The Investor’s Conundrum
What happened last week?
- The S&P 500 rose 0.79%
- The Dow Jones climbed 1.20%%
- The Nasdaq composite increased 0.29%
The first big banks to report benefited from higher rates, deposit flows from smaller banks, and volatility that boosted fixed income trading revenues. The market now expects the Fed to raise rates one last time by 0.25% on May 3rd.
This week, the market will focus on Q1 earnings with 60 S&P 500 companies reporting their results.
3 Things to Know
It’s not easy being an investor these days. Investors experienced major losses across equities and fixed income in 2022. Inflation and deglobalization emerged as new crosscurrents amid greater stresses between East and West. Then, bank runs raised questions about the safety of deposits. Finally, this past week, the Fed acknowledged a recession later in the year as more likely than not. Despite of all this news, the S&P 500 Index has remained rangebound since September 2022, even as the factors driving different sectors have diverged sharply.
This volatile mix of news and contradictory economic data has led to investment paralysis, with large investment balances sitting on the sidelines.
Why are so many investors waiting for a better entry point?
Some are concerned about a 2008-like financial crisis, while others think the dollar’s value will plunge as the US deficit keeps rising. Still others believe inflation will prove to be an endless battle.
The doomsaying might be exaggerated. Facts and data are often ignored when large, disparate trends converge.
There are true near-term risks
In March, private employment in the US showed the smallest monthly gain since recovery from the Covid shock.
We expect two million job losses — hardly a catastrophic result given the Fed’s huge tightening campaign, but still a material departure from today’s economic outlook. The US central bank views today’s 3.5% unemployment rate as “unnaturally” low. And they view inflation as more persistent than it is.
In our view, economic growth is still being exaggerated by the post-Covid recovery in the services sector and distorted measures of seasonal economic strength.
This means the Fed is still more inclined to raise rates than lower them, with markets expecting a final 25-basis-point rate hike as roughly a 65% chance early next month.
This is despite the risk that additional Fed action could exacerbate fears of financial instability again.
The banking crisis is another pocket of market stress. Signs of weakening bank lending are beginning to appear more rapidly following the loss of more than $300 billion in US bank deposits in March.
Reasons for optimism
We continue to believe the economy did not build up a dangerous overcapacity in the period following the Great Financial Crisis or the brief post-Covid recovery.
Gains in US employment were just 2.1% since the pandemic hit when a normal cyclical recovery might have generated gains nearly twice as large.
While home sales have collapsed, unlike the late 2000s, tremendous unmet demand for housing remains. March’s CPI report showed a continued slowing in headline price measures and hopeful signs that the last significant driver of inflation — housing services — will decelerate as has happened in prior cycles.
See our weekly CIO Strategy Bulletin for more details