It's hard to believe that we have already arrived at the last trading week of the first half of 2023.
It certainly has been an eventful year to this point. Investors have experienced the second, third and fourth largest bank failures in U.S. history, the yield curve is as inverted as it has been since 1981, and we even have seen what appears to be a failed coup in Russia over the weekend.
And despite fast rising interest rates, accelerating corporate defaults and myriad other economic concerns, the Nasdaq has risen more than 35% so far this year. Albeit, breadth has been lousy with the small-cap Russell 2000 up less than 5% year to date.
What lies ahead in the second half of 2023? I have three predictions:
The Nasdaq Has a Significant Pullback
The mega-caps that have powered the huge rise in the Nasdaq in 2023 are clearly overextended at this point.
Tesla (TSLA) trades for more than 60 times trailing earnings and profits are projected to fall this fiscal year. Nvidia (NVDA) , powered by AI mania, sells for more than 125 trailing profits. Apple (AAPL) is relative bargain at 'just' 30 times earnings, until you take into consideration both revenues and profits are projected to fall slightly in FY2023.
At some time in the second half of 2023, some 'sanity' will return to this corner of the market and the Nasdaq will have at least a 15% 'hiccup' before year end.
Commercial Real Estate Continues to Deteriorate
The commercial real estate sector is facing accelerating challenges in the era of higher interest rates and declining property values, especially in the office and retail space. The owners of the largest mall in San Francisco as well as the two largest hotels in the city by the bay have recently turned in the keys to their creditors as loans on their properties had to be refinanced by the end of this year.
This will become a much bigger story in the second half of 2023. Roughly a quarter trillion dollars has to be refinanced at much higher rates before now and the end of the year, approximately 30% of that on office buildings. Over the next three years, $1.5 trillion needs to be rolled over.
There are many situations where the underlying collateral has lost considerable value and the owner now has little to no equity left in the asset as a result. Faced with refinancing at double the interest rates of just a couple of years ago on these types of loans, many will just walk away. This will erode asset values further.
It also will put further strain on regional banks who hold some 70% of the loans to the commercial real estate sector. This will result in increasing writes offs for the industry, which will likely tighten credit criteria even further as a result.
The Economy Is in a Recession by Year End
A hugely inverted yield curve is historically a good sign of a recession looming on the horizon. Add in negative money supply growth since late last year, a potential 'credit crunch' as the result of accelerating loan delinquencies, fast increasing layoffs across many sectors of the economy such as technology, the Leading Economic Indicators falling for 14 straight months now, a continued restrictive monetary policy, etc...
It's hard to see how the economy is not in a recession by year end despite reassuring words from our Treasury Secretary recently that the nation will skirt one.
Not exactly an optimistic set of predictions for the back half of 2023. However, I would be surprised if at least two of the three don't come to fruition. Investors should position accordingly.