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Good morning. Summer has come to an end, which is a bit disappointing. However, it’s important to note that 2023 has been going much better than expected. And there are reasons to remain hopeful that the positive trend continues. Think I’m being too optimistic? Feel free to email me at [email protected].
Pessimism seems to be lingering, as reported by the WSJ yesterday: Stock market bulls are feeling uneasy as we head into September…investors are questioning whether stocks can continue defying expectations and sustaining this year’s gains… Institutional investors have been cashing in on their gains, withdrawing money from US-focused equity mutual funds and exchange traded funds for the past five weeks, according to Refinitiv Lipper data… The unease is also evident in bets against domestic stocks, which reached $989bn last week, up from $886bn at the end of 2022, according to S3 Partners.
It’s important to approach any report on investor pessimism with skepticism, especially over the Labor Day weekend, which is often a slow period. There will always be bears out there, and reporters looking for stories may amplify their concerns. However, the Bank of America Global Fund Manager Survey from August, titled “Fearflation,” reveals a similar sentiment. More managers remain underweight equities than overweight by a margin of over 20%, and they anticipate slower growth in the next year by a similar margin. Cash allocations, which had been decreasing since late 2022, are now on the rise again. Commodities are currently very unpopular. There is a significant amount of gloomy sentiment prevailing.
What’s striking about this negative mood is the context: a series of events that, just a few months ago, would have been considered the best-case scenario. The August jobs report, often described as “Goldilocks,” showed slow job and wage growth that helps alleviate concerns about inflation while also increasing the likelihood that the Federal Reserve won’t tighten policy further. This was preceded by a strong July inflation report.
Despite concerns about higher interest rates and slowing global growth, second-quarter earnings for the S&P 500, although lower than the extraordinary results from a year ago, exceeded expectations (the actual decline was 4%, compared to the expected decline of 7% just two months ago, according to FactSet). Profit margins are declining, but at a manageable pace. Notably, results for the Big Tech companies that have been driving the market met expectations. After months of concerns about liquidity issues, the markets are functioning smoothly: stock and bond volatility indices are near their historical lows. The rise in bond yields seems to be having no detrimental effect on risk assets. The housing market, a key driver of economic cycles, appears to have hit bottom and may be rebounding. While China’s economic news is concerning, the government’s stimulus measures, such as easing mortgage requirements, are starting to take effect.
So why does this persistent pessimism persist despite positive surprises? Confirmation bias likely plays a role. Many investors and observers believed that the market and the economy heading into 2023 were in dire straits. Personally, I was convinced that a recession was imminent. Admitting that things are actually much better than they appeared would require me and many others to admit that we were fundamentally mistaken about the relationship between inflation, interest rates, and growth. Dario Perkins from TS Lombard summed it up well in a tweet, pointing out that the recession Wall Street had anticipated for late 2023 has simply been pushed back by six months, a move he humorously dubbed “the most economicsy move ever.” His chart, based on Bloomberg data, supports this notion. I consider this to be a general rule of Wall Street: it takes two quarters for all predictions to come true (and for all problems to be resolved). Why six months? I suspect it’s because it’s a short enough time period to seem credible, but long enough that the original prediction is forgotten.
Of course, we cannot dismiss the possibility that the pessimists may be right, rather than just stubborn. What arguments do they have to support their case? The most obvious and popular argument is also the strongest: higher interest rates will eventually have their usual negative impact, and the current delay is not particularly long in historical terms. The Fed may tighten policy too much or too little. There is no definitive answer to this argument, other than reiterating (once again) the ways in which the pandemic-induced economic cycle deviates from historical patterns. We will simply have to wait and see. Additionally, concerns about exhausted consumer savings, higher gas prices, weakness in Europe and China, and the relatively high valuations of risk assets can be attached to this central argument.
Fair enough. The global economy is slowing down, and risk assets cannot sustain their remarkable performance indefinitely. However, let’s not overlook what is happening right now. Things are actually quite positive at the moment.
One interesting read: I remember sitting in a meeting 15 or 20 years ago with an executive from International Paper. He had been with the company for decades and candidly shared that the company had only managed to earn back its cost of capital in one or two of those years. The paper industry is challenging, even by commodity industry standards. Many types of paper face uncertain secular demand trends, and there are idle paper plants waiting to be activated whenever prices rise. International Paper’s stock has hardly seen any growth over the past 30 years. With that in mind, I found it interesting to read Justin Lahart’s case for owning the company in the WSJ. In short, the company’s shares are currently at a low point, while inventories of goods shipped in corrugated cardboard have been depleted, and ecommerce trends remain strong. I can’t say for certain if Lahart’s argument is correct, but I do appreciate a bold contrarian call.
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