Broker Check

Seeing the Forest for the Trees

October 02, 2023

Throughout 2023, investors have tended to take a near-term disappointment or surprise from the economic data and extrapolate it to have some medium or longer-term implications, and that happened again with this recent pullback in stocks, as markets were volatile again last week as some anecdotally stagflationary data early in the week hit markets, while a drop in global inflation metrics on Thursday/Friday provided a bounce back. 

The problem with reacting to individual data points too intensely is that, more times than not, it leads to the wrong conclusion. Consider that at the start of the year, high inflation data and soft growth led to widespread expectations of unholy stagflation. That stagflation has yet to materialize.

It happened the opposite in July when markets fully embraced the "soft landing" narrative and dismissed inflation as already vanquished, the Fed as done, and growth as invincible. Similarly, that positive outlook proved premature. 

And I think we've seen this again in this latest pullback. It wasn't that the data had suddenly turned that bad. Yes, some growth metrics wobbled (flash PMIs), and yes, some inflation metrics bounced back. But when watching economic data, one must be able to separate the forest from the trees; otherwise, you're sentenced to this whiplash between "everything is great" and "everything is terrible." 

The job of anyone watching data is to cut through that noise and find the truth, and here is the truth of this market as I see it. 

The recent pullback did have merit from the near-term highs near 4,500, as rising Treasury yields, some anecdotally high inflation data, and mixed growth readings simply didn't support stocks at those levels. But none of the data recently has been that "bad" that all of a sudden, we need to be materially skeptical about the Three Pillars of the Rally. And the shift in sentiment to current negative levels again seems overdone in the near term, compared to the data. 

The point being that things weren't as good as they seemed near 4,500, but they're not much worse than they have been for the past several months with the S&P 500 testing 4,200. For now, the data says it's somewhere in the middle, i.e., growth that's generally stable, inflation that is still declining (albeit more slowly than before), and a Fed that probably isn't much more hawkish than feared. That said, real challenges for this market are looming on the horizon. 

On growth, the "easy" part is now mostly behind us. It's not shocking that a spike in yields hasn't caused a slow-down, given high savings, low unemployment, and the fact that rates have only been high for less than a year. But with each month that passes, that situation tilts more negatively. Excess savings are likely gone (or almost gone), employment is showing some initial signs of deterioration, and high rates are biting more each month. 

On inflation, again, the easy part is behind us. It's not hard for inflation growth to slow when we're comparing to unsustainable levels of 2022. Now, the comps get harder, and the monthly data will become substantially more important. And with rising oil and commodity prices, the prospect of a bounce back in inflation is real and must be watched. 

Finally, on the Fed, they have proven quite clearly that they will react to the data. This is not the Fed of the 2010s. This is not a Fed looking for any excuse to provide stimulus. It's a Fed that's focused on inflation, and if killing inflation slows the economy, so be it. 

Here's what I think it all means. Data is driving this market, and that isn't changing anytime soon. But investors are much too focused on taking select data points that are surprisingly good or surprisingly bad and extrapolating out a larger narrative, and that's why we've seen an uptick in volatility. The key for this market, going forward, is to look through the "forest" of data and identify whether those longer-term risks are materializing because if they are, it will be time to get more defensive. But it'll take more than one or two anecdotal data points to decide that. And that's exactly what we'll be focused on, cutting through the noise and monitoring the economic forest and not getting lost in the trees of individual data—because that will be the key to finishing 2023 strong and navigating what could be a more volatile 2024. 

The bottom line is that we will remain defensive until the data is clear and markets have corrected a bit more. My belief is that by the end of the year, the data will show us that the economy is not headed for a recession and that the markets are on solid growth. I expect that by Christmas, we will have a clear indication that it is time to switch to growth with some certainty that the markets are on solid ground. The number of reports that we will watch over the next couple of months will either confirm that thesis or not. We stand ready to make the moves if my best estimate is realized. For now, we will remain diligent. Until then, we are exiting the international sector and adding growth to our portfolio as I see the US market as the leader in this next move.  

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