Amada Agati:  

As we come back from a relaxing Fourth of July long weekend, there's just so much to catch up on, so consider this edition of "Adding Alpha" your Halftime Report for markets.

It's pretty amazing that the S&P 500 is having one of its best first halves of the year in the past 10 years. And we'll take it, we're very happy to have such strong returns on a year to date basis, but let's just say the crystal ball did not have clear blue skies and abundant sunshine in the forecast.

The trouble is these gains are really being driven by just a handful of mega cap stocks while the remaining 490 stocks have been pretty muted by comparison. 

You have to look under the hood. While price may be telling a narrative that all is seemingly well and fine, it's a very different narrative under the hood.

On an equal-weighted basis the S&P 500 is only up about 5% year to date, and small and mid-cap stocks are not much more than that either.

Low to mid single digit returns are really what we'd expect with the Fed still in policy tightening mode, global economic growth decelerating, and already being in an earning's recession.

We're just three short weeks away from the next Fed meeting where we expect they'll raise rates by 25 basis points, taking the Fed funds rate to a whopping 5.5%, in the highest level since 2001.

The headlines have been describing the June meeting as the Hawkish Paws, but the stock market is reacting as if the Fed is done and dusted.

I sort of get the market's perspective since the Fed hasn't paused and then resumed rate hikes since the early 1980s, but it's yet another important reminder that the markets and the Fed aren't on the same page.

Headline inflation is thankfully well below the 9% highs of last summer, but if you back out food and energy, core CPI started this year at 5.7% and it's still 5.3% that's more than double the Fed's long-term target of 2%.

Between that and some continued strong economic data, namely housing and labor market related, in our view, this all gives the Fed enough ammo to keep on keeping on tightening policy.

So we're still in a longer for longer Fed dynamic. More rate hikes to come, a higher terminal rate than what the market expects, and a longer overall tightening cycle. Fed's not out of the driver's seat yet.

Believe it or not, second quarter earning season starts in about a week. We're expecting it to be the third quarter in a row of negative earnings growth.

As a reminder, the S&P 500 delivered -5% for Q4 of 2022, -2% for Q1 of this year, and the forecast for Q2 is -7%. Key for us will be to understand the trajectory of revenue growth from here.

Will we finally start to see signs that demand is in fact slowing down? We think that that is the next shoe to drop in this cycle.

If we zoom out and take a look at expectations for the balance of the year and beyond, consensus is still expecting positive 1% earnings growth for 2023 and plus 12% for 2024, which just seems way too high and optimistic.

We think those estimates do need to come down, which would ultimately lead to markets giving back some of those precious year to date returns we've enjoyed so far.

We don't think this means the market has to finish the year in negative returns territory, but we still think at least a 10 to 15% pullback from present levels seem appropriate giving the headwinds that continue to swirl. A forward P/E of nearly 19 times market valuation definitely looks stretched.

When we look under the hood, the top 10 stocks are trading at a forward P/E of more than 31 times, while the remaining 490 stocks are trading at roughly 16 times. No matter how you slice and dice it, this market is not priced for recession.

As a result we're continuing to run a defensive playbook but encouraging our investors to stay invested, which means don't raise a lot of extra cash and shift to the sidelines. FOMO is driving sentiment, not fundamentals.

In this macro dominated Fed induced environment, investors just aren't being paid to take big bets in any direction. Stay focused on long-term strategic targets, and stay well diversified, and lean into quality and investment grade exposures.​