Working on these posts each week has me thinking a lot about how to square the short term with the long term. The human desire for immediate satisfaction is real, whether investing or otherwise, but so is the knowledge that with investing, often solid wealth is built with time. Just like the desire to just get something over with must be balanced with the knowledge that some stuff just can’t be rushed.
The moves in the equity markets so far this year have really got me thinking, too. Here are the 2023 numbers by area of market and region.
Pretty remarkable, relative to the 2022 range of -14% to -33%, considering we’re only three weeks into 2023.
This short-term rally is confusing, though. There is a lot of recent good news built into it. Of course, as I analyze it, I try to stay aware of my emotions — and check my fears that the market is only discounting the recent “better-than-feared” stuff vs. the stuff that still has yet to come (and could be “not-as-good-as-hoped”).
We are entering the main part of the Q4 reporting season this week and next, with about 60% of S&P 500 companies scheduled to report. So we should get a good sense of where we are in the short term here in the US. And then the Fed’s next announcement is on February 1… so we can form a better view for the long term.
In reading research last night, I learned I am not the only one with this fear. I had a negative view of the markets last year, with good reason, and that was generally right. A lot of professional strategists were positive for much of 2022 — until the end of the year, when they had to capitulate. So I keep checking in with myself… am I negative for the first half of the year because last year was a bad one in the market? Or is there negative news not discounted in current market prices?
As I considered this question, here’s where I got to:
Technical factors seem to be playing a big role here. Many investors are still quite negative, and as a result, aren’t as invested in the US stock market as they’ve historically been. The most recent Bank of America fund survey showed fund managers are collectively the most “underweight” to US stocks since 2005 (39% said so).
Plus, according to a recent PWC survey, 73% of CEOs think global growth will decline in the next year, which is the most pessimistic outlook in 12 years. Also, according to the Wall Street Journal, business and academic economists put the probability of a recession in the next 12 months at 61% (we believed we started one last year already, which would be a light one).
Now normally, I would say this technical aspect (of pessimism) would have an impact, but not as much as it’s had so far… except that the technical imbalance is here in conjunction with an (at least perceived) inflection point. An inflection in inflation (less hot), an inflection in the direction of interest rates, with the hikes likely ending soon, an inflection in China’s Covid policy and reopening, and an inflection in the direction of the US dollar (falling for the first time in a while). These “good news” inflections plus skeptical positioning seem together to be driving prices, to potentially rise past where fundamentals (like earnings and income) alone would lead one to expect.
My aforementioned concerns are grounded in the fundamental side — I believe valuations are still a bit high relative to where earnings will come out and this will come back to the dialogue — maybe even as earnings season progresses. Earnings expectations have fallen over time but I expect they need to fall a bit further. See below for a chart of expectations of earnings of companies in the S&P 500 Index. The 2023 line in red is the one I focus on the most.
In the meantime, experience tells us markets could go up a bit more before dealing with the fundamental side of the equation. And to be fair, the positive momentum in emerging markets is not as surprising — in our outlook for 2023, we thought China’s reopening would be a positive to this. Thus, diversification, the term for having a number of different investments that don’t all act the same, helps in this situation — and often many more. Which also happens to usually help me bridge the gap between short-term markets and a long-term time horizon.
*Small Cap Stocks represents the Russell 2000 Index, International Developed represents stocks in Europe, Australia, and developed Asia including Japan in USD terms, Emerging Markets represents stocks in emerging countries such as China and Brazil in USD terms.
Sources: Robinhood Financial, Bloomberg