historically low mortgage rates, which have been in the 3% range, for new loans that come with higher costs of over 7%. Consequently, the sales of existing homes are being limited by this unwillingness to let go of advantageous mortgage rates.
However, the sales of new homes have seen a significant increase of 20% compared to the previous year. This growth has been reflected in the rise of home builders’ shares, surpassing even those of tech stocks. The iShares U.S. Home Construction ETF (ITB) yielded a return of 41.45% in the first half of the year and an impressive 64% in the 12 months leading up to June 30th, according to Morningstar data.
Booming Automobile Sales
Contrary to predictions of declining sales, the automotive industry has experienced a remarkable boom. In the United States alone, new car sales witnessed a notable 13% increase during the first half of the year. Moreover, the sales of automobiles and light trucks in June ran at an impressive annual rate of 15.7%. Surprisingly, incentives in this sector were not as prevalent as industry analysts had anticipated.
These positive sales figures suggest that the primary impact of higher interest rates is on inflated asset prices rather than the real economy. Although Treasury yields on the short end of the market have risen significantly from previous lows, reaching 5%, they still fail to outpace inflation.
Impact on the Economy and Asset Prices
Taking into account the most recent consumer price index data, there was a 5.3% increase in May compared to the previous year. In light of this information, the Federal Reserve’s key federal-funds target rate range of 5%-5.25% essentially implies that money is virtually free in real terms after accounting for inflation. This has a positive effect on the S&P 500, which currently trades at roughly 20 times optimistically forecast earnings. However, it is important to note that these earnings projections may be subject to downward revision once companies begin releasing their results and forward guidance in the upcoming weeks.
Given the historical context of 1987, it is evident that high valuations and increasing interest rates present a challenging atmosphere for equity bulls. These circumstances may prove almost as unfavorable as the prospects for the Mets (baseball team), as humorously mentioned in the original text.