The bull and bear cases for 2023

Our Top Market Takeaways for April 17, 2023

Market update

It ain’t 2022 anymore

Perhaps the clearest sign that markets have moved on from 2022 is that not even the latest U.S. Consumer Price Inflation data could cause much of a ruckus last Wednesday.

After the release suggested a relatively ho-hum increase in prices in March (0.4% for core, 0.1% for headline on the month), investors shifted focus to the upcoming earnings season, hoping to learn more about the state of bank deposits, consumer spending and technology turnaround efforts. And earnings season got off to a solid start on Friday with a handful of large U.S. banks exceeding expectations despite concerns that last month’s banking turmoil might have weighed on first quarter profits.

The returns we have seen stand in stark contrast to 2022’s risk-off environment. From their respective lows, Bitcoin has surged almost 100%, Chinese internet companies and mega-cap tech stocks are both up ~50%, and even the ARKK Innovation ETF, which shed two-thirds of its value in 2022, has bounced by around 30%. The best-performing stocks in the S&P 500 this year (Meta and NVIDIA) are up over 80%. In 2022, they both lost more than 50%.

European equities are close to all-time highs, and core bonds have provided a workmanlike 3.5% return. The U.S. dollar is close to its lowest levels in a year. 

The most valuable players in portfolios last year were short-term U.S. Treasuries. This year, most major asset classes are outpacing T-bills. Energy and commodities, the other 2022 standouts, have also lagged.

We welcome the vibe shift in markets, but there is no shortage of debate about what the rest of the year has in store. In today’s note, we review the case that both bulls and bears make for the path forward, then provide our take.

Spotlight

Bull vs. Bear

The U.S. economy

The bears have a lot of evidence they need to make their calls for a U.S. recession. Rate hikes have consequences after all. The failure of Silicon Valley and Signature Banks may not have led to a crisis of confidence, but the problems for bank profitability and credit availability may just be getting started. Small businesses are already reporting that credit is harder to find, the U.S. office real estate sector will likely have a material distress cycle, given higher interest and vacancy rates, and continuing jobless claims are starting to signal cracks in the labor market.

The bulls still have a decent case to make. Wage inflation seems well on its way to normalization without any rise in the unemployment rate, which seems to settle one of the key macroeconomic debates of the last 18 months. Even though strains are just starting in the office sector, the residential housing market is showing tentative signs of turning a corner. Housing market sentiment and home sales are tentatively perking up.

Our take is that it still seems like a recession is more likely than not, but a softer landing is possible. We will be watching closely for signs that the credit crunch from March is having a sustained negative impact through the spring.

The global economy

The bears on the global economy seem to be worried about geopolitical risks, energy crises, an unpredictable war and unresolved trade issues between the U.S. and China. It makes sense to keep a keen focus on all of these unresolved issues that threaten economic growth and stability. In fact, our Chairman and CEO Jamie Dimon spent time discussing them in his latest letter to shareholders. The biggest risks facing the global economy outside the U.S. are probably not endemic to the business cycle, but are still very important to monitor.

The bulls seem to have the upper hand here. Global Purchasing Manager Indices, which offer a real-time indication of business activity, are at their highest levels since last summer and have had a tremendous bounce since last fall. A weaker dollar helps grease the wheels of global trade, and China’s reopening continues to provide a boost. For example, Louis Vuitton helped to drive the French stock market to an all-time high last week after reporting strong sales in China for Q1.

Our take is that growth prospects outside the U.S. look better than they do inside the U.S.. This means the dollar is likely to continue to weaken, and investors may want to consider diversifying some of their U.S. overweights by rotating into other regions like Europe and China, which could continue to perform well.

The bond market

The bears on bonds have a simple case: the economy is still chugging along and inflation is still at ~5% in the U.S., and ~7% in Europe. It doesn’t make much sense for yields to fall (and bond prices to rise) as long as growth remains resilient and inflation stays sticky.

The bulls say markets only have ~80 basis points (bps) of interest rate cuts priced in over the next 12 months. In the average recession back to the 1950s, the Federal Reserve has cut by an average of ~300 bps (excluding Volcker’s 1980 campaign). In a recession, Fed cuts will likely be deep, and price gains in core bonds could be steep.

Our take if our base case on the economy plays out is that we could be in for much lower interest rates (and higher bond prices) over the next 12–18 months. However, for the tactical investor, there may be better entry points in the weeks ahead.

The stock market

The bears point to the ominous economic backdrop in the U.S. to justify their view that stocks should head lower. Valuations also seem to be embedding a high degree of confidence in a relatively benign earnings outcome. The forward P/E multiple of the S&P 500 is above 18x again, and the spread between what you can yield from earnings and what you can get from corporate bonds is the tightest of the last 10 years.

The bulls suggest the U.S. earnings recession that we have been in is set to end after this quarter. After that, consensus expectations call for earnings growth to quickly bounce back to a low teens pace by the end of the year. In Europe, earnings look set to remain fairly resilient too. Beyond the fundamentals, positioning seems short, which could set the market up for a squeeze higher if we have an upside surprise this earnings season.

Our take is that neither are right. Instead, we expect choppy, rangebound trading for U.S. equities through the rest of the year. Certain sectors (healthcare, industrials and reasonably priced tech) and sizes (mid-caps) may outperform, but at an index level, we are pretty close to where we think the market will likely end the year. Other regions like Europe and China may have more potential upside in our view, but it is still unlikely to be a smooth ride.

Takeaways

Back to reality

The hardest part about 2022 was that barely any investments worked.

What we have learned so far this year is that 2022’s environment of boiling inflation and aggressive interest rate hikes is in the rearview mirror.

The debate between bulls and bears will continue, but investors should take comfort in the idea that assets are doing what they need them to do to achieve long-term success. Equities drive long-term growth. Bonds provide stability and security. Alternatives allow for the potential to outperform public markets and access unique opportunities.

We can help address the investment challenges ahead while building portfolios that help you reach your financial goals.

All market and economic data as of April 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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