Market Commentary: The Summer Rally Has Legs

Six months ago, most financial experts were talking about an imminent recession and the likelihood of stocks breaking the October lows. But instead, stocks had one of their best six-month starts and the economy shows no signs of slowing.

• The first half of the year is in the books, and it was great for investors.
• The second half of the year should see continued stock gains, potentially back to new highs.
• There’s a good chance the surprise summer rally will continue.
• Business investment is rising once again, and that’s a big deal for the economy.
• The resurgence of manufacturing construction in the U.S. is a hugely underrated story.

At 2023’s midway point, the S&P 500 was up 16.9% on a total return basis, which marked the best start since 2019; the NASDAQ total return was up 22.9%, which was the best start in 40 years; and the NASDAQ-100 total return was up an incredible 40.3%, marking the best start to a year in the index’s history.

Some investors may be wondering if the strong start indicates poor returns for the remainder of the year, but we don’t think that’s likely. We reviewed all years that were negative to start and up more than 10% by end June — in other words, a slingshot move. Our research showed stocks did even better when they were rebounding. The S&P 500 was higher during the final six months of the year eight out of nine times and up a median of 12.4%. That’s well above the 10% median return over the final six months when you consider all years.

Can the Summer Rally Continue?

We believe the summer rally may be followed by some pullbacks and volatility, likely in the fall, which is typically more variable. But overall, we expect the rally will continue and stocks will be higher in six months.

For starters, stocks have gained during nine of the last 10 years in July, with no month sporting a better average return than the S&P 500’s gain of 3.3%. July kicks off second-quarter earnings season, and doubt has been high over the last decade. It is likely that earnings came in better than expected, calming many fears and allowing a rally. We think that could happen once again this year.

Let’s be clear. July is usually a good month relative to the weak summer months, as illustrated in the chart below. Since 1950, stocks have gained 1.3% on average in July, but this has gone up to 2.2% in the last 20 years and 3.3% the last 10. Pre-election years are typically a little weaker, up 0.9%. Lastly, when stocks gain more than 3% in the usually weak June (15 times since 1950), they gain only 0.8% on average in July and have been higher only eight times. So, there’s a chance June could steal some of July’s gains.

Below is our Carson Cycle Composite, which is a proprietary indicator that combines the last 20 years, pre-election years, the third year of a new president, and years that saw stocks gain at least 5% in January, such as they did in 2023. As the chart shows, a rally in July is normal and we don’t expect 2023 to be any different.

We want to be clear, at some point stocks will take a well-deserved break. This type of volatility often occurs in August, September, and October, and it could happen this year. But our stance remains overweight equities and view seasonal weakness as an opportunity to add to core equity exposure.

This is a Big Deal: Business Investment is Rising Again

We’ve been getting a string of economic surprises from the consumer side for several months. Employment data are prime examples, with monthly payroll gains coming in above expectations for 14 straight months. For a change, good news recently came in from the business side, particularly business investment.

The U.S. Census Bureau collects data on manufacturers’ shipments and new orders for durable goods — big ticket items such as transportation equipment, including vehicles and aircrafts, machinery, computers and electronic products, electrical equipment and appliances, etc. New orders are particularly useful because they tell us how businesses are viewing current and future economic conditions and investing accordingly. They also signal future production commitments for manufacturers.

New orders rose 1.7% in May, even as economists expected orders to decline almost 1%! New orders are now up 5.4% since last year, and this pace is higher than at any point in 2019.

A large part of this rise is due to nondefense aircraft orders, which surged 32% in May and a whopping 61% over the past year. This is huge for the aircraft industry in the U.S. The recent uptrend stands in sharp contrast to 2018-2019 when aircraft orders were declining amid Boeing’s 737-Max woes. However, aircraft orders are volatile. It helps to strip them out, along with new orders from the defense industry, which can also be quite volatile.

What’s left is a key economic data point — a category called nondefense capital goods ex aircraft, which is a proxy for business investment, or capital expenditures (capex). This rose 0.7% in May, yet another data point that beat forecasts as expectations were for a 0.1% increase. New orders for these core capital goods are now up 2.1% from last year and have risen at a 3.2% annualized pace over the first five months of this year.

These data are nominal, in that they are not adjusted for prices. And we’ve had a lot of inflation over the past year and half. But even after adjusting for inflation, this proxy for business investment rose 0.3% in May, following a 0.5% increase in April. Investment in real terms has been falling since the beginning of 2022, and so the 0.8% uptick over the last two months is very welcome.

We do recognize that two months do not make a trend. But other data also corroborate the fact that businesses are investing again.

Something Big is Happening in America

Nonresidential construction is booming in the U.S., mostly thanks to manufacturing construction. This March article discusses the boom, and there has been no slowdown since. Even after adjusting for inflation, manufacturing construction is up 84% over the past year through April. Much is being driven by a 233% increase in construction in the computers, electronics, and electricals sector, i.e., semiconductor and electric vehicle battery plants.

The chart below shows how manufacturing construction has been stagnant across most of the past decade, but it seems to have broken out now. There was an inflection point last summer after Congress passed the CHIPS Act and the Inflation Reduction Act, which had less to do with inflation and more to do with promoting investment via subsidies and tax credits. Also interesting, this phenomenon is happening only in the U.S. Other developed countries, such as Germany, Japan, U.K., and Australia, are not seeing similar surges.

Business sentiment has been quite poor, perhaps because of all the headline-grabbing recession forecasts. However, the hard data suggest that businesses are investing and looking to expand capacity — a sign they view future economic conditions positively when it comes to putting money to work.

Ultimately, this is good for the economy today but also for the future, as increasing business investment is the best path to higher productivity and a better economy for all.

This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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