Analysis: 5 surprises for investors after the first half of 2023

The US and world economy in the first 6 months of this year did not meet the expectations of investors, creating new lessons different from history.

Many thought a recession was inevitable in 2023 as pessimism swept stock exchanges around the world last year. But in the first half of this year, Germany was the only major economy to actually shrink, to a mild degree. At the same time, more and more countries are realizing the prospect of a soft landing, where the economy decelerates slowly and steadily rather than sharply, triggering a recession. Central banks have also gradually succeeded in curbing inflation without knocking growth. The stock market reflects that, too, with months of gains.

Here are five things the Economist says investors realize after half a year.

Graphic painting 5 lessons with investors this year. Photo: Economist

The US Federal Reserve (Fed) is not kidding

Interest rate expectations in early 2023 are different than they are now. In the last nine months of 2022, the Fed conducted its strongest monetary tightening campaign since the 1980s. However, investors remain adamant that the Fed will continue to be aggressive this year. In January, the market still expected the US benchmark interest rate to peak at 5% in the first half of the year and then the Fed would start cutting.

But as of the last adjustment, the reference interest rate in the US is around 5.25-5.5%, the highest since 2001. Fed officials think interest rates will end the year above 5% and not cut until 2024. By continuing to raise interest rates despite a minor crisis in the US banking sector, the Fed has finally convinced investors that it is serious about keeping inflation in check.

Markets now expect rates to end the year at 5.4%, a big win for the Fed. In the past, the Fed's calm response to inflation has damaged its reputation, according to the Economist .

Borrowers can afford it

In the years of cheap money, which means low interest rates, the prospect of a sudden increase in borrowing costs is scary but hard to believe for investors. But when interest rates were higher, this scenario played out, but it wasn't too scary.

Since the beginning of 2022, the average interest rate on the riskiest debt of US companies has increased from 4.4% to 8.1%. However, there are very few cases of bankruptcy. The default rate for high-interest loans has increased over the past 12 months, but is only around 3%. This number is much lower than during stressful periods in history. For example, after the 2007-2009 global financial crisis, the default rate rose above 14%.

Maybe it's because the worst is yet to come. Many companies are running out of cash that has accumulated during the pandemic and are relying on low-interest, fixed-rate loans in the past. Still, there's reason to hope the worst-case scenario doesn't play out. For example, the differential between profit and interest expense for firms with the riskiest debt remains near the healthiest level in the past 20 years. So, rising interest rates may make it harder for borrowers, but not to a dangerous extent.

Some bank failures are not necessarily the crisis like 2008

After the collapse of Silicon Valley Bank - a mid-sized US bank on March 10, the atmosphere of panic was easy to imagine the 2008-2009 financial crisis.

Two other American banks, Signature Bank and First Republic Bank, shared the same fate. The situation seems to be spreading globally. Credit Suisse, a 167-year-old Swiss investment bank, has been forced into a merger with longtime rival UBS. At one point, Deutsche Bank, a German lender, was also in a precarious position.

But a full-blown financial crisis did not appear. The US stock market has pared losses for several weeks, although the KBW Index (KBW Index) that tracks the performance of financial firms in the US is still down about 20% since the beginning of March. Fears of a recession. The long-term financial crisis has not yet occurred.

This result is not easily achieved. The collapse of several banks in the United States was averted by a massive Fed bailout. The downside to this is that even mid-tier banks have a mindset that they're "too big to fail". This may encourage them to continue taking risks, thinking that the Fed will come to the rescue if they are in danger.

Investors are pouring money into tech stocks again

2022 is the time when investors in the US tech giants must be disappointed. Just a set of five, including Alphabet, Amazon, Apple, Microsoft and Tesla, account for nearly a quarter of the value of the S&P 500. Rising interest rates, however, have weakened them. Over the course of the year, the value of set 5 fell 38%, while the rest of the index companies fell only 15%.

But this year, that set of 5 has regained its form. Joining the group are also Meta and Nvidia, known as the "magnificent seven" for dominating profits on the US stock market in the first half of 2023. The group's share price skyrocketed to the point of accounting for more than 60% of the price. value of the Nasdaq 100 index in early July, prompting Nasdaq to drop its weight in a set of 7. The boom in tech stocks reflects investors' interest in artificial intelligence. They believe that the biggest companies have the best advantage to take advantage of this hot technology.

An inverted yield curve doesn't cause an immediate recession

The yield curve is a chart that shows the difference in the returns investors receive for buying short-term and long-term bonds. Yields on long-term bonds are often higher than short-term bonds, due to many unpredictable risks. So the yield curve is usually upward sloping.

But since October 2022, the yield curve has inverted, meaning short-term bond yields are higher than long-term bonds. Investors see this as the strongest signal of an upcoming recession. Because, the yield curve inversion (measured by the difference between 10-year and 3-month Treasury yields) has occurred only eight times before in the past 50 years in the US. Each time was followed by an economic downturn.

So, in October 2022, when the yield curve inverted, the S&P 500 fell to a new low of the year and investors forecast a recession very close to 2023. Contrary to history, the US economy and The stock market is still good so far. Therefore, there will be two possibilities, either that the recession comes later than expected or the way the recession is forecast by the inverted yield curve is no longer correct. In a year full of surprises, a second possibility will be what everyone has been waiting for.