Climbing a Wall of Worry
What happened last week?
The S&P 500, Nasdaq and Dow gained 1.54%, 2.11% and 1.24%, respectively, as each recorded a new all-time high.
We don’t think “normal” interest rates will fall to post-2008 lows. The risk of supply shocks and other negative catalysts is ever present. The Fed may still slow the US labor market more than it intends to. This does not dissuade us from sticking to balanced investment allocations with equities overweight during an economic expansion (the US economy has expanded in 86% of all months since WWII).
3 Things to Know
Global Growth Is Broadening and US Employment Slowing
Today, we expect a “normalization” of the conditions of 2022-2023.
For a time, this will include rising profits and slowing employment together. This means less US interest rate pressure and exchange rate pressure — apart from the possibility of a new tariff shock we discussed in last week’s CIO Bulletin.
In the meantime, the world economy is regaining its footing, as demonstrated by new optimism in Europe following the trade and manufacturing weakness of the past two years.
There is little holding back many of the world’s equity markets from delivering returns well in excess of cash, consistent with economic development and risk. We believe it is time to reexamine diversification and global exposures.
In 2022, US employment growth exceeded real GDP growth by the most since 1974. The gain in US hiring through 2023 — led by services that were held back deep into the post-pandemic recovery — helped the economy grow through a period of sharp monetary policy tightening.
The gain in employment also coincided with a drop in corporate profits in cyclical industries last year. These declines for profits and strong gains for employment are reversing. In essence, the economy has been “out of sync” with historic norms.
Recessions and recovery cycles tend to be more uniform across industries. The pandemic recovery broke this pattern.
Don’t Wait, Investors
2022 was one of just three years in the last century during which combined bond and stock returns were negative together. In the previous cases (including those that did not fit neatly into a calendar year) returns twenty-four months ahead were well above average.
Yet despite the opportunity presented by this “great valuation reset,” many investors told us they wouldn’t allocate more to bond investments because rates “will stay higher for longer.”
They also said they wouldn’t allocate more to equities because of a coming recession. We saw these views as inconsistent.
Our message on markets is that the depressed “snap back” phase is over. This means broad index returns — particularly for the S&P 500 — are likely to be less spectacular than the 47% annualized gain of the last two full quarters.
However, the present period has some positive characteristics that are the mirror opposite of the unusual negatives of 2022.
History Is Against Timing the Market
Investors cannot succeed by investing only when markets and the economy are depressed.
An investor who put money to work in the S&P 500 only in the 12 months following a recessionary trough in the economy — assuming one could tell perfectly when this is, earning cash yields in other periods — missed out on the returns of “routine” expansions.
Consider, US economic expansions comprised 86% of all months since WWII.
The strategy of “buy only when the economy reached a bottom” returned 6.4% per year vs 10.9% for a “buy and hold all periods” strategy.
Another scenario that would require “perfect insight” is the following: if one could know exactly when the S&P 500 would hit a bottom associated with recession during the past 50 years and invest only in the recovery year following equity market low points (earning cash otherwise), the return annualizes 7.8%. This is still inferior to “buy and hold” to the tune of 3.1 percentage points per annum.
See our weekly CIO Strategy Bulletin for more details