The S&P 500 Index finished higher by 16% for the first half thanks to a handful of secular growth stocks. The Invesco S&P 500® Equal Weight ETF finished just shy of 7%. In June, the stock market, measured by the S&P 500 Index, rose more than 20% from its October 2022 low confirmation a new Bull market is underway. Albeit it a concentrated Bull market with a small part of overall market racing ahead. A study by Capital Group concludes that concentrated market rallies in the past have often been followed by steady gains for the broader market. I favor investing in reasonably valued areas of the stock market that are trailing such as U.S. Mid-to-small cap stocks. Those areas may catch up as the consensus call for an outright recession fade. The U.S. Fixed-income market, measured by the iShares Core US Aggregate Bond ETF, is up 2.26% year-to -date. This time last year it was down significantly.

The late-cycle economic phase with declining risks of garden variety recession calls for a balanced diversified portfolio with a tilt to cyclical stocks. With the Federal Reserve nearing the end of its tightening cycle and a resilient US economy pushing out any recession, an asset allocation that addresses both slower economic growth and a reacceleration in future earnings is the way to position a portfolio at this stage of the market cycle. Primarily, when the Fed stops tightening then historically it is time to buy stocks, Long-term Bonds, and not Treasury-bills. Typically, stocks and bonds have outpaced cash after a Fed hiking cycle ends.

The S&P 500 Index returned 7% for the first quarter and the SPDR Aggregate Bond ETF 3.23%. Semis conductor stocks are leading the market. Historically, when semis lead it is a bullish sign for investors. Historically, when the S&P 500 ended a quarter up so much it also ended the year higher according to BIG research. Markets are anticipating the end to rate hikes this year. Interest rates are the key to markets. Higher rates depress valuations across all types of assets, not just stocks and bonds affecting wealth, and consumption.

The late-cycle economic phase with high risks of recession calls for a balanced diversified portfolio. With the path of the economy either slipping into a mild recession or narrowly averting one, an asset allocation that addresses both recession scenario and slower economic growth is the prudent approach. Investors cannot ignore the end to this tightening cycle and the opportunity for future growth. There are reasons not to be overly risk off and invests entirely for a recession only. After a recession comes the early cycle recovery which has historically yielded strong U.S. equity returns.

The U.S. equity market and bond market simultaneously entered a bear market last year – an uncommon event. Behind both Bear markets are inflationary supply side constraints and government Fiscal and Monetary Policy mistakes. The Federal Reserve (Fed) is closer to the end of its rate tightening cycle, the fastest ever, aimed at slowing economic growth which in turn should lower inflation that reached a 40-years high. This Bear market ends when the Fed stops hiking the Federal Funds Rate (FFR) this quarter. Every Bear market is followed by a Bull market. Investors are close to the shore…stay invested.

The late-cycle economic phase with stagflation conditions and high recession risk calls for a balanced diversified portfolio. With the path of the economy highly uncertain, an asset allocation that addresses both recession scenario and slower economic growth is the prudent portfolio strategy. Bonds offer better risk-adjusted returns than equities for the time being. Although selective economically sensitive stocks offer greater long-term growth potential. I am staying balanced with a laddered approach towards investing in investment grade bonds, and own quality dividend growing stocks both defensive and cyclical ones.

Stocks and bonds posted their third consecutive quarter of negative returns, as aggressive monetary tightening has taken a toll on equity and fixed income valuations. The S&P 500 Index is down 24.9% Year-to-date (YTD). The conventional “all weather” 60% Equity/40% Fixed-Income portfolio is down 20.1% YTD according to Morningstar – worst on record. Higher rates have adjusted valuations down for both stocks and bonds closer to normal levels associated with slow economic growth.

The late-cycle economic phase with stagflation conditions and high recession risk calls for a balanced diversified portfolio. There-Is-No-Alternative-To-Stocks (TINA) is dead. Bonds for the first time in years are competitive to stocks. Although many stocks offer greater long term growth potential. Stay balanced by overweighting quality short term bonds, and quality dividend growing stocks both defensive and cyclical ones.

The S&P 500 had its worst first half of a year in more than 5 decades and so did the Bond market. What happens next? My assessment is that the S&P 500 Index bottoms setting stage for stocks to rally over next twelve months. A normal Bear market last on average 11 months and declines 28% on average. This Bear market is in its 7th month and has given up intra-day gains of 24.5% from it’s high. The decline in stock values reflects stagflation economic conditions. The S&P 500 Index could decline another 4% from here if the economy is just in a shallow recession (3% or less contraction in real economic growth).

The business cycle is rapidly moving through its late stage. Economic activity and demand have peaked in the face of Monetary and Fiscal policy headwinds.

It is too late to underweight equities. I would stay the course with equities because equities should outperform over the next 12 months as the stock market bottoms ahead of the economy. In 2023 Fed hikes end, and the S&P 500 Index should be significantly higher than today as it anticipates a rebound in economic activity. Today’s pain will be next year’s gain for both stocks and bonds. It is time to start dollar-cost-averaging into stocks and bonds. Be defensive by buying high quality profitable stocks. At this point buy cyclical stocks versus defensive ones. Buy investment grade bonds only.

In the first quarter, the S&P 500 Index corrected intraday 14.9% from its high, and on a closing basis 13% implying that the U.S. economy is in a growth scare rather than an impending recession. By quarter end, a broad rally in stocks recovered more than half this correction losses. This was the worst correction since the start of the Covid pandemic two years ago. A faster tightening cycle by the Federal Reserve, runaway inflation and Russia’s invasion of Ukraine all contributed to the stock market’s correction.

The S&P 500 could retest current correction low if inflation does not peak in Q2. Parts of the Treasury yield curve inverted, typically a harbinger of a recession ahead. The yield curve subsequently quickly un-inverted to a positive sloping curve making an argument for growth ahead not a recession. The 3 months-to-10-years Treasury Yield Curve, a more reliable indicator, remains steep signaling no recession ahead. Which way the market goes depends on the path of inflation. If the Fed through its front-loaded hikes cannot curb inflation soon then expect a recession and down market in stocks over next twelve months. Furthermore, weighing on stocks is the upcoming Mid-term election. Historically stocks correct sometime from May through October period before Mid-term election.

The bottom line, this will be a transition year for the U.S. economy but worth the pain. Does anyone really expect that transitioning from abnormal monetary policy (zero Fed Funds rate in an economy that grew at 5.7%) to more normal monetary policy will happen smoothly? In the end the U.S. economy will be better off with normal yields and rates and so will income investors.

There may be room for investors to gain from stocks later this year. The S&P 500 typically peaks 18 months after an inversion and a recession typically starts shortly after that – late 2023. It takes around a year for stocks to peak after a point of the Yield Curve inverts, and the S&P 500 usually trades higher by 15% during that period, according to JPMorgan. Following the Midterm election, this November through April 2023, S&P 500 enters its historically best return period of the Presidential cycle, with past returns strongly positive one hundred percent of the time according to the Stock Trader’s Almanac. Given inflation recedes and U.S economy avoids a recession, stocks would rally. For the time being, I am only buying stocks at lower entry levels than today’s market level. I expect to be overweight stocks again before Midterm election day.

Portfolio strategies are closer to their neutral weighting in equities because it pays not to fight the Federal Reserve (Fed). The Fed is removing liquidity from the economy by hiking its key interest rate and reducing its Balance sheet (not buying Treasuries). The S&P 500 index has an inverse relationship to the Federal Balance sheet. When the Federal Balance sheet expands the S&P 500 Index moves higher and when it shrinks so do stock multiples. This year poses numerous headwinds for stocks and bonds.

The U.S. economy is in early Late cycle experiencing stagflation. Certain areas of the equity market have more upside than other areas. Those areas are Energy, Commodities, Materials, Technology, and Consumer Staple sectors. In addition, defensive type sectors such as Healthcare. Portfolios will remain underweight in bonds and near neutral in cash-equivalents and ultra-short bonds until the second-rate hike. Historically, by the Fed’s second-rate hike bonds become a buy.

I am rebalancing portfolios from neutral to overweight equities at the beginning of the fourth quarter before mid-term election day. The headwinds troubling stocks now should abate by then producing a strong year-end rally. Until then hold onto stocks which are the best long-term inflation hedge. Many companies have been able to pass on rising costs, and I see low real rates favoring equities.