Financial markets: Economic outlook for the second half of 2023

A closer look at financial markets. Key questions answered.

The financial markets can look back on a robust first half of 2023 – despite all expectations to the contrary. Inflation has slowed significantly, especially in the US. Find out what lies ahead for investors in the second half of the year.

In the US, the first half of 2023 was marked by resilience: Companies posted better results for the first quarter than expected, and the US economy continued to grow despite interest rate hikes measuring a total of 500 basis points since March 2022. Read on for the answers to three key questions.

1. How should investors position for the second half?

As the second half of 2023 ramps up, equity markets are pricing a benign path forward. But from here, investors face a balancing act. There is a path higher for stocks, but it is a narrow one and comes with risks: Economic growth can neither be so strong as to force the Federal Reserve into further rate hikes, nor so weak as to drive fears of a recession. On balance, economic growth will most likely weaken over the second half of the year.

Increased uncertainty means that fixed-income investments currently offer a better risk/return ratio than equities. In light of healthy yields and the uncertainty regarding further economic growth, higher-quality bonds should be prioritized in this context – including highly rated and investment-grade bonds. Potential options for a thematic focus could include dividend-paying equities or emerging market equities, for example. Investors would currently also be well advised to prioritize gold.

2. Can the equity rally continue?

The S&P 500 has rallied more than 15% this year. However, the positive US macro news is probably largely priced into the S&P 500, setting the bar higher for the rest of the year. The rally was supported particularly by a robust US economy and optimistic assessments of a small group of AI shares. The latter are now trading at high valuations and are concentrated on a handful of mega-cap growth stocks. Historically, such narrow rallies have been less sustainable.

Within equities, investors should therefore focus on areas that have lagged this year’s rally, like emerging markets, consumer staples, and industrial stocks, and prefer equal-weighted US indexes to cap-weighted ones.

3. Will the US dollar fall further?

The US dollar proved resilient in the first half of 2023, with better-than-expected data pointing to further rate hikes from the Federal Reserve. But the USD index is still down roughly 12% from a 20-year high reached in September, with the decline resuming in the wake of muted June US inflation data. Overall inflation rose by 3% year on year in June, the lowest increase since March 2021.

As the Fed’s hiking cycle comes closer to an end, the rate differentials between the US dollar and other currencies i.e. the US interest rate advantage could continue to narrow. As such, the US dollar will most likely depreciate further over the months ahead – to the benefit of the price of gold, which consequently has the potential to reach a new all-time high of USD 2,250 per ounce by June 2024.

This means that the Swiss franc will most likely continue to serve as a safe haven as well, since the Swiss National Bank is expected to stand by its restrictive monetary policy in the interest of containing price pressure in Switzerland and keeping the real external value of the Swiss franc stable.

We wish to thank Christopher Swann, Strategist, UBS Switzerland AG, and Vincent Heaney, Strategist, UBS AG London Branch, for providing this article.

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