2023 Mid-Year Outlook: U.S. Stocks and Economy

A broadening out in market performance would help bolster a more sustainable stock rally, but that hinges on increasing clarity for monetary policy, recession risk, and bank stress.

Before getting to our outlook for the second half of this year, let's "report card" our 2023 outlook, published in late November last year. There were four categories covered in our outlook: Federal Reserve policy/inflation, the economy, the labor market, and stock market behavior.

Report card

One expectation we had, which doesn't fit neatly in any of the four categories, was that concerns about government debt would become a larger part of the 2023 conversation. Sadly, we were right about that, even with the recent deal to avoid a debt default.

With regard to the Fed, inflation, the economy, and the labor market, what we expected has largely panned out. Inflation has continued to trend down, the Fed is not poised to pivot to rate cuts any time soon, leading economic indicators have weakened further, more cracks have appeared within labor market data, and the concept of a "rolling recession" continues to define economic activity.

In terms of the stock market, we believed the first half could bring some rougher sledding if the economy weakened notably, giving way to a sunnier second half. Along with that, we anticipated that last year's outperformance by equal-weighted indexes relative to cap-weighted indexes would likely persist. We missed the boat to some degree on that. As will be detailed below, cap-weighted indexes like the S&P 500 and Nasdaq have had a strong first half, driven by a concentration of performance among a small handful of mega-cap stocks.

That said, performance under the surface has indeed been more connected to the macro uncertainties that persist. In addition, as we expected, quality-oriented factors (like strong free cash flow, healthy balance sheets, and positive earnings trends) continue to perform well, which has likely been aided by large-cap outperformance this year.