Broker Check

Put differently, there’s no shortage of things that can go wrong with the economy and markets

May 15, 2023

Stocks proved resilient yet again last week, as the S&P 500 saw only a modest decline despite more bank stress (PACW), another rate hike from the Bank of England, a pop in jobless claims and a drop in consumer sentiment. The reason these negatives didn’t create a bigger move lower is clear: They don’t make the big risks in this market more likely, and so several material risks to the market will remain on the periphery. 

A hard landing may occur. The Fed may keep hiking rates. Inflation may not decline. Earnings guidance may get cut. The debt ceiling may be breached. 

In normal times and in normal markets, this formidable list of potential negatives would pressure stocks. But context matters, and after experiencing the worst year in the market since the financial crisis in 2022, and with the S&P 500 still nearly 20% below the all-time highs, in 2023 the market has adopted a “show me” state of mind. Put more bluntly, all those risks mentioned above may happen, but until it looks like they actually will, the combination of 1) The 2022 drop in stocks and 2) Continued broad expectation of calamity by the majority of investors is combining to support markets, as the news simply isn’t bad enough, yet, to cause material selling. 

The net result, I believe, is that we must respect this market’s resilient nature by staying long, but we must do so by controlling downside exposure, and that’s again, done via defensive sector tactical allocations, utilities, staples, and healthcare. 

Looking forward, economic data remains the key. I know that’s not the most exciting topic, but we will continue to watch the data very closely for you over the coming weeks and months because that hard vs. soft landing question is the question that decides the next 10%-20% in this market. And we are going to make sure you get it right, as early as possible. 

Debt Ceiling debate:

It’s hard to open up a newspaper these days and not see a scary story about the debt ceiling debate. The Biden Administration is saying that a “default” is approaching if an agreement isn’t reached soon.

The US has enough revenue to pay all bondholders, but a roughly $1.5 trillion deficit this year means that if the debt ceiling isn’t lifted, it won’t be able to pay all its obligations, maybe even entitlement payments under Medicare, Medicaid, or Social Security.

We’ve been here before, and as we have seen in the past, we think an agreement will be reached and that all bond payments will be made on time. We also think it’s very unlikely that any payments on entitlements will get delayed. Much more likely is that the Congress and White House will agree on some sort of framework to hold the line on increases in discretionary (non-entitlement) spending. Maybe they’ll also agree to form some sort of bipartisan commission to review proposals to reform entitlements.

In other words, lots of smoke and very little fire.

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