We in the investment field are living in rather interesting times, to put it mildly. Depending on one’s perspective, this might be a blessing or a curse. Some investors view turbulence as an opportunity, while others see only risk. To provide some context on where we are currently, let’s take a moment to review where we’ve recently been economically, and look to the future with an informed perspective.
Starting in the winter/spring of 2020, the Covid pandemic, associated shut down of the global economy and the resulting supply chain issues presented extreme and unprecedented challenges. Subsequent inflation and the continual fiscal and monetary moves by central banks across the globe only added to concerns for investors. Add to the list the recent debt ceiling debacle, liquidity concerns, general political conflict domestically and the war in Ukraine and you have quite a set of challenges for financial assets. Yet we think that markets have exhibited remarkable resiliency. Many investors, we would contend, would have expected far worse market performance from the events we’ve seen over the last three years.
Again, if informed in advance of the eventual happenings, many might have predicted cataclysmic market outcomes. While we have not returned to the highs on the major equity averages that were seen in late 2021, and the bond market has yet to recover, we have not seen investors leaving the markets as they did during the 2008 financial crisis. A look at the two major U.S. equity market indices shows that over the period from 3/1/2020 (just before Covid) to 6/20/2023 the S&P 500 was up over 48% and the Dow Jones Industrial Average up over 33%. On the other hand, bonds (as defined by the Bloomberg Aggregate Bond Market index – AGG) which have traditionally been thought of as a more conservative option to equities, have been down about 15%1,2, not what we would call a devastating downfall. Then, more recently, with the resolution of the debt ceiling debate at the beginning of June, less alarming inflation numbers and the economy continuing to chug along, we saw a welcome advancement in equity markets from the uncertainty and volatility that preceded it. Beginning in early June, equities went on a run for about two weeks.
We think that one of the lessons of the last three years is that we need to be watchful of our own worst fears, and wary of consensus thinking. As for the former, we are always mindful that in investing, fear is a more potent motivator than opportunity. Many individual investors are motivated to adjust portfolios based on perceived fear, only to miss out when things turn positive. The latter, consensus thinking, can be equally perilous. This might be depicted in the consensus opinion that recession was imminent sometime in early 2023, resulting from the inverted yield curve of 2022. The inverted yield curve is itself a product of consensus thinking. We’re fond of the saying “The inverted yield curve has predicted nine of the last five recessions.” Our point is that we, as investors, should focus on longer term trends and opportunities, and discount short-term menaces.
So, as we confront the second half of 2023, lingering (but diminished) concern over recession, Artificial Intelligence becoming more and more a topic of discussion and a new political season heating up, we remain careful but constructive on markets and their direction.
Our view is based on the perception that we now find ourselves in a position where investors may be beginning to look through any possible recession. At Atlas, we hold out the possibility that rather than experiencing a general U.S. recession, we may instead see what we call “rolling recessions” across sectors. We could see a scenario whereby the recent “recession” in the technology sector ends, then a slowdown occurs in another sector or sectors, and so on. This may result in a situation where at no point does the overall U.S. GDP drop below 0% growth but is also held back by lagging sector activity. In such a scenario, it would be important to maintain a properly balanced portfolio, with tactical tilts maintained to take advantage of sector effects.
As we move into the second half of the year, we look for the beginnings of a recovery in corporate profits into 2024 after the “earnings recession” of 2023. While falling inflation may impact margins, we think that an overall improvement in earnings and forward guidance could provide optimism to market participants. In addition, while we do expect further increases in overnight lending rates from the Fed, we look forward to an extended pause, then a pivot toward lower rates sometime in 2024 providing another catalyst to markets.
As for bond valuations, as stated, we think lower rates may return to the market in 2024 providing a tailwind to the bond market. In addition, over time as bonds move steadily toward maturity and recover from the impacts of recent rate hikes, we anticipate a healthy recovery in the overall market. As always, the attractive feature for bond investors remains the assurance that principal will be returned at maturity, despite the impacts to interim valuation due to interest rate effects. For many bond investors, the old adage, “If you buy the cow for milk, you don’t care what happens to the price of beef” remains as true as it ever was. With rates higher now, we think there are some legitimate reasons to be constructive on the bond market.
One of the more uncertain areas of the capital markets at this point, we think, is in the international space. This is not to say that we’re negative on international equity as an asset class, but rather to make the point that there are more uncertainties pertaining to it. The strength or weakness of the U.S. dollar vs. foreign currencies, an ongoing restructuring of the global trade architecture, re-shoring of manufacturing, money supply and geo-political relations all seem to be in flux now. That said, valuations for many foreign companies remain attractive relative to domestic opportunities and could still provide attractive openings. So, despite the uncertainties we are attracted to international for its potential to add return over the intermediate to long term. Accordingly, we remain allocated to international with a portion of the equity holdings within our strategies. Time will tell how this plays out, and we remain watchful.
We are living in interesting times, to be sure. We hope that you are well, enjoying a pleasant summer and looking forward to new opportunities as we move toward 2024.
As always, if you have any questions about our investment strategies or other financial issues, please feel free to reach out to your Atlas Wealth Management Advisor. We are always happy to speak with you and appreciate the opportunity to serve our valued clients.