Facing numerous adversities, the American stock market overcame all expectations with a rally in the first quarter of 2023. As the final quarter of the year begins, several challenges persist - however, many catalysts have also emerged, fueling the surge in the first quarter.

Main Points

• Historically, after strong returns in the first quarter, the American stock market tends to continue rising.
• The tech shares have been on the rise during the first quarter amidst a resilient economy.
• However, there is concern about potential interest rate hikes by the Fed and the looming threat of a downturn.

Despite balancing competitive forces, investors propelled the S&P 500 index up by 17% in the first quarter, marking a strong start for the new bullish market.

Historical data reveals that when shares receive a robust start, they tend to perform similarly in the second quarter as well. Since 1950, when the S&P 500 has recorded positive returns in the first quarter, it has seen an average growth of approximately 6% in the second quarter. If the first quarter's return exceeds 10%, the average gain in the second quarter rises to 7.7%, while the second-quarter return itself stands at a positive 82%.

Amidst an Elastic Economy

The American economy has displayed considerable resilience in 2023 so far. The job market remains robust, and corporate earnings have not witnessed the anticipated decline.

The total income of S&P 500 companies increased by 0.1% in the first quarter, surpassing the estimates of a 5-6% decline predicted at the beginning of the reporting period three months ago.

The stability of earnings reflects the overall resilience of the American economy, which increased by an annualized rate of 2% in the first quarter, nearly double the initial estimates.

Furthermore, investor enthusiasm regarding artificial intelligence has aided a significant surge in technology shares. Their substantial contribution played a vital role in the market's first-quarter growth, keeping the momentum intact.

The tech-rich Nasdaq Composite Index witnessed a remarkable 32% increase in the first quarter, the highest since 1983, effectively doubling its presence in the expansive market.

U.S. Stock Markets Had A Strong First Half

Percentage change for major U.S. stock indexes in the first six months of 2023

Challenging Obstacles

On the other hand, while currency fluctuations have decreased, they remain troublesome. As a result, interest rates have reached their highest levels in two decades, with the possibility of further increases. This implies that concerns about a downturn and the impact of high rates on banks and credit markets are not yet alleviated.

The dominance of technology shares also raises some concerns for investors. Five stocks - Apple (AAPL), Microsoft (MSFT), Nvidia (NDVA), Amazon (AMZN), and Meta platform (META) - were responsible for approximately two-thirds of the S&P 500's first-quarter returns.

Five Tech Stocks Drove The Rally In Broader U.S. Equities

Percentage change in the stock prices of top five stocks that lifted broader U.S. markets in the first half of 2023.

Contrasting the aforementioned, 44% of the index's shares experienced a decline in value. By May, 286 American companies had filed for bankruptcy protection, marking the highest number in the first five months of a year since 2010.

However, the relative strength of the economy against rising interest rates implies that the Federal Reserve, possibly for an extended period, will not halt the increase in rates after pausing in June for the first time in 15 months to curb the upward trajectory.

In the mid-year update for investors, a senior economist at Vanguard, Josh Hart, stated, "Despite ongoing currency fluctuations, consumer spending has remained remarkably stable over the past year." He added, "If spending continues along this path, the Federal Reserve will have to do even more work."

Is the Downturn Still Looming - and Does It Matter?

In fact, minutes from the Federal Reserve's latest policy meeting held on Wednesday suggest that several Fed officials expressed support for raising rates at that time. The indication is that the Fed is likely to resume rate hikes in its next policy meeting at the end of this month.

In the market preview of the second quarter, J.P. Morgan stated that there is a possibility of a mild downturn towards the end of this year or the beginning of next year, with two more rate hikes beyond the Fed's current projections.

The company's preview stated, "We expect more challenging backdrop for stocks in the second quarter," with softening consumer trends and a sluggish trading cycle presenting "an unattractive risk-reward proposition" for stocks.

Not all analysts agree. The downturn may lead to a decline in corporate earnings. However, the 19% drop in the S&P 500 in 2022, its worst annual return since the global financial crisis in 2008, suggests that investors may have already factored this in.

Furthermore, this means that they may weather any potential upcoming downturn in the final quarter of 2023.

Victor Costa, a macro strategist at Seaport Research Partners, told Baron, "A 2023 EPS (earnings per share) recession is well known." "As the year progresses into the second quarter, the market will start discounting the rebound in EPS."