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Weekly Market Analysis - The Market Outlook Explained in Three Phases
Posted on3 Things to Know
Global Growth is Broadening and US Employment Slowing
In our last CIO Bulletin, we answered questions posed to us from investors tied to particular risks. All were about feared negatives. Our own question is “why so glum?” Global economic growth seems to be stabilizing and broadening. Corporate profits are rising. US employment growth – which drove interest rates pressure – is slowing.
Don’t Wait, Investors
To be clear, in our “three phases” thesis in Wealth Outlook 2024, we are heading toward a “normalization period” rather than a “V-shaped” collapse and recovery pattern in financial markets. Unlike 2023, markets are not broadly depressed, investors are not “bearish on everything” and certain US policy risks (such as excessive trade protectionism) remain. Yet investing only during depressed periods is a strategy of underperformance.
History is Against Timing the Market
If one had implausibly perfect knowledge of when US equities bottomed in recessionary troughs and invested only for the year of recovery (earning T-Bill interest at other times) the return in the past 50 years would have trailed a buy-and-hold S&P 500 return by 3.1% per annum. This is the case even when including eight recessions and four severe bear markets.
Summary
Last year, we delineated “three phases” to best describe the world financial market outlook. In 2020-2021, both equity and bond markets saw strong, stimulus-induced returns despite severe economic weakness and building inflation pressure. In 2022 and much of 2023, markets reset lower in value, depressed by monetary policy tightening. Lower inflation allowed for a more normal functioning of the world economy and markets by mid-2023. This pointed to higher returns after two “payback years.”
Our message here is not to dwell on the past and a missed opportunity for some, but rather to recognize the present: an ongoing economic expansion rather than a recession/recovery pattern.
Portfolio considerations
Bond yields have begun to fall again but remain compelling for intermediate durations. US Treasuries have posted a positive return in all but two US equity bear markets during the past 50 years, providing a “hedge with yield.” The most recent experience in 2022 differed from this as US yields were at 1.3%, just above historic lows. Today, the average US Treasury yield is 4.6%.Our Global Asset Allocation is overweight US assets and underweight non-US in both equities and bonds. With global growth stabilizing and US interest rate pressure again subsiding, we look with interest at broad non-US equities for diversification and opportunity. Non-US equity returns have trailed behind the US by 15 percentage points over the past 12 months. At the recent low, this outperformance was the most extreme since 2012, the European sovereign debt crisis.
Source: Haver Analytics, May 15 2024. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events.
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. In conclusion, 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 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. As the chart overleaf shows, 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.
