Big Tech was the story of the first half of 2023. After a brief bank scare earlier this year, cash infusions and enthusiasm for the potential of artificial intelligence drove the seven largest technology companies to lofty valuations. The remaining companies in the S&P 500 are in negative territory for the year to date, as shown in the chart to the left. The differential is remarkable and highly unusual, but the cause is clear. Increased liquidity, not earnings, drove investment into the largest ‘risk-on’ stocks.
The second half is expected to be a different story. Liquidity is being rapidly withdrawn as bank funding moderates and the U.S. Treasury refills its coffers after the debt-ceiling increase. Even absent this change, the valuations of this handful of stocks are overdone, despite their optimistic earnings expectations. Several analysts are cautious going into the second half of 2023, blaming unattractive risk/reward profiles. We are trimming our larger holdings in these companies and increasing investment in more reasonably valued sectors.
Earnings across the spectrum are trending lower. The top reasons cited by company management teams are weaker sales and higher material costs, consistent with a slowing economy. The tight labor market and accumulated savings have supported consumer spending until now but are weakening. U.S. real wages (adjusted for inflation) are approximately 4% below where they were at the end of 2020. High inflation has eroded the benefits of the booming labor market.
The good news is that this slowing is largely priced into most companies’ stocks, perhaps with the exception of large-cap growth. We expect another Federal Reserve quarter-point increase at their July meeting, and possibly a second increase later in the summer, but their prior increases are showing results. At some point this year, they will declare a pause and we expect the market will react positively. Locking in current rates in intermediate bonds now could work well as inflation and short-term rates eventually moderate.
We continue to overweight industrial and materials stocks. The combination of the 2021 Bipartisan Infrastructure Bill, the $50 billion CHIPS Act, and the 2022 Inflation Reduction Act will energize infrastructure spending for the next several years. We are also increasing our investments outside of the United States. Foreign valuations are more attractive, and selective country and sector exposure allows us to strategically pinpoint our portfolio investments. The U.S. Dollar is expected to stay strong due to its defensive qualities and U.S. high relative interest rates. This presents a challenge for U.S. companies selling their products overseas but is a tailwind for foreign companies exporting to the United States.
Earnings season begins shortly and will provide more clarity on the outlook for the rest of 2023. Employment, inflation and spending data will also be critical to monitor. We believe there are reasons for optimism for the rest of 2023 for properly positioned portfolios.