Key takeaways

  • A rally that lifted stock prices through the first seven months of 2023 paused in August and early September.

  • The market’s recovery this year is due in large part to a narrow band of S&P 500 sectors, including technology stocks.

  • Investors should be prepared for uneven stock market performance in the weeks ahead.

Nearly one year into a recovery from 2022’s bear market, the stock market hit a choppy patch. By the end of July 2023, the benchmark Standard & Poor’s 500 Index recovered all but 4.4% of the 25.4% decline suffered between January and early October 2022. But then gave back some of those gains in August and September of this year.

“We’re out of the bear market environment, it appears,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “But it isn’t clear yet that a new bull market has emerged.”

The Federal Reserve (Fed) continues to maintain elevated interest rates to combat inflation. While the inflation rate declined considerably since peaking in mid-2022, it remains higher than the Fed’s 2% target. The U.S. economy continues a steady but slow pace of growth. Favorable economic developments, like a strong job market and resilient consumer spending, have helped keep the economy on a modestly positive track. Corporate earnings slowed in the first and second quarters, but not as dramatically as anticipated by many market observers.

How will these and other factors determine the stock market’s direction in the closing months of 2023 and the start of 2024?

Clawing back from a challenging year

2022 marked the second bear market for U.S. equities in three years. While challenging for investors, a notable consolation is that the 2022 bear market was less severe than the three previous bear markets. Four bear markets have occurred in the U.S. stock market in the 21st century. You’ll note that the level of decline in the most recent bear market cycle is not as dramatic as the previous three.

Source: S&P 500 daily close. 2022 bear market represents the Index’s peak-to-trough through December 2022.

“We’re out of the bear market environment, it appears. But it isn’t clear yet that a new bull market has emerged.”

Rob Haworth, senior investment strategy director, U.S. Bank Wealth Management

“In 2022, we saw a massive change in sentiment,” says Haworth. The persistent nature of elevated inflation appeared to cause investor anxiety. Higher inflation was a result of demand for goods and services outpacing supply. Haworth notes that despite policy moves by the Fed to slow economic growth, inflation, though trending in the right direction, remains stubbornly high.

Stock markets continue to exhibit volatility. However, the S&P 500 showed more consistency lately, generating gains in five consecutive months and eight of 11 months dating back to October 2022.

Source: S&P Dow Jones Indices. Figures shown represent monthly total returns for the Standard & Poor’s 500 Index, an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results. * Monthly total return as of August 31, 2023.

Key factors to watch

What factors could lead to a more definitive, sustained bull market recovery? Haworth says two key considerations deserve the most attention:

  • Inflation trends and future Fed policy moves. After peaking at 9.1% for the 12-month period ending in June 2022, inflation (as measured by the Consumer Price Index) dropped to 3.0% for the 12-month period ending in June 2023, but since has trended higher, to 3.7% for the 12-month period ending in August.1 Haworth notes that the Fed’s primary focus is how wage gains might affect inflation. “Average hourly earnings growth, which rose significantly in 2022, has slowed but stabilized at more than 4%, still higher than the Fed’s goal.” He notes that the unemployment rate remains historically low, with significant job openings still reported. If that changes and the labor market weakens, the Fed may feel its inflation goals are within reach. The Fed hiked the short-term federal funds rate, from near 0% in early 2022 to 5.25% by July 2023, in a focused move to slow inflation. The Fed’s rate hikes resulted in higher yields across the bond spectrum and borrowers’ loan costs increased. This has, to an extent, slowed demand, which the Fed anticipates will help quell inflation. “If we look at the Fed’s definition of progress on inflation, they want to get it closer to their target of 2% per year,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “The question is how much further inflation must level out before the Fed is again willing to change course on interest rates.” While the potential of additional interest rate hikes this year is unclear, Fed officials have indicated that they won’t be reversing course by cutting rates anytime soon.2
  • Consumer spending. “Consumer’s willingness to maintain reasonable spending growth has been the linchpin for the economy,” says Haworth. Although savings accumulated during the COVID-19 pandemic have declined, consumers have shown resilience, likely due in part to the strength of the labor market and more significant wage growth. Consumers devoted more discretionary spending to travel, restaurants and services than toward goods over the past year. “Data on housing starts, housing demand and auto sales show us consumer demand remains solid,” says Haworth, meaning to this point, there is no sign of a major consumer pullback. “We’ll keep an eye on credit card delinquencies, which are up, and could be a sign of consumers being more restrained going forward.”

Haworth believes these are the most likely variables in determining the stock market’s near-term performance. “In particular, the impact of higher interest rates on mortgage refinancing activity, automobile loans and student debt could have a major impact on consumer activity going forward.”

Other considerations for investors

While they may not represent decisive factors, policy issues and geopolitical matters could affect investor sentiment and be reflected in positive or negative movements in the markets. For example, disagreements in Washington on how to fund the federal government's operations when its new fiscal year begins on October 1 is a potential issue. If agreement cannot be reached by a September 30 deadline, a partial government shutdown could result. The ongoing Russia-Ukraine war and simmering economic tensions between the U.S. and China along with China’s own economic challenges could evolve into bigger issues that have an impact on the U.S. stock market, though these aren’t yet major issues.

Another consideration is that the market’s rally in 2023 has been dominated by a narrow group of stock market sectors. “Communication services, information technology and consumer discretionary stocks have carried the market in 2023,” says Haworth. “Performance has lagged in all other sectors, including negative returns year-to-date (through August) for utilities, health care and consumer staples stocks.”

Source: S&P Dow Jones Indices, LLC.

Keep a proper perspective

Market volatility and periods of market uncertainty are not unusual. “Keep in mind that we’re likely to periodically experience market ups and downs, and over time, as we’ve seen recently, markets have shown an ability to recover,” says Haworth. Market volatility can be expected to persist given the range of issues that contribute to the market’s near-term uncertainty. “While we may see a more favorable environment develop down the road, the market still faces many challenges given the current fundamental and policy underpinnings,” says Haworth.

Freedman says it’s important to maintain an appropriate perspective about the markets. He encourages investors to view markets with a long-term lens. “Timing the markets and trying to be precise on when to be in and when to be out is challenging,” says Freedman. “Markets will do things at the exact opposite time you expect them to.”

Freedman emphasizes that having a plan in place that helps inform your investment decision-making is critical, particularly in times like these. “That’s the foundation of investing,” he says.

Despite the stock market’s strong 2023 start, Haworth says investors shouldn’t expect the sudden appearance of an “all-clear” sign that market risks have subsided. “We can expect choppiness in the markets, and not necessarily a straight upward path for stocks in the coming months,” says Haworth. “While we briefly witnessed wider participation beyond a narrow band of large, technology-oriented stocks in June and July, we’d like to see participation broaden further.” Price gains across a broader spectrum of stocks would be considered a more encouraging signal of a market positioned to resume a consistent, upward trend.

Yet Haworth says it’s important for investors to consider positioning their portfolios for the long run. “We’re encouraging investors who may have taken a more cautious approach before to adjust back to their long-term strategic target portfolio today.” Haworth says for those who still have a sense of caution about the stock market, “Consider putting a portion of your portfolio to work in equities in a systematic way, such as dollar-cost averaging available cash over a series of months.”

Check in with a wealth planning professional to make sure you’re comfortable with your current investments and that your portfolio is structured in a manner consistent with your long-term financial goals.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. Diversification and asset allocation do not guarantee returns or protect against losses.

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  1. Source: U.S. Bureau of Labor Statistics.

  2. Mercado, Darla, “Fed recap: Here are Chair Powell’s market-moving comments after the latest Fed rate hike,”, May 3, 2023.

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