Where can investors turn when the markets are a riddle? Raymond James CIO Larry Adam seeks advice from antiquity.
To read the full article, see the Investment Strategy Quarterly publication linked below.
More than 200 years ago, a French military officer stumbled across the Rosetta Stone, a 2000-year-old carving with clues to deciphering the Egyptian hieroglyphs that had puzzled the world for centuries. We don’t exactly have a Rosetta Stone for our perplexing market’s future – no one does. But just as the Rosetta Stone opened a window into Egypt’s mysterious past, we have some clues that might help investors crack the code for the coming months.
The discovery of the Rosetta Stone was unexpected – just like the duration of the Ukraine crisis, China’s zero-tolerance COVID policy, and elevated inflation are today. As 2021 came to a close, few analysts (including us) would have predicted the worst start to a year in decades for both equity and fixed income investors. Then, the economy appeared easy to read. Whether you read it from right to left or top to bottom, the consumer was well positioned due to strong job growth, wage gains, and abundant savings. The only question was how quickly consumers would transition their spending from goods to services.
Data from airlines, restaurants, and vacation destinations sketch the speed and magnitude of that shift, but uncomfortably high inflation clouds the picture. Yet from our vantage point, that should clear up soon since retail inventory levels remain high, transportation prices are falling, and discounting is becoming more prevalent. If that anecdotal evidence isn’t enough, the Federal Reserve’s (Fed) message cannot be lost in translation: Inflation will be its singular focus as it aggressively raises rates to slow demand. We believe the Fed will raise rates to as high as 3.5%, with most of the rate hikes by year end. Of course, there are risks to our interest-rate-sensitive economy (particularly for the housing market) and the possibility of a recession next year is growing. But we hope the Fed can construct the eighth wonder of the world: a front-loaded tightening cycle that doesn’t tip the economy into the ruins of a recession. Our base case sees 2022 GDP of approximately 2%.
The one straw that could break the global economy’s back is towering oil prices. With gasoline prices near $5 per gallon, drivers dread the fuel pump hieroglyph on their dashboard; on average, per driver, it could represent $600-$850 in additional costs annually. (Add to this the potential of higher heating costs this winter.) The price of gasoline has a strong inverse correlation with consumer confidence, so the more it costs, the lower confidence trends. If consumer and business confidence sink simultaneously, spending could retreat and create a self-fulfilling prophecy of recession. Controlling energy pricing pressures may seem like a riddle from the Sphinx. It remains to be seen how the Biden administration will engineer an exodus from these price pressures to dodge a recession and float the president’s approval rating higher. While increased production by the US and OPEC might drive oil prices modestly lower by year end (target: $105), peace in the Ukraine will likely be needed to sustainably sink oil below $100 per barrel.
With elevated inflation and expectations for Fed tightening flooding the bond market like the Nile River’s annual rise, we have lifted our near-term outlook for the 10-year Treasury yield. But unlike the Nile, the world’s longest river, the increase in yields will be short. Egyptians still celebrate the river’s high-water mark; we’ll celebrate as soon as the eventual easing of inflationary pressures causes interest rates to recede. Our year-end and 12-month targets for the 10-year yield are 2.85% and 2.65%, respectively. After a years-long drought of attractive options for fixed income investors, the 10-year yield that recently approached 3.4% makes Treasury bonds appealing, as does the approximately 5% yield for high-quality, investment-grade debt. With strong state finances and favorable supply dynamics expected this summer, municipal bonds are also compelling.
The ancient Egyptians are credited with the first written language, but it took time for the hieroglyphs to evolve from simple pictograms to the complex forms that so long mystified archaeologists. While the equity market has also evolved, dry times such as these inspire us to get back to basics – valuations, earnings growth, and corporate shareholder actions – like oases in the desert. The S&P 500 is wandering in a bear market, but hope for the future is not a mirage. Even if the economic expansion ceases, the recent decline inequities has already discounted about 98% of the pullback historically seen during a mild recession. Therefore, the potential rewards of a significant rebound outweigh the risks of further declines.
The building of the pyramids may seem an easier feat than timing this market’s bottom, but investing inequities following a selloff has paid off, time and again. Since1950, the S&P 500 has rallied about 15% on average and is positive 70% of the time after a 20% index drop. Attractive valuations, mid-single-digit earnings growth, increased dividends, and robust buybacks support our year-end and12-month S&P 500 forecasts of 4,180 and 4,400, respectively. The three least expensive sectors are our favorites: energy, financials, and health care. From an international perspective, a more dynamic, resilient US economy, with less direct ties to the Ukraine conflict, is extending the reign of domestic equities over other global investments.
Until inflation abates and Fed policy clarifies, market volatility may continue. In the meantime, view your portfolio through the Eye of Horus – a symbol of both prosperity and protection. Don’t be misled by the incessant headlines that cause many investors to misconstrue the market’s messages and make ill-timed portfolio decisions. Diversification, asset allocation, and a long-term investment horizon remain timeless investing principles. An ancient Egyptian proverb says: “To have peace there must be strife; both are part of the structure of the world,” and this is true of the financial markets too. The first half of this year brought significant strife, but when those more peaceful times inevitably come, we’ll appreciate them all the more.
All expressions of opinion reflect the judgment the author, the Investment Strategy Committee, or the Chief Investment Office and are subject to change. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. The performance mentioned does not include fees and charges which would reduce an investor’s return. Dividends are not guaranteed and will fluctuate. Investing involves risk including the possible loss of capital. Asset allocation and diversification do not guarantee a profit nor protect against loss. Investing in certain sectors may involve additional risks and may not be appropriate for all investors. The indexes mentioned are unmanaged and an investment cannot be made directly into them. The S&P 500 is an unmanaged index of 500 widely held securities.