Cooling But Still Hot - Holdun

Market Performance

ending March 20th, 2023


Holdun - Market Performance ending April 20th, 2023

YTD Overview

  • Equities jumped year to date as last year’s worst performing stocks continue to be the best performers in 2023
  • Volatility in the bond market following the banking crisis has seen the 2-Year Treasury drop almost 1% in the last month
  • European equities have continued to outperform while the ‘China reopening’ lost steam over recent weeks
  • The market rotation was clear for all to see as energy and financials lagged while technology outperformed (+20.3%)
  • Money market Funds have led the way in 2023 with $460 Billion of inflows in Q1 vs. $27 Billion across Equity ETF’s
  • Bitcoin’s ‘stealth rally’ continues, briefly hitting $30K and now up 66% in 2023

What to expect for the rest of 2023

The fickle nature of market sentiment has gone into overdrive this year.

The narrative has jumped from hard landing to soft landing to no landing at all. We now exist in this zero gravity economy where the outcome appears inevitable, but the timeline becomes increasingly unknowable.

Throw in a banking crisis, a frozen housing market and ‘De-dollarization,’ and you’re only about halfway there.

To quote Tom Peter’s,

“If you’re not confused, you’re not paying attention.”

Deciding exactly what happens next is a migraine-inducing endeavour. Endless variables result in a comical game of ‘it this, then that’ with each scenario as likely as the next.

You could argue the minutia all day, but in order to get some clarity, we need to focus on the economic outlook from a macro perspective.

So, Instead of regurgitating what has already happened in markets this year (I’m sure you have heard enough from ‘banking crisis experts’), here are 9 of our base case views that formulate our current position in the market.

1. Inflation

U.S. Inflation peaked in June of last year. While the rate is still above the Fed’s target of 2%, I think I see a trend emerging.

  • June 9.06%
  • July 8.52%
  • Aug 8.26%
  • Sept 8.20%
  • Oct 7.75%
  • Nov 7.11%
  • Dec 6.45%
  • Jan 6.41%
  • Feb 6.04%
  • March 4.98%

As mentioned in our 2023 outlook, our view was that inflation would trend lower, reverting to 2-3% by the end of summer 2023. Whether inflation neatly stops at this level remains to be seen.

We expect the disinflation to continue in the coming months.

2. Interest Rates

Evidence that Inflation is cooling has created the expectation that the hiking cycle could be coming to an end.

Change in Fed Funds Rate (%)

Source: Bloomberg

The market is currently pricing in a <90% probability of a 25bp rate hike in May, but we believe this will represent the top of the hiking cycle.

After years of being starved of income, the end of the hiking cycle represents an opportunity for investors to generate 5% ‘risk-free’

This risk-free rate was unthinkable just 18 months ago and should be welcomed with open arms.

3. Labour Market

Cooling but still hot’ is the term being thrown around to describe the current state of the labour market.

Job openings fell to 9.93 million in February, down from 10.56 million in January. This represented the lowest level of job openings since May 2021.

FRED - Job Openings: Total Nonfarm

Source: Federal Reserve

Job openings are clearly trending downward, but there are two key points to note.

  • Job openings are still well above pre-pandemic levels
  • Despite slower economic activity, the cooling in job openings hasn’t been accompanied by a notable acceleration in layoff activity. U.S. employers laid off 1.5 million people in February, which is actually below the pre-pandemic trend.

We expect the current negative trend to continue. Whether employment numbers will continue to fall without dragging us into a recession (soft landing) remains to be seen.

The consensus view is that the labour market is still ‘hot’. In our opinion, it is lukewarm at best if you look at the numbers from a 3 months moving average standpoint.

If the current rate of change continues, rate hikes will quickly turn into rate cuts.

4. Earnings

Earnings season kicked off last week, (as I type this, Tesla has just reported a 20% drop in the YoY net income, let’s hope that’s not reflective of the entire market)

In our January outlook, we highlighted the likelihood for earning projections to contract significantly.

“In our opinion, projections of 5% earnings growth against the backdrop of tighter monetary policy and weakening fundamentals were overly optimistic.

An earnings decline closer to 20% from the peak would seem more justifiable as we stare down the barrel of a slowing economy.

Until earnings growth is downgraded sufficiently to reflect the new reality, volatility will remain.”

Since then, consensus estimates have fallen considerably, with the S&P 500 now expected to contract for the second quarter in a row, as shown below.

Exhibit1: Quarterly path of consensus S&P 500 EPS growth

as of April 4, 2023

Bottom-up consensus S&P 500 EPS estimates (year/year growth)

Source: Goldman Sachs

While we still believe some of these estimates remain optimistic in a recessionary environment and could fall further, it’s important to remember the stock market is a forward-looking machine, and stock prices usually start recovering months before earnings bottom.

Exhibit 118 – Indexed Price and EPS During US Bear Markets.

Equities have typically troughed 6-9 months before earnings reach their low in past bear markets.

Exhibit 118 - Indexed Price and EPS During US Bear Markets. Equities have typically troughed 6-9 months before earnings reach their low in past bear markets.

Source: Goldman Sachs

We expect prices to come under pressure again in the second half of the year but remember, some of this earnings decline has already been priced in.

5. Systemic Risk

The financial reproductions of higher interest rates have come knocking.

Liquidity issues posed by the latest banking crisis have been backstopped but this is unlikely to be the last economic crack that appears.

Much of the impacts of the rate hiking cycle operate on a lag, meaning the negative economic effects of higher rates are yet to play out.

The ’higher for longer’ narrative increases the likelihood of something breaking in the second half of the year.

6. Fewer Winners

Stocks have done well year to date but the top line performance of a few big winners has masked the underperformance of the majority of the market.

This chart tells you pretty much everything you need to know.

This narrow rally isn’t exactly a characteristic of a healthy market.

You’re not as diversified as you think.

7. The Real Estate Market is Frozen

Existing home sales in March (4.44 million SAAR) were down 2.4% from the previous month and were 22.0% below the March 2022 sales rate.

This was the nineteenth consecutive month with sales down year-over-year.

Existing Home Sales, 2022 and 2023, SAAR (000s)

Existing Home Sales, 2022 and 2023, SAAR (000s)


Despite the steep decline in home sales and rising inventory, prices have remained elevated.

The median existing-home price for all housing types in March was $375,700, a decline of 0.9% from March 2022 ($379,300)

As it stands, with mortgage rates at between 6-7%, housing is currently as unfordable as it has ever been. Still, prices are yet to meaningfully adjust as the stand-off between buyers and sellers continues.

Inflation-Adjusted Monthly Mortgage Payment: 1989-2022
Median Single-Family Homes Using 30 Year Fixed Rate Mortgage

Inflation-Adjusted Monthly Mortgage Payment: 1989-2022 Median Single-Family Homes Using 30 Year Fixed Rate Mortgage

Source: Ritholz Wealth

In our view, the frozen housing market will continue to place a chokehold on the economy and despite the supply constraints, house prices will continue to come under pressure as long as rates remain at current levels.

8. A Strong Starting Point

Yes, the economy is slowing, but it is slowing from record highs. Financial Strength post covid has allowed consumers to absorb much of the bad news in the market.

Household debt as a percentage of disposable income has declined 50% since the 2008 financial crisis, and household leverage is currently at levels last seen in the early 1980s.

Household Debt Service Ratio
Debt payments as % of disposable personal income, SA

Household Debt Service Ratio. Debt payments as % of disposable personal income, SA

Source: Goldman Sachs

As the unemployment rates rise, consumer spending will slow down, but the starting point for U.S. households is still strong. This financial flexibility will help us avoid the capitulation that many of the apocalyptic doomsday economists are predicting.

9. The 30,000 Foot Macro View – Money Printing

Last but not least, we must take a step back and look at where we are in the credit cycle.

Public and private debt levels as % of Global GDP jumped from less than 220% to 350% in less than a decade.

Total Global Debt Surpasses $300 Trillion

Total Global Debt Surpasses $300 Trillion

Source: IIF, BIS, IMF

Stagnant labour and productivity numbers were no issue when you could simply offset any shortcomings in GDP with an ever-increasing amount of cheap debt.

But now, as we grapple with inflation and higher interest rates, the spending spree is officially over, and Central banks are flipping the money printer into reverse.

Easy money is over, and the contraction in credit will re-adjust valuations going forward. (negative credit impulse)

It’s worth noting in Q1, G5 Central Banks ended up printing money despite ongoing QT programs in place (bank funding facilities and yield curve control in Japan etc) . Going forward, we expect this surprise financial money printing to stop and the purse strings to tighten again.

Putting it all together

Inflation is falling, The jobs market is slipping, growth is slowing, earnings are contracting, the real estate market is frozen an manufacturing data paints a bleak picture.

But we knew all that and markets are still moving higher?

Thankfully, consumers have remained resilient and are coming from a very strong position with record unemployment, low debt to household income ratios and strong savings rates still intact following record pandemic savings rates.

Our base case remains unchanged.

  • Forward looking macro indicators and negative money creation point to a global recession in the back end of 2023. Bear in mind, a recession does not mean ‘economic calamity’.
  • Some short-term money is on the table as the potent mix of momentum, FOMO, and liquidity combine, but the risk/reward is difficult to justify.
  • With a risk-free rate of 5%, equities offer more downside than upside in our view. Long-lasting bull markets require rapidly expanding valuations and/or strong earnings growth. We don’t see evidence of either in the data.

More specifically:

  • We remain underweight equities with a tilt towards quality and energy.
  • We prefer EM and international equities to US equities.
  • Duration risk is difficult to justify given the inverted yield curve. We continue to favour the short end of the curve.
  • The credit spread on offer across the corporate bond space doesn’t compensate for the added credit risk on offer.

Anything is possible, but the risk/return is poor for investors so we remain defensive across traditional assets for the next 3-6 months.

To learn how we can help you protect your wealth from the volatility ahead, simply reach out to us using the link below.