Broker Check

Stay patient as this all is about to change...

May 22, 2023

For all of 2023, due to a long and substantial list of risks facing the markets, investors (especially institutional investors) have expected stocks to decline (this is backed by multiple sentiments and investment surveys from throughout the year). But as those risks have failed to materialize, it’s caused the “pain trade” to be higher as underinvested managers chase returns higher, and that is exactly why the S&P 500 hit the highest level since August last week.
Put in plain English, money managers expected stocks to extend the losses from 2022 as more bad “stuff” would happen (recession, earnings declines, debt ceiling, higher rates, high inflation, etc.) However, those bad things haven’t happened yet, and that has caused stocks to lift and for the rally to be fueled by “chasing.”

Again, that was the case last week. Economic data clearly showed the economy is losing momentum, but still mostly pointed to a soft landing. Earnings from major retailers pointed to more restrained consumer spending focused on staples and low-margin items, but not a sudden collapse. The debt ceiling negotiations showed progress and made a debt ceiling breach less likely. All those events are not as bad as feared.

However, it’s important to remember that none of them are “good” either. Economic growth is clearly slowing and that’s really not good for anything. It’s now just a question of by how much (and we won’t know that for at least another few months). Earnings growth is challenged, and while companies are navigating it well so far, the slowdown is just in the early innings. Finally, the debt ceiling has shown progress, but there’s no deal yet and we’ve got less than 10 days until the “X” date! Finally, the Fed has likely paused rate hikes, but the market is expecting cuts by year-end, and there was some serious pushback on that idea last week from Fed officials.
Bottom line, not-as-bad-as-feared events have largely fueled the YTD rally, and that can continue, especially if the S&P 500 can sustainably break out to new highs because that will create more “chasing.”

But “not as bad as feared” cannot support a sustainable rally (one that lasts for quarters). The point being, the “pain trade is higher,” but at this point, it’s long in the tooth. And while it’s not over, it can’t push the S&P 500 sustainably into the mid-4000’s (the valuation will get too stretched). Instead, we need an actual positive resolution from these events, i.e. clear soft landing (that doesn’t pressure the market multiple), earnings stability (which keeps valuations reasonable), Fed debt ceiling deal, and Fed confirmation that rate cuts are coming sooner than later (the sought-after pivot).

We’ve advocated maintaining being fully invested throughout 2023 given our recognition that despite numerous risks to markets, investors’ expectations were already very cautious. But we also must account for the fact that those risks are still real (hard landing, earnings drop, more- hawkish Fed) and our experience from ’99 and ’07 gives us one clear lesson: These risks can take longer to appear than anyone appreciates, but just because they haven’t occurred yet doesn’t mean they won’t occur.

My preference is for a conservative defensive approach to our investments. When these macro risks are materially reduced, it’ll be time in my opinion to get more aggressive. But while momentum is clearly higher, the macro risks facing this market haven’t been reduced so far in 2023, they just haven’t happened, and that’s an important context to keep in mind.

As I have been saying for months, the clear picture will be evident about mid-summer. Until then no changes to the portfolio. Stay patient as this all is about to change.

"This material is provided for general information and is subject to change without notice.  Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. The information does not represent, warrant or imply that services, strategies or methods of analysis offered can or will predict future results, identify market tops or bottoms or insulate investors from losses. Past performance is not a guarantee of future results.  Investors should always consult their financial advisor before acting on any information contained in this newsletter.  The information provided is for illustrative purposes only.  The opinions expressed are those of the author(s) and not necessarily those of Geneos Wealth Management, Inc."