Written By Mark Martiak

As of August 11th, the top ten stocks in the S&P 500 accounted for 90% of the index’s year-to-date gains. (Elle Caruso, Top 10 Names…ETFTrends.com, 4/5/23) In fact, with the 2Q23 earnings season ending, corporate profits have surprised to the upside, with strength in the consumer sectors, construction, travel, and streaming/gaming. With that being said, the recent broadening has been moderate at best, and mega-cap tech stock valuations remain stretched. The top ten stocks currently account for over 30% of the index, which is down from the peak levels we saw in the spring, but still extremely high relative to the last 25 years. Importantly, and in contrast to their weight in the index, the earnings contribution of these top ten stocks is sitting near its pre-COVID level, but well below the pandemic era highs. Despite this misalignment in weights and earnings, the VIX, which is known as the volatility index, has remained at historically low levels, perhaps aided by the market becoming increasingly confident in a soft landing for the U.S. economy.

Whether this performance is sustainable hinges on inflation. Any prolonged stickiness in core CPI may push the Fed to maintain a hawkish stance, thereby increasing the odds of a recession. In such a scenario, we would expect to see earnings revised lower, leaving the market, where valuations are already stretched, particularly vulnerable. 

Recent strong employment figures and lower inflation data have led the equity market to price a stronger economic growth outlook.

As inflation recedes, the pace of price increases should also decelerate and be less of a tailwind for sales, placing more importance on volumes to grow sales. Consensus estimates show that analysts expect 92% of S&P 500 companies will post positive nominal sales growth in 2024 and expect aggregate sales will rise by 4%.1

While many management teams were pessimistic on the economy in late 2022 and following banking stress in March, sentiment has improved. Several companies acknowledged the resilience in the U.S. economy had led them to now expect a soft-landing. But other companies still anticipate a near-term recession, albeit later than previously expected, and some companies continue to incorporate a slowdown in economic growth into their planning and guidance.

Artificial intelligence (AI) continues to be a hot topic for both investors and company managements. The proportion of companies discussing AI on earnings calls soared this quarter. Several management teams explained to Wall Street Analysts how recent increases in demand for AI will boost demand for their products. 

Stocks deemed to be AI winners have exhibited robust performance so far this year. In particular, the seven largest stocks in the market are widely considered to be major AI beneficiaries. These stocks have rallied by 59% YTD. 

Expected future uses of AI include financial advisory, efficiency improvements, customer personalization, automation, pharmaceuticals, data modeling, and marketing.

Consumer Spending and the Budget Situation: 

The Commerce Dept reported in mid-August that consumer spending was up in July as inflation slowed. “The advanced retail sales report showed a seasonally adjusted increase of 0.7% for the month, better than the 0.4% Dow Jones estimate. Excluding autos, sales rose a robust 1%, also against a 0.4% forecast. Both readings were the best monthly gains since January.” As the numbers are not adjusted for inflation, they showed a consumer able to keep ahead of price increases that have been prevalent over the past two years. The consumer price index rose 0.2% on the month, indicating solid demand.2

Up: food service, bars, online retailers, sporting goods. Down: furniture sales, appliances, electronics, vehicle sales, gas stations.3

Much of this consumer spending has been on credit – credit card balances reached $1T for the first time in 2Q23.4

In a series of eleven increases since March 2022, the Fed has taken up its key borrowing rate by 5.25 percentage points to reach its highest level in more than 22 years. Regardless, consumers, who power about two-thirds of the entire $26.8 trillion U.S. economy, have persevered.5

We are entering an era where the national budget will be stretched thin by the Boomers’ retirement, and the basic economic conditions that existed in the 80s and 90s no longer apply, particularly with regards to interest rates. “Interest costs last year were 1.9% of GDP, the highest since 2001. We are projecting this year will be 2.5% of GDP, the highest since 1998.”6

From Washington to Wall Street and Main Street, the U.S. is on the cusp of some big budget challenges. If voters do not hold politicians’ feet to the fire investors will.

Expect the unexpected over the final four months of 2023. The markets dictate the economy, not the other way around. Plan and be disciplined about your asset allocation strategies. When you need to be defensive, cash can be your friend.

If you need to define whether you have any financial blind spots, please reach me directly at mmartiak@allianceg.com.

Mark Martiak is a New York-based Investment Adviser Representative and Accredited Investment Fiduciary® for AGP / Alliance Global Partners, a registered investment adviser and broker-dealer, Member FINRA | SIPC. Mark is a regular Contributor to VEGAS LEGAL MAGAZINE and has appeared on CNBC’s CLOSING BELL, YAHOO! FINANCE MIDDAY MARKET MOVERS, FOX BUSINESS NETWORK and has been quoted in THE WALL STREET JOURNAL. Check out the Martiak Market Update Podcast wherever you listen to your podcasts.

Such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data is taken from sources believed to be reliable, but no guarantee is given of its accuracy. Indexes are unmanaged, and investors are not able to invest directly into any index. Past performance is no guarantee of future result.

News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified, when necessary, with secondary sources such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities and should not be relied on as financial advice. Forecasts are based on current conditions, subject to change, and may not happen. U.S. Treasury securities are guaranteed by the federal government as to the principal and interest. The principal value of Treasury securities and other bonds fluctuates with market conditions. Bonds are subject to inflation, interest-rate, and credit risks. As interest rates rise, bond prices typically fall. A bond sold or redeemed prior to maturity may be subject to loss. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.

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1 Goldman Sachs Portfolio Strategy Research S&P 500 Beige Book, “3 themes from 2Q 2023 conference calls: AI, US economic growth, and drivers of sales growth (volume vs. pricing),” 8/15/23

2 CNBC.com, “Retail sales increased 0.7% in July, better than expected as consumer spending is holding up,” Jeff Cox, 8/15/23.

3 CNBC.com, “Retail sales increased 0.7% in July, better than expected as consumer spending is holding up,” Jeff Cox, 8/15/23.

4 CNBC.com, “Credit card balances jumped in the second quarter and are above $1 trillion for the first time,” Jeff Cox, 8/8/23.

5 CNBC.com, “Retail sales increased 0.7% in July, better than expected as consumer spending is holding up,” Jeff Cox, 8/15/23.

6 First Trust Monday Morning Outlook, “An Age of Fiscal Limits,” 8/15/23