The first half of 2023 just ended, and what a first half it was! The question now becomes: What’s going to happen in Q3? While I’m tempted to borrow a line from the great Bob Dylan and say, “The answer, my friend, is blowin’ in the wind,” I will refrain from doing so and give you what I think you’ll find to be a much more substantive response, explains Jim Woods, editor of The Deep Woods.

After a very bearish 2022 that saw the S&P 500 lose some 19% of its value, stocks have made a rather robust rebound through the first six months of this year, with the benchmark domestic equity index turning in a near-16% move to the upside.

Now, last year stocks were down nearly across the board, but the declines were particularly deep in tech and other high-beta sectors. This year, we’ve seen a huge reversal of fortune in tech, and particularly mega-cap tech stocks such as Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Meta Platforms (META) and Nvidia (NVDA).

The heavy market-cap weighting in the Nasdaq Composite of these mega-cap techs, and of course their big moves higher, helped vault the index up more than 31% year to date. Below, the chart of the major domestic averages year to date tells the tale of a tech-fueled rally that looks to me like it wants to continue much higher.

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The way I see it, as we begin the third quarter, the outlook for stocks and bonds is arguably the most positive it’s been since late 2021. Think about this: Inflation has just hit a two-year low, economic growth and the labor market remain impressively resilient, the Fed has temporarily paused its historic interest rate hiking campaign, the debt ceiling extension is resolved, and we’ve seen no significant contagion from the regional bank failures from earlier this year.

All of these positives augur well for a continued rally. And while clearly the past quarter brought positive developments in the economy and the markets, it’s important to remember that potentially significant risks remain.

Keep in mind that the economy has not yet felt the full impact of the Fed’s historically aggressive interest rate hikes. And while the economy has proven surprisingly resilient, we know from history that the impacts of interest rate hikes can take far longer than most expect to impact economic growth.

There’s also the fact that markets are trading at their highest valuation in over a year, and investor sentiment has become intensely optimistic. For example, the CNN Fear/Greed Index ended the second quarter at “Extreme Greed” levels, while the American Association for Individual Investors (AAII) Bullish/Bearish Sentiment Index hit its most bullish level since November 2021, right before the market collapse started in early 2022.

So, while clearly there have been positive macro developments in 2023 that have helped the stock market rebound, it’s important to remember that multiple and varied risks remain for the economy and markets.

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