My thoughts on 2023 so far We started the year with a much higher inflation number and it was evident that inflation was coming down. The mainstream media reported on this and the investment community ran away with the idea that we're going to get back to 2% without an interruption to the jobs market. The S&P 500 and Nasdaq rallied for the year as inflation expectations were coming down. Generally speaking, growth stocks do well when inflation is low and future profits can remain high. This pushes the valuation higher which is exactly what took place this year.
As it turns out, the equal weighted S&P 500 is up ~ 2% for the year. It has been the "magnificent 7" that has pushed the index higher. It does not surprise me that short term cash and equivalents has outperformed the equal weighted S&P.
What's likely to happen going forward? Well, the market is entertaining the idea that inflation may not be coming back down to 2% anytime soon. The higher for longer narrative is not good for equity markets as it pushes the cost of capital higher which drives valuations lower. As always, the stock market is always late at receiving the memo. The bond market is telling you what has to happen for the economy to get back on the right path. It may be a combination of the 10 year yield going higher and the 2 year going lower but that a steepening of the curve is going to be difficult for the economy to handle either way.
The path to a soft landing can occur if the following conditions hold true:
1) The Fed decides to change the inflation target from 1-3% to maybe 3%-5%.
2) the labour force becomes more productive than the historical trend over the last 15 years or so. This will push the 10 year higher and the yield curve would steepen with the far end moving higher rather than the short term moving lower.
Anything is possible....
But, I don't believe in the first scenario as the Fed will lose all credibility if they move the goal post further. The second point is unlikely to improve as Fed Policy remains at restrictive levels for the foreseeable future.
Anyone who believes that raising interest rates will not have an effect on the resilient consumer is like saying if I throw an apple off the tree then it will not fall to the ground.