In this episode of KayneCast, Julie Kutasov, Portfolio Manager for the KAR Small-Mid Cap Core Strategy, joins host Steve Rigali, Executive Managing Director with Kayne Anderson Rudnick. Together, they review the state of the equity market during Q2 2023 and discuss the Small-Mid Cap outlook for Q3.

Q2 2023 Passes Without Anticipated Recession

The most significant influence on the market in Q2 was the absence of a widely anticipated recession. While the threat of recession continues to dominate the market, swift action from bankers and regulators in the wake of the March 2023 collapse of Silicon Valley Bank helped prevent a financial crisis. The labor market remained solid despite layoffs in the tech sector. While partisan arguments over debt limits raised fears the U.S. government would default on its loans, a last-minute agreement on government spending averted economic disaster.

Equities advanced in the second quarter, with the S&P 500 Index up 8.7 percent and NASDAQ rising 13.1 percent. These gains resulted from investor interest in large technology companies at the forefront of the artificial intelligence boom, which many believe will usher in a disruptive new era for computing.

All this led to investors willing to buy riskier assets. As Kutasov notes, “The second quarter’s performance of the Russell 2500 Index, this strategy’s benchmark, was driven by companies with lower earnings quality, weaker balance sheets, and higher share price volatility.”

Slowing Economic Growth May Cause a Flight to Quality

Despite modest gains in Q2 2023, the slowing economic growth continues to impact the market. Geopolitical and inflationary pressures top the list of investor concerns. While still an issue, inflation has improved since the beginning of the year; however, the Fed may continue to raise interest rates.

The March banking crisis was an unexpected consequence of the Fed’s hawkish approach to inflation. A rash of company bankruptcies in the U.S. and deteriorating manufacturing data also indicate a 2023 recession remains a possibility. On the positive side, the labor market, while tight, appears to be improving.

Kutasov ends her Small-Mid Cap outlook by noting that slowing economic growth usually prompts a “flight to quality” among investors, which bolsters KAR’s high-quality investment philosophy. She also notes AI is a fast-growing aspect of the technology sector and that KAR will continue to seek out companies “best positioned to benefit as the technology is being developed and deployed over time.”

Listen to the podcast to learn more about Small-Mid Cap performance in Q2 2023 and read our Quarterly Market Review written by KAR CIO Doug Foreman for additional insights on Q2.