Financial markets have no clear direction, trapped in No-Man’s Land until at least the next Federal Reserve meeting on May 3rd. Depending on the economic data points of the day, stocks are gyrating up and down within a narrow band without clear direction or conviction. Such is a time when opinions and predictions bounce markets until enough data exists to prove one right or wrong. There are several directions for future economic and market performance that need to clear up.
The First Compass is monetary policy – driven by the Fed moving interest rates and the supply of money. It is expected that rates will be raised another ¼ percent in May, and then a pause announced as the toll previous increases are having on the economy becomes clearer in the data. This includes inflationary pressures receding, employment growth cooling, and the availability of credit shrinking. Tighter financial conditions weigh on small businesses, who employ 2/3 of all workers. The possibility of recession has increased, and slower corporate earnings – the primary basis for stock valuations – are expected.
Secondly, virtually every recession indicator is flashing red, from manufacturing data, commodity prices, and a very inverted yield curve. But consumers will determine if a recession occurs and how severe it might be. Will consumers keep spending while bank credit is reduced, the economy slows down, confidence is eroded, and a true recession occurs? No one knows. So, today we are stuck in No Man’s Land.
There are clear signs that once the corner does turn, the recovery in stock prices could be fairly swift. While this all sounds ominous, the reality is that a possible recession should be shallow and short. Despite potentially slower short-term earnings, corporate and household balance sheets remain quite strong. Assuming this persists, any damage due to recession may not foster further reduction in stock prices. Earnings also historically prove stronger than pessimists fear. Finally, investor sentiment and positioning is downright despondent. Troughs in sentiment tend to precede strong equity returns. We are currently in the 16th consecutive month of negative market sentiment. The Great Financial Crisis had a span of 18 months. With the second longest period of negative sentiment in place, and cash accounts flush with $3-$4 trillion to invest, there will likely be great demand for equities when sentiment turns.
Barring a major unforeseen event, we expect a turnaround later this year as markets “look through” to next year. In the ten prior periods when markets were up in the first quarter after a negative year, the year finished higher in all of them. Further, 15 out of the last 16 periods produced positive annual returns in years when the market was up greater than 5% in the first quarter. We believe the stage is set for the market to accelerate into year-end once earnings and consumer strength pictures clear up.
So, what parts of the market are best positioned for growth?
Enjoy today and tomorrow, and let us do the worrying!
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