Despite rally in Q2, risks will persist

Oksana Patron

11 July 2023

Although markets were significantly helped by the tech rally in the second quarter and hopes of an imminent end of monetary tightening, there are still risks ahead, according to Principal Asset Management.

And one of the risks was an ‘increasingly hawkish’ Fed which will warrant caution from investors in the second half of the year, the manager said.

The other major factors which contributed to the rally also included things like continued resilient economic data, which raised hopes that the Fed may successfully navigate a soft landing, and the fact that markets were looking forward to what they thought was the end of Fed tightening.

At the same time, the markets saw improved inflation, the Fed slow its pace of rate hikes and stabilisation of the banking sector.

On top of this through the first half of the year, the S&P 500 gained 16.9% with reinvested dividends, while the Nasdaq and Dow returned 32.3% and 4.9%, respectively. Interest rates were also steady after their sharp jump last year, with the 10-year treasury yield hovering around 3.8%.

“However, many risks still lie ahead. Despite surprisingly stable U.S. economic growth and a historically strong labor market, leading indicators still point to a recession inflation is stubbornly above policy target, requiring further Fed tightening and reducing the likelihood of near-term rate cuts,” Principal said.

“Bond yields have already risen sharply just two weeks into the third quarter. Additionally, with broad equity valuations having once again become stretched and market breadth extremely narrow, the market is priced for perfection, leaving it vulnerable to earnings disappointments.

“So, while recent market gains are positive, investors should maintain a cautious perspective in the second half of the year.”