1148 West Legacy Crossing BLVD
Scott Hoxer, CIO – Alliance Wealth Advisors
For large swathes of the United States, the summer of 2023 has been scorching and many areas throughout the world have seen record breaking heat. Here are just a few records of note:
Markets too have been heating up and July in particular was a great month. A few items of interest are:
Will this trend continue? For this month’s Insights, we’ll review the potential for markets to continue their winning streak.
In our view, the market rally we’ve seen has been built upon the following factors:
Inflation has started to subside fairly significantly. As of June 2023, the Consumer Price Index had fallen to 3% from over 9% in June 2022. While consumers are still feeling the effects of elevated prices (an average good that cost $100 in June of 2020 would cost $118 today), 3% is a much more palatable rate of increase and gives policy makers much more room to maneuver. The market (as measured by Fed Funds futures contracts) is of the opinion that policy makers can and will have a more accommodative rate policy throughout much of 2024 and that additional increases in 2023 are less than likely and modest if they do occur:
Source: CME. Probabilities of rate increasing, easing, or status quo for a given Federal Reserve meeting
In terms of economic growth, in spite of ongoing predictions of a recession, GDP has been fairly resilient. The first quarter of this year saw 2.0% GDP growth, while the second quarter of the year had 2.4% GDP growth. This economic growth and the waning recession risk have definitely helped buoy up markets.
In an otherwise very active time geopolitically, we’re currently seeing a bit of a lull. We’re seeing some minor rapprochement between the US and China and the Russia/Ukraine conflict is currently in a stalemate on the eastern front. This relative lull has reduced overall uncertainty and has also been a bit of a tailwind for markets.
The combination of waning inflation, solid growth, and reduced geopolitical uncertainty have helped spur improved investor sentiment, which ultimately has driven this rising market. Coming out of a bear market, we often see the following rough cycle play out:
In the back half of a bear market, we often see “dead cat” bounces or bear market rallies. These have the appearance of a true turnaround and true recovery, but inevitably fizzle out and markets fall further. At some hard-to-define point, sentiment starts to improve and buyers exceed sellers. Initially, many investors greet the rising market with skepticism (i.e. “we’ve seen this show before…”). As markets continue to rally, however, skepticism is replaced by cautious optimism. The buying on the back of this optimism begets more buying. At this point, the masses begin to take notice, and the bear market is left in the rear-view mirror. Observe how the Nasdaq index, for example, has actually performed:
Source: Wall Street Journal, Nasdaq Index
Once bull markets are moving, they often persist for relatively long periods of time. Look at the difference in duration and magnitude in bear markets (red) and bull markets (blue) over time:
While it does appear that markets have turned a corner and that probabilities are now firmly in the camp of generally rising markets, it is worth noting some of the things that keep us up at night:
On the interest rate front, the effects of higher interest rates take some time to fully be felt in the system. We are less than 18 months removed from the initial increase in interest rates and at the time of this writing, the Federal Reserve had just moved on another rate increase. High interest rates slow economic growth and can cause unanticipated damage (i.e. the Spring 2023 Banking Crisis). We’re not yet out of the woods on this front.
As mentioned above, we’re in a bit of a relative geopolitical lull. The key word, however, is relative. We’ve entered a period of great power struggle that we haven’t seen in decades and the coming years will be very consequential as we consider the possible resolution and aftermath of the Russia/Ukraine war and the evolution of the US/China relationship and potential for conflict. Geopolitical risk is complicated because one is often dealing with low probability/high impact scenarios (i.e. a Chinese invasion of Taiwan). The overall potential for market moving geopolitical events is higher today than what we’ve seen in recent decades.
Lastly, we worry about long-term structural headwinds as a result of the significant expansion in sovereign debt outstanding. In the case of the United States, the total public federal debt has risen to over $31 trillion and the debt to GDP ratio has risen to over 120%:
These and other factors led to the recent US credit downgrade. Our concern is that as baby boomers depart from the work force, there are fewer replacement workers in the successive generations. The US was able to move out of the high post WWII debt levels through robust economic growth. The potential to grow out of this debt burden is lessened due to the demographic headwinds we face. We do, however, have an incredibly dynamic economy, and productivity gains through technological advances (like artificial intelligence) is a distinct possibility. We do nevertheless face an uphill battle to bring debt to more manageable levels.
Overall, we view the coming months more glass half full than glass half empty with the above reservations. We hope this note finds you well and wish all of you the best as you wrap up your summer and transition into fall.
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