August has seen the unwinding of the seven-month rally in technology and digital stocks that, to varying degrees, lifted equities across most sectors this year. Stocks often struggle in the summer; but usually that means they are lethargic, not heading notably lower. What caused stocks to give up big parts of their year-to-date gains? AI mania drove much of the stock rally in the first half of the year. And in any stock-market mania, unbridled enthusiasm gives way to second-guessing at some point. Consumers and businesses show few signs of spending fatigue, contributing to inflation’s persistence. We think the difficulty in getting inflation down to the 2% target level, along with some buyers’ remorse on AI mania, has prompted investors to take profits.

Just like that, 2023 has reached the half-year mark. As the years pile up, each passing year seems to compress into a tighter timeframe, and 2022 feels like it was six weeks not six months ago; but that is a discussion for another time. The outlook at mid-year 2023 is certainly an improvement over that of mid-year 2022, when inflation was near 40-year highs and rising, the supply-chain crisis was raging, and the central banks were just getting started on their aggressive rate-hiking policies. The war in Ukraine was just a few months old, and China was still in its zero-tolerance phase of COVID-19 lockdowns. As July 2023 gets underway, the major central banks have largely completed their rate-hiking campaigns. The annual rate of change in inflation is about half the peak level reported in June 2022. Supply chains now appear to be normalizing. China has reopened; and Russia is surrendering ground in Ukraine.

The odds are increasing for a potential recession in the second half of 2023. The banking system seems to be back on its feet after the Silicon Valley Bank collapse; but the implications for loan and credit availability are uncertain and could play out unpredictably in the coming months. For all that, the FTSE 100 is up 3% year-to-date. The stock market is of course anticipatory, and investors are looking past near-term challenges. Up ahead, they see the end of the Bank of England’s rate-hiking cycle, stabilisation and eventual reduction in inflation, and – hope springs eternal in – the BoE successfully navigating the economy into a soft landing.

Bullish sentiment in the stock market can occur during both a bear market and a bull market. When we are in a bear market, sentiment gets bullish during counter-trend rallies, only to see new lows ahead. However, during the initial stages of a bull market, sentiment will also get bullish. To those who don’t analyse history, this is assumed to be a bad thing that is likely to doom the rally. One could argue though that we are at that point in the cycle right now. There are plenty of technical indications that stocks have transitioned into a bull market, whether it’s price action, the chart structures of certain major indices, or market breadth. At the initiation stage of a bull market, we need investors to turn more positive and start getting back into stocks. We have had some of that lately, yet we think part of the rally was short-covering as there was a lot of pessimism at the end of 2022. Now that the shorts have covered, that fuel is gone. If the market can hold on and grind higher, it would be a great sign that the stock market has indeed turned the corner.

We wish all our clients and readers a very Happy New Year. The FTSE 100 has seen heightened volatility as of late – falling 5% in September, before rising 3% in October and a further 7% in November. Those monthly moves up and down are substantially larger than typical monthly changes in the 1%-2% or lower range, and signal a developing battle between bulls and bears. Bulls want to believe that the rise in inflation is moderating, and that central banks will take their foot off the gas as pricing pressures ease. Bears believe past central bank actions as well as inflation’s dampening effect on consumer discretionary spending will push the economy into recession in 2023. Our view is that the stock market should continue to grind higher over the course of the year. However, it could be a bumpy ride and investors need to get used to such volatility.