By Thomas A. Martin, CFA, Senior Portfolio Manager,
Mixed, still. 2022 is behind us now, and investors have a lovely tradition of feeling like they are starting each new year with a clean sheet of performance paper. The fundamentals of markets and economies, however, are continuous. The lay of the land remains mixed, and the bias, in the short term, remains to the negative. One thing that feels different this time around, is that the consensus, as we view it, is that the time horizon to better visibility, if not positivity, is sometime mid-year 2023, as opposed to the usual year end.
Mostly this is because there is a palpably increased confidence that the peak Fed rate is in sight. Two or three rate hikes away. A mere 50 to 75 basis points over the next three months or so, as opposed to the unexpectedly fast 425 basis point sprint we experienced the last nine months of last year. Sure, there was confidence all along the way that a pivot was imminent, but it is different now. There is more grounding from the journey. Perhaps less hope and more experience.
What do we know now, and think we’ll know better in six months? For one thing, we know that equities are down, and interest rates are up. Some, if not all, of the damage has been done, and is incorporated to a degree in prices. We know that mortgage, credit card, and loan rates are up (along with credit standards), and that housing activity has cooled along with used car prices and rents. We know that supply chains are still disrupted, and inventories (generally) are still elevated, but both are improving. We know that the odds of some sort of recession are also elevated but not certain. We know the yield curve is inverted, many PMIs are below 50, and leading indicators have been declining. We know that the rate of inflation has begun to gently waft lower. We know earnings estimates for the S&P 500 for 2023 have been lowered a little over 8% since June of last year.
Geopolitical uncertainty remains a wildcard. That’s shorthand for Russia/ Ukraine and China/Taiwan/Technology/COVID/Common Prosperity. But it is no longer brand new like it was last year. Nations, companies, and people have been resilient and have adjusted.
Optimism, however, is not rampant. There is still a lot of adjusting left to be done. Where inflation settles out, where employment lands, how much consumers retrench, how much further corporate earnings decline, and the Fed’s rate path from here are key unknowns. We expect that visibility will be significantly better in the next six months, but for now there is reluctance to look through the bottom. Running in the background is that, although they have improved somewhat, valuations are still high by most measures. Almost nothing is cheap. That may be one reason why sentiment is still very negative across a number of disparate measures. That in itself is a positive, but it is not yet enough.
Investment positioning requires patience. We reiterate that when uncertainty is high and lopsided positioning can engender fast and significant volatility, it does not pay to guess. We believe the current environment is best addressed with cautious and conservative positioning and investing informed by meaningful weight of the evidence.
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