Three Minute Digest for February 16, 2023
“Thunder is good, thunder is impressive; but it is lightning that does the work” Mark Twain
Global stock and bond indices started 2023 with a lot of thunder and a bit of lightning, bouncing back after a dismal December. This has been aided by institutional money managers buying stocks to cover “short” positions in the markets as well as expectations for the Federal Reserve to slow the pace of interest rate hikes in 2023. A short position is a transaction to profit from a decline in prices by selling a stock first and then buying it back at a lower price in the future. This “short-covering” can produce a strong short-term rally that often follows a weak period in the markets such as the weak December followed by the strong January we just experienced. This is a normal part of a bear market rally and while rallies are welcome, we remain cautious going forward.
Inflation concerns will continue to dominate the financial markets in 2023. Recent reports show that inflation remains at elevated and persistent at levels not seen in 40 years. The current US Inflation Rate is at 6.41%, compared to 6.45% last month and 7.48% last year. This is significantly above than the long-term average of 3.28%.
The daily headlines of corporate layoffs will continue and are a normal part of a weak economic environment which is indicative of an existing or pending recession. The difficult personal impact of losing a job is significant but within the economics of running a business, a recession forces businesses to streamline and become more efficient, which in turn benefits the overall economy going forward.
We have just highlighted inflation and recession in the same breath. In typical economic cycles you either get one or the other. When you pair them together, it is referred to as “stagflation”. This is a period of stagnant or recessionary economic activity which typically causes demand for products to fall and thus should lower prices but at the same time we have inflated prices for goods and services. The 1970’s was the last time the term “stagflation” was needed in our vocabulary.
Stocks Versus Bonds in Your Portfolios
2022 posed many challenges across stock and bond markets, as the usual diversification benefits between stocks and bonds, as typically weakness in stocks is offset by strength in bonds and vice-versa, essentially broke down and a traditional 60% stock and 40% bond portfolio fell 16% during the year as each component posted a negative return for the first time since 1974.
Just a few of the factors that contributed to a historically weak year for both the stock and bond markets and the historic sell-off included record inflation and central banks responding with the fastest ever rise in interest rates, geopolitical unrest, primarily the Russian invasion of Ukraine, lockdowns in China, supply chain disruptions and a possible government default.
While the markets have shown some surprising resiliency so far in 2023, a large number of Wall Street analysts see more pain ahead for the markets. At Affinity Capital, we also see caution lights ahead, such as a slowing housing market, persistent inflation, and weak corporate earnings. While we find some confirmation of our concerns by market analysts, we also remain aware of the spotty history of many experts on Wall Street.
The markets are forward-looking creatures. We are currently in a market environment that wants to advance on the hope for better economic conditions in the future but is constrained by a lack of clarity on too many issues for us to break free from this bear market.
The thunder rolls, but a good old fashioned lightning storm of consistent economic good news and a more sustained market rally needs to be present in our forecast.