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Capital Market Update: "The Triumph of Hope Over Experience"

Capital Market Update: "The Triumph of Hope Over Experience"

February 15, 2023

Happy Days are here again!  After spending the entirety of 2022 in a downward spiral of negative returns in every major asset class driven by 40 year high inflation, the Federal Reserve Bank’s “shock and awe” campaign of skyrocketing interest rates, resultant US/global recession fears, and the geopolitical mayhem of war in Ukraine and China’s self-inflicted economic nose-dive, positive returns are back!

How far “back” you ask?  Well, as of this writing, the S&P 500 has had a positive YTD return of 7.76%, the tech-heavy Nasdaq 13.62%, EUROSTOXX 11.73%...all at or above the long term average full year stock market returns in just 45 days.   Even the bond market indices have posted 1-3% positive returns…less than two months into 2023.[1] 

What prompted the markets’ mercurial swing from despair to elation?  Nothing less than a complete reversal of the 2022 fear and loathing hitlist: US inflation dropping from over 9% to 6.4%,[2] the Fed reducing its interest rate increases from 0.75 to 0.25% per increase (with the expectation of rate reductions before 2023 year end!), China reopening after finally abandoning their failed “zero covid” policy (with 1MM+ COVID deaths over three months in the process), a warm winter in Europe with no oil/gas shortages, energy prices dropping, US unemployment hitting a 54 year low, and the growing consensus that there won’t be a recession in the US after all…i.e. an economic “soft landing”.[3]

On top of all that, consensus is that US company earnings will increase even after huge interest rate increases are reducing inflation and slowing the US economy. All of the above has coalesced into a market participant narrative which looks and sounds a lot like “It’s all good news!  Let’s party!!!”

Everyone loves a good story with a happy ending, and I wish I could end this update right here with the words “and they all enjoyed attractive positive risk-adjusted returns happily ever after.”  But I cannot, because my interpretation of recent events in the capital markets looks less like the complacent optimism outlined above, and more like the Samuel Johnson protagonist’s infamous “triumph of hope over experience”: possible, but unlikely.

The core of my concerns is this: much of the recent optimism in the stock market are predicated on the words that have ended badly with great consistency in the past, “It’s different this time”.  How can energy prices continue to stay low with China demand coming back online, and the US economy still running hot as evidenced by 54 year low unemployment?[4] How can corporate earnings increase if the massive interest rate increases of the last year have indeed slowed the US economy?  Why are the equity market ignoring the Federal Reserve bank’s consistent messaging that they will keep rates “higher for longer” in order to bring inflation down an additional 4 percent to their stated target of 2%?

One truism has persisted throughout capital market history; the more convoluted and contradictory positive outlook (think dotcoms in 2000, sub-prime in 2007, etc.), the higher the likelihood things don’t work out as hoped.  To be clear, I do not foresee a negative outcome remotely similar to 2007-2009 or 2000-2003, I think the recent equity market jubilation is unwarranted and premature.

In light of the above, what actions have we taken in client portfolios to bring them in line with our outlook and concerns?  We followed the “sell high” strategy on stocks, and bought T-Bills.  Over the last week, we’ve reduced stocks in by around 5%, and used those proceeds to either pay down portfolio lines of credit for those who have them, or invested in T-Bills and other short-term bond with current yields approaching 5%.  If our thesis is correct, and there are more rocky roads and declines ahead for stocks, we won’t hesitate to redeploy that 5% back into whatever equities offer the most attractive entry points.  If not, we are happy to collect an almost 5% yield in short term US treasuries with zero stock market risk.

I hope the above is helpful, and feel free to email or use the following link to schedule a meeting at your convenience: Schedule a meeting


Very Truly Yours

Jonathan Lonske

Managing Partner, Financial Advisor

jl@windsorpw.com

Office/Cell: 857-328-1100

125 High Street, Suite 220, Boston, MA 02110


[1] The Wall Street Journal. “Market Data.” The Wall Street Journal, Dow Jones & Company https://www.wsj.com/market-data.

[2] “Consumer Price Index Summary - 2023 M01 Results.” U.S. Bureau of Labor Statistics, U.S. Bureau of Labor Statistics, 14 Feb. 2023, https://www.bls.gov/news.release/cpi.nr0.htm#:~:text=Not%20seasonally%20adjusted%20CPI%20measures,percent%20prior%20to%20seasonal%20adjustment

[3] Board of Governors of the Federal Reserve System, https://www.federalreserve.gov/monetarypolicy/openmarket.htm.       

[4] “News: Unemployment Is at Its Lowest Level in 54 Years.” U.S. Department of Commerce, 3 Feb. 2023, https://www.commerce.gov/news/blog/2023/02/news-unemployment-its-lowest-level-54-years#:~:text=%E2%80%9CPresident%20Biden's%20economic%20plan%20is,the%20lowest%20in%2054%20years.%E2%80%9D.