The Great Divergence: Opportunity Amid Uncertainty
What happened last week?
- The S&P 500 index lost -1.1%
- The Dow Jones index fell -0.2%
- The Nasdaq composite index shed -2.4%
In the economy, trade, manufacturing, and construction are slowing and the Fed is positioned to raise rates again next month to keep this going. Yet some cyclical areas of the stock market have turned up.
Our investment strategy holds that “market timing doesn't work.” We prefer to seek out areas of the market with valuation readings and fundamentals that are relatively attractive given these uncertain times.
3 Things to Know
Signs of a cooling economy
This can be seen in multiple private and public sources, such as the number of rail cars being filled and the declining imports coming to the US.
- First, total real consumer spending fell in both November and December, leaving the end—2022 pace of spending 1.0% below the fourth—quarter average
- Second, the US manufacturing purchasing managers orders index fell to 42.5 in January (below 50 marks contraction). This is the lowest reading since 2Q 2020 when Covid shuttered the US economy
- Third, US housing starts dropped 22% over the past year as new home inventories surged 19%
While areas of strength persist in services, these negative data points suggest that high inventory in wholesale and retail goods are stalling manufacturing demand for domestic and foreign producers.
Small 'r' recession
The definition of recession is the period just after a peak in the economy. When a “Recession” begins, employment is at its highest level. The point of “Recovery” is when employment is at its low point for a cycle.
Within a tumultuous three years, US job losses and gains have been the most rapid in history. However, the meager net US job gain since the pre-Covid peak — +2.7 million jobs or just 1.8% over three years — suggests there are not as many jobs for the US economy to lose during its next recession.
In other words, the absence of an employment boom shows the economy is not meaningfully vulnerable to a large employment bust.
With this said, we do not believe US employment has already slumped and is poised for a strong recovery.
Avoid portfolio paralysis
Our investment strategy holds that “market timing doesn't work.” A fully invested portfolio should shift to where one sees greater or lesser value. While we remain fully invested in global, diversified portfolios, we don't own everything.
Indeed, a still—challenging economic and profits backdrop speaks to maintaining a high—quality bias with non—cyclical sector tilts. While areas like dividend growers or pharmaceuticals may underperform during “junk rallies” like we've experienced in the last month, these areas may provide us with a more compelling long—term risk/reward. In the coming few months, the extreme contradictions in the data will most likely be resolved.
What's more, we don't see an endless period of weakness or contraction in the US and other economies. China, for one, should strengthen soonest. But we also don't believe the US economy will go unscathed from the lagged effects of “rapid” Fed tightening, as Powell put it at his last press conference.