We’re halfway through 2023, and as I look across the market landscape, it’s difficult not to notice the numerous divergences that have cropped up across asset classes and economic indicators. Some of these make intuitive sense; others, less so. To name a few:
- Large companies have significantly outperformed small ones YTD. Just the top five stocks in the S&P 500 have generated a whopping 60% of its returns this year, and now represent a full 26% of the total index.
- Growth stocks are wildly outperforming value – Growth is up 34% vs Value up only 3% (based on their respective Vanguard ETFs).
- In the economy, the services sector remains robust while spending on goods continues to weaken.
However, there is one notable divergence that I think stands above the rest:
Stocks heat up while the economy cools down
Economy has been resilient, but slowing…
While economic performance has generally been better than was expected at the beginning of the year, it’s hardly the picture of strength, evidenced by this year’s Trumpian superlatives: “2 of the 3 largest bank failures in history” and “the steepest pace of interest rate hikes in decades”. When one looks around, there’s plenty of evidence of economic deceleration:
Johnson Redbook Index shows retail sales now negative YoY
Note: the end of student loan forbearance later this year is likely to make this even worse. By my math, there are $100B to $160B of incremental annual student loan payments that are going to be hitting household budgets over the next 6 months, providing a fairly significant headwind to consumer spending.
Excess consumer savings built up during COVID is mostly gone, leaving very little cushion
Job market weakening, with unemployment claims up YoY
However, while higher rates act as a handbrake on the economy, there have been plenty of positives to point to as well:
Real wage growth (% YoY) is finally positive again
Housing sector bottomed in December and has since performed extremely well
There are dozens of datapoints to look at on both the negative and positive side, so, I think at best we could charitably describe the economy as “mixed”. To sum it up:
…yet equities haven’t gotten the message
In the face of this anemic growth, the stock market has been extremely strong, with the S&P 500 increasing by 18% YTD, leaving valuations near the high end of their historical range – a condition that has typically presaged poor future returns:
Based on the exhibit above, investors can expect 5-year forward returns of 6-7% in equities vs. 5.5% in short-duration treasuries – so investors here are taking on all of the risk inherent to owning equities but only receiving an expected return of ~1% over bonds.
This has created yet another divergence – one of valuation – equities sit near their 25-year high, while treasuries remain in the doldrums near their 25-year low:
So where does that leave us from an investment and portfolio management perspective? The above data is not to say that equities should be avoided – quite the contrary – the stock market has been one of the greatest wealth generation tools in human history with 10-year rolling returns averaging ~140% historically.
But I do think it means investors should think more deeply about their asset allocations, as for the first time in a long time, treasuries are providing a genuinely attractive alternative to owning equities.
I’ll leave off with one of Buffett’s more famous quotes:
The first rule of investing is don’t lose money. And the second rule of investing is don’t forget the first rule. And that’s all the rules there are.
Please get in touch with any questions, comments, or feedback – I welcome the conversation!
About Chris Stevenson, CFA®
Mr. Stevenson is an investment advisor representative of and offers investment advisory services through Forrest Financial Partners, LLC, a registered investment adviser offering advisory services in the State of Connecticut and other jurisdictions where registered or exempted. Tel: 860‐222‐0232
Nothing in this article constitutes investment advice and all content is subject to the Legal and Disclaimer Policy of Forrest Financial Partners.
