Some good news (finally)!
The man who is a bear on the United States will eventually go broke. -- J.P. Morgan
After a tumultuous 2022, some good news to report. The equity markets defied skeptics and rallied to start the year. As detailed in your first quarter statement, we experienced a strong Q1 performance.
We are now amidst earnings season and will review what U.S. companies have to say about the economy. Nevertheless, in the face of bank collapses, continuous recession fears and a looming debt ceiling fight - the stock market is indicating perhaps the worst of America's economic pain is behind us. Investors are growing increasingly confident that the Federal Reserve will end the cycle of interest-rate hikes that spurred the S&P 500's plunge in 2022. If the stock market can continue to advance from the October bottom, such would signal the start of a bull market. While we are in a wait-and-see mode for the equity markets, another positive opportunity is the U.S. bond market. After experiencing one of its worst years on record, the U.S. bond market is similarly recovering. The 6-month U.S. treasury is paying nearly 5% APR. The point being is that there are now interesting investment opportunities across the risk spectrum. Given this situation, we do not recommend holding a sizeable cash position at this stage of the recovery.
In my prior correspondence, Silicon Valley Bank collapsed, and we cautioned investors not to overact to the news. Although we are only one month out from this issue, the events still do not appear to be a banking crisis. A banking crisis is a fundamental problem within the banking system. This was a banking tremor: A few banks were caught offside, poorly supervised, and collapsed. As we saw last week during the initial bank earnings reports, the large banks are fine (JPMorgan, Citigroup, and Wells Fargo each reported an increase in profits). We only hold the large financial institutions within our portfolio. The larger banks appear resilient and safe because they have diversified business models. Granted, the deposit run and the speed thereof at First Republic, Silicon Valley Bank and Signature Bank startled the market and Federal regulators. But this was a failure of supervision and poor bank management. When you change the interest rate paradigm as quickly as the Fed did, some companies will be caught flat-footed. The larger banks can easily adjust. We likely will see a divergence when the smaller capitalized banks report over the next several weeks.
On the inflation front, the data last week was encouraging and indicates that inflation may be falling faster than consensus expects. Foremost, the drops in the March Consumer Price Index (CPI) and Producer Price Index (PPI) show the "higher for longer" Fed narrative may not occur. The equity and bond markets are now positioning for the opposite of a deep recession. In fact, the S&P 500 now spent 25 weeks above its 200-week moving average. Checking historical data, since 1950 there are zero instances of the S&P 500 returning to a previous market-cycle low after the market recovered the 200-week moving average and spent 25 weeks there. In fact, after passing the 25-week milestone, the 3-month, 6-month and one-year returns have been positive in every single instance. When we are modeling for probability, we need to take these odds. Avoiding impetuous moves and patiently tilting toward attractive asset classes are the keys to higher performance for long-term investors. This year, it is more important than ever.
Kind regards
Michael
