Walking the Line
Telemus Weekly Market Review May 15th - May 19th, 2023
This past week, progress appeared to be made on resolving the debt ceiling debate in Washington, which has been an overhang to markets as investors assess the probability and risk around a potential Treasury debt default. The debt ceiling debate is a legitimate concern for investors given that even after its resolved, the way its resolved and corresponding impact on economic sentiment could have an influence on the cadence of economic growth going forward.
The debt ceiling concern is a singular event and one that markets should be able to move beyond in short order. However, there remains uncertainty on whether the U.S. may or may not be entering a recession and whether inflation will progress along a downward, disinflationary trend that will curb any further interest rate moves from the Federal Reserve.
On top of these broader macro concerns, market dynamics are atypical. First, cash levels in money market funds sit at all time highs at over $5 trillion in balances. Granted some of these are formerly bank deposits that migrated toward government money market funds because of recent bank failures and may not ultimately end up invested in stocks and bonds. Second, sentiment amount professional investors is low as many are awaiting greater clarity on a debt ceiling resolution as well as further data on inflation and economic growth. Last, the combination of lower valuation in international markets and a modest depreciation of the dollar in recent months is leading some domestic and foreign investors to slowly migrate capital to markets outside of the U.S.
The factors, alongside the significant, yet unpredictable, large macroeconomic influences have created a wall of uncertainty for investors. What makes these issues more challenging is that the outcomes will ultimately be predicated on decisions of government officials. This makes the near-term more challenging to invest in as one must foresee their behavior.
If we take a practical view of the economy, we think the question of whether we are or are not going to be entering a recession is the wrong way to assess the current climate. In this context we are reminded of the economic recession in 2001 when the U.S. economy entered a mild recession. In this instance it wasn’t the entire U.S. economy that went into a recession, rather it was certain sectors such as technology, media and telecommunications that led the downdraft. Today, consumer goods are in decline, commercial real estate is facing challenges, banks are seeing lower levels of profitability, and home builders are seeing lower demand. This is offset by what is still strength in leisure and hospitality, restaurants, and parts of the healthcare. Thus, we answer the question on whether we are going into a recession as parts of the economy already are in a recession and others currently appear resilient to one.
From the standpoint of the market, it’s been an unusual year to say the least. As we’ve commented on previously, markets are bifurcated in what they are pricing. Treasury bonds indicate a recession is imminent in the second half of 2023. Alternatively, corporate bonds indicate a soft landing for the economy. Furthermore, one might argue stocks are pricing in more stagnant growth in 2023, and an acceleration in economic activity in 2024. While anyone of these scenarios may prove right, a diversified portfolio sure has a mix of signals.
We think the picture is a bit clearer looking beyond the last quarter or the next quarter. Some of the oddities that we have seen in the market during the first half of 2023 should resolve themselves over time. For example, the S&P 500, which puts more weight in larger companies, is up 9.9% year-to-date. However, the equal weighted S&P 500, which does not weight each index constituent by its size (market capitalization), has gained only 1.7%. This level of divergence between the two indexes is unusual. Second, in the bond market, over time we’d expect the conflicting expectations embedded in corporate and Treasury bonds to resolve themselves. Should the economy head into recession we would expect corporate bonds to cheapen to account for higher default risk. Alternatively, if a broader recession is staved off, then portions of the Treasury yield curve are likely to adjust higher to reflect the ability of the Fed to be more patient in managing interest rates lower.
The message in this perspective is that there is a greater degree of opaqueness today and answers to many questions on the economy and markets aren’t straight forward. Our perspective on such an environment is that diversification is key. Given the wider degree of short-term uncertainty, it’s prudent to avoid taking more narrow and specific views on the direction of government policy, inflation, or interest rates. Over time, we’d expect markets to normalize as a common expectation around the direction of the economy and government policies develops. Having a diversified portfolio that leaves you less scenario dependent and able to capture any normalization in asset prices should prove prudent.
All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Telemus Capital cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. Investment decisions should always be made based on the client's specific financial needs, goals and objectives, time horizon and risk tolerance. Current and future portfolio holdings are subject to risk. Risks may include interest-rate risk, market risk, inflation risk, deflation risk, currency risk, reinvestment risk, business risk, liquidity risk, financial risk, and cybersecurity risk. These risks are more fully described in Telemus Capital's Firm Brochure (Part 2A of Form ADV), which is available upon request. Telemus Capital does not guarantee the results of any investments. Investment, insurance and annuity products are not FDIC insured, are not bank guaranteed, and may lose value. Any reference to an index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indices are unmanaged vehicles that serve as market indicators and do not account for the deduction of management fees and/or transaction costs generally associated with investable products. The S&P 500 index includes 500 leading companies in the US and is widely regarded as the best single gauge of large-cap US equities.
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Matt joined the Telemus team in 2018. As Chief Investment Officer, he leads the firms the investment process and research effort. Matt has experience as an equity analyst and portfolio manager and has advised corporate pension plans on their manager selection. He’s been quoted in Money Magazine and Barron’s.