JUNE + MID YEAR 2023
Throughout the first half of the year, companies grappled with continued supply chain issues, higher interest rates, and diminished visibility. The current “rolling recession” is impacting companies at varying rates and degrees. As a result, most managements are issuing cautious outlooks. We spent the first two quarters of the year determining where the companies in our universe are positioned within the current cycle and when their demand could start to improve. While we were not perfect in the second quarter, the environment continues to be favorable for our strategy.
After nearly eighteen months of pessimism, stock volatility, rising interest rates, high inflation, war in Ukraine, and slowing economic trends, the market rallied through the first half of 2023 due to two key macro themes and one secular driver. First, the most predicted recession of the last 20 years has yet to materialize. Companies are maintaining profit margins better than anticipated, and the US economy is still growing. Second, the market perceives that the interest rate hiking cycle and rapid inflation period is waning. This has expanded price-to-earnings ratios and driven most of the stock price appreciation this year.
The third leg to this year’s rally has been the rapid arrival of artificial intelligence (AI). The early signs of accelerated investment in AI, and the potential cost efficiencies that could accrue, have bolstered optimism of some equities. We have spent time with several companies addressing the risk and opportunities from AI, and it will be interesting to watch who the true winners and losers are going forward.
The markets have skewed heavily towards big tech this year as evidenced by the outsized returns of the S&P 500, and even larger returns of the Nasdaq. AI captured the attention of investors and played a significant role driving the tight concentration of gains at the top of the market. Notably, the performance of the S&P 500 is now the most concentrated it has been since the 1970’s, with only five stocks representing nearly a quarter of the market capitalizations of the entire index.
Although we expect stocks to face some fundamental and share price volatility in the second half of the year, the extreme pessimism that weighed on stock prices through most of 2022 appears to be easing. We believe investors have grown more comfortable with some of the uncertainties facing the economy and, to some extent, are discounting most of them as mild irritants to growth.
Earnings season will ramp up over the coming weeks. We will be on conference calls and follow-up calls to determine what managements’ assumptions are for the remainder of the year, and where they may be too aggressive or conservative. We continue to look for company specific catalysts and fundamental inflection points and will position portfolios accordingly.
Fortunately, SG Capital has a proven long-term track record regardless of market conditions, and we are confident that we will continue to find companies that will yield generous returns for our investors.
We are happy to speak with any clients or interested investors that have questions about our performance or portfolio positioning. We look forward to reporting back in a month with our July newsletter.
As always, we thank you for your continued trust and support in SG Capital.