From the global economy to stocks and bonds, investors consider the path forward for a market that’s looking much different this year than last.
Our Top Market Takeaways for April 14, 2023
Market update
It ain’t 2022 anymore
Perhaps the clearest sign that markets have moved on from 2022 is that not even the latest Consumer Price Inflation data could cause much of a ruckus.
After the release suggested a relatively ho-hum increase in prices (0.4% for core, 0.1% for headline on the month), investors shifted focus to the upcoming earnings season, hoping to learn more about the state of bank deposits, consumer spending and technology turnaround efforts.
The returns we have seen stand in stark contrast to 2022’s risk-off environment. From their respective lows, Bitcoin has surged almost 100%, Chinese internet companies have gained over 70%, mega-cap tech stocks are up nearly 50%, and even the ARKK Innovation ETF, which shed two-thirds of its value in 2022, has bounced by 33%. The best stock in the S&P 500 this year (NVIDIA) is up over 80%. In 2022, it lost 50%.
European equities are close to all-time highs, and core bonds have provided a workmanlike 3.5% return. The U.S. dollar is close to its lowest levels in a year.
The most valuable players in portfolios last year were short-term Treasuries. This year, most major asset classes are outpacing T-bills. Energy and commodities, the other 2022 standouts, have also lagged.
We welcome the vibe shift in markets, but there is no shortage of debate about what the rest of the year has in store. In today’s note, we review the case that both bulls and bears make for the path forward, then provide our take.
Spotlight
Bull vs. Bear
The U.S. economy
The bears have a lot of evidence they need to make their calls for a U.S. recession. Rate hikes have consequences after all. The failure of Silicon Valley and Signature Banks may not have led to a crisis of confidence, but the problems for bank profitability and credit availability may just be getting started. Small businesses are already reporting that credit is harder to find, the office real estate sector will likely have a material distress cycle, given higher interest and vacancy rates, and continuing jobless claims are starting to signal cracks in the labor market.
Bears say: a credit crunch will restrict growth further
The chart describes the % of Federal Reserve Board senior officers saying that banks are tightening C&I loans to large firms. There are recession shades throughout the chart to represent the time and window of recession.
The first data point came in at 54.4% in June 1990 before dropping to a low at -25% in September 1993. Then it rose to 59.6% in March 2001 before dropping to a low point at -24.1% in June 2005. Then it reached the all-time high at 83.6% in December 2008 before dropping shortly after to a low at -21.8% in September 2011. Then it fluctuated in the range before jumping to a high point at 71.2% in September 2020 before dropping to -32.4% in September 2021. The series ended at 44.8% in March 2023.
For recession shades, the first recession shade started in August 1990 and ended in March 1991. The second recession shade started in April 2001 and ended in November 2001. The third recession shade started in January 2008 and ended in April 2009. The fourth recession shade started in March 2020 and ended in April 2020
The bulls still have a decent case to make. Wage inflation seems well on its way to normalization without any rise in the unemployment rate, which seems to settle one of the key macroeconomic debates of the last 18 months. Even though strains are just starting in the office sector, the residential housing market is showing tentative signs of turning a corner. Housing market sentiment and home sales are tentatively perking up.
Our take is that it still seems like a recession is more likely than not, but a softer landing is possible. We will be watching closely for signs that the credit crunch from March is having a sustained negative impact through the spring.
The global economy
The bears on the global economy seem to be worried about geopolitical risks, energy crises, an unpredictable war and unresolved trade issues between the United States and China. It makes sense to keep a keen focus on all of these unresolved issues that threaten economic growth and stability. In fact, our Chairman and CEO Jamie Dimon spent time discussing them in his latest letter to shareholders. The biggest risks facing the global economy outside the United States are probably not endemic to the business cycle, but are still very important to monitor.
The bulls seem to have the upper hand here. Global Purchasing Manager Indices, which offer a real-time indication of business activity, are at their highest levels since last summer and have had a tremendous bounce since last fall. A weaker dollar helps grease the wheels of global trade, and China’s reopening continues to provide a boost. Louis Vuitton helped drive the French stock market to an all-time high this week after strong sales in China.
Bulls say: global PMIs are their highest levels in 9 months
The chart describes Global PMI from January 2010 until March 2023. Values that are higher than or equal to 50 are considered expansionary.
The first data point came in at 55.3 in January 2010. Shortly after, it rose to a peak at 56.9 in April 2010 before dropping all the way and bottoming at 50.0 in September 2012. It then went up to 55.2 in June 2014 before bottoming at 50.5 in February 2016. It soon went back up to 54.8 in February 2018 before dropping all the way to 39.1 in March 2020. Then it climbed all the way to 58.5 in May 2021. It soon dropped to a low point at 48.0 in November 2022. The series ended at 53.4 in March 2023.
Our take is that growth prospects outside the United States look better than they do inside the United States. This means the dollar is likely to continue to weaken, and investors should look to European and Chinese stock markets, which could continue to perform well.
The bond market
The bears on bonds have a simple case: The economy is still chugging along and inflation is still at ~5%. It doesn’t make much sense for yields to fall (and bond prices to rise) as long as growth remains resilient and inflation stays sticky.
The bulls say markets only have ~80 basis points (bps) of interest rate cuts priced in over the next 12 months. In the average recession back to the 1950s, the Federal Reserve has cut by an average of ~300 bps (excluding Volcker’s 1980 campaign). In a recession, Fed cuts will likely be deep, and price gains in core bonds could be steep.
Historically, the Fed cut by an average of 300bps in recession
The chart describes the change (in basis points) in the effective fed funds rate 12 months following the start of recession. The chart data describes a total of 10 recessions in a bar chart format. It also included a bar that describes the average of all recessions except for the 1980 outlier, and another bar that describes the current market pricing for 12 months from now.
Here are the change (bps) in effective fed funds rate 12 months following the start of recession:
1957: -171
1960: -243
1970: -407
1973: -58
1980: 526
1981: -645
1990: -233
2001: -376
2008: -408
2020: -147
Average ex-1980: -299
Current Market Pricing: -81
Our take if our base case on the economy plays out is that we could be in for much lower interest rates (and higher bond prices) over the next 12–18 months. However, for the tactical investor, there may be better entry points in the weeks ahead.
The stock market
The bears point to the ominous U.S. economic backdrop to justify their view that stocks should head lower. Valuations also seem to be embedding a high degree of confidence in a relatively benign earnings outcome. The forward P/E multiple of the S&P 500 is above 18x again, and the spread between what you can yield from earnings and what you can get from corporate bonds is the tightest of the last 10 years.
The bulls suggest the earnings recession that we have been in is set to end after this quarter. After that, consensus expectations call for earnings growth to quickly bounce back to a low teens pace by the end of the year. Beyond the fundamentals, positioning seems short, which could set the market up for a squeeze higher if we have an upside surprise this earnings season.
Our take is that neither are right. Instead, we expect choppy, rangebound trading through the rest of the year. Certain sectors (healthcare, industrials and reasonably priced tech) and sizes (mid-caps) may outperform, but at an index level, we are pretty close to where we think the market will likely end the year.
Takeaways
Back to reality
The hardest part about 2022 was that barely any investments worked.
What we have learned so far this year is that 2022’s environment of boiling inflation and aggressive interest rate hikes is in the rearview mirror.
The debate between bulls and bears will continue, but investors should take comfort in the idea that assets are doing what they need them to do to achieve long-term success. Equities drive long-term growth. Bonds provide stability and security. Alternatives allow for the potential to outperform public markets and access unique opportunities.
We can help address the investment challenges ahead while building portfolios that help you reach your financial goals.
Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.
Small capitalization companies typically carry more risk than well-established "blue-chip" companies since smaller companies can carry a higher degree of market volatility than most large cap and/or blue-chip companies.
International investments may not be suitable for all investors. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations. Investments in international markets can be more volatile.
Diversification does not ensure a profit or protect against loss.
The Bloomberg U.S. Aggregate Bond Index is an unmanaged, market-value weighted index comprised of taxable U.S. investment grade, fixed rate bond market securities, including government, government agency, corporate, asset-backed, and mortgage-backed securities between one and 10 years.
Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The index consists of 23 developed market country indexes and 24 emerging market country indices.
The NYSE FANG+ Index is an equal-dollar weighted Index designed to represent a segment of the technology and consumer discretionary sectors consisting of 10 highly-traded growth stocks of technology and tech-enabled companies.
All market and economic data as of April 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
RISK CONSIDERATIONS
- Past performance is not indicative of future results. You may not invest directly in an index.
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