18 May Difficult Times Ahead but not Insurmountable: Economic Outlook May 2023
Difficult Times Ahead but not Insurmountable
Now that May is upon us, many Investors fall back on the classic Investors Almanac and Sell in May and Go Away. And while we love the idea of taking the Summer off the facts don’t support this maxim. In the 95 years since the start of the S&P 500 the Index has risen 65% of the time from May to October. If we look at just the May-October periods since 1990 the S&P has risen 70% of the time.
Source: Birinyi Associates
Walking away and hitting snooze is a good way to miss a rally.
But maybe this year will be one of the other 35% of the time. Banks going into receivership, the Fed moving Rates at a historic speed, global tensions over Ukraine still unresolved and now Congress and the White House are playing Chicken with the United States standing as the most stable currency the world has ever known.
Let’s look at these one at a time.
While worrisome the current banking problems are more similar to the Savings & Loan problems of the 1970s than to the 2008 financial crisis, and are caused by a combination of quantitative easing, abundant-reserve monetary policy, and ultra-low interest rates. The Federal Reserve is backstopping the problem by taking back government debt, which restarts quantitative easing, and insuring all deposits to prevent money from moving to large banks. The decline in M2 money supply will result in some decline in deposits, but economic growth is expected to continue. We expect more banking problems to arise, but they will be dealt with through policies that defer the problem. The stock market may be overly optimistic about the situation.
The US Treasury is expected to hit its maximum debt limit by early June, which is earlier than originally anticipated due to weaker than expected tax receipts. Global investors are beginning to take notice, with credit default swaps on Treasury securities rising in recent weeks. The House Speaker has unveiled proposed legislation to increase the limit, but it includes significant cuts to discretionary spending, stricter work requirements on assistance for low-income households, and rolling back much of the Biden administration’s climate change and student lending agenda. If lawmakers do not act in time, the debt limit drama could end in default sometime in June or July.
With this past 25 basis point hike the Fed is giving the impression that it will pause further hikes unless the data forces are move in either direction though for right now it seems we are in a holding pattern. Because of the Banking turmoil the dirty work may already have been done with Banks tightening their lending volume and raising their qualifications causing the Fed to take a backseat as recession risks come to the fore. This shift may ultimately be supportive of fixed income, especially compared to other asset classes. However, there is a lack of consistency across various asset markets in terms of recession pricing, with the rates market fully in recession-pricing mode while the equity and credit markets remain resilient. The article expects markets to meet halfway, with the equity market potentially experiencing downside risks and credit markets experiencing some spread widening. Overall, fixed income appears to be well positioned to weather potential recession-related macro turbulence ahead.
With Cash and Ultra Short Bonds giving a return of 4-6% we have no problem adding to Bonds and letting cash sit. We are still not bearish enough to actively reduce Equity exposure unless a better alternative presents itself. Illiquid Alternative investments can present these opportunities, so we continue to do our Due Diligence to uncover the best choices.
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