The stock market hasn’t had much to celebrate for the last 15 months. I admit, the tone of columns has been dour throughout that time. So, let’s start with some good news before I get back to what else is happening in the world, which is, well, dour.
On March 23, 2023, the S&P 500 celebrated the third anniversary of its COVID-19-pandemic low. The annualized return over that period was 22.8 percent, the best three-year return in a long while. I pulled up a historical chart of the market to determine when the index previously experienced three-year returns like that. However, nothing in recent history looked close. The best three-year return for the S&P 500 was about 33 percent, starting from the Great Depression lows of January 5, 1932.
Yes, it has been a depressing year for the stock market. Unfortunately, there is a cost to participate in a stock market that provides annualized returns of 22.8 percent. And that cost is going sideways for much longer than most of us would like it to.
The good news is that three-year return. The bad news is that a recession is looming.
Last week, I noted that “the Fed raised the federal funds rate another 0.25 percent. The recent collapse of three giant banks (Silicon Valley, Signature, and Credit Suisse) could create at least the equivalent of as much monetary tightening.”
Moody’s Analytics would like to correct me, and I’d like to agree. I postulated that bank stress would tighten monetary supply equal to about one quarter-point hike; Moody’s calculated that the bank pressure is more like two to three such hikes. That’s terrible news for the economy, especially considering that banks have already tightened lending standards since the third quarter of 2021.
You can see in this chart from the St. Louis Federal Reserve Bank that when banks tighten standards for commercial and industrial (C&I) loans (as they have for six quarters now), recessions tend to follow. It’s hard for me to believe we will get out of 2024 (if not 2023) without a recession. The big question for investors is, has the stock market already priced it in?
According to FactSet, analysts expect earnings declines for the first half of 2023 for S&P 500 companies. And they expect earnings growth for the second half of 2023. For all of the calendar year 2023, analysts expect earnings growth of 1.9 percent. Assuming analysts are correct, the forward-looking price-to-earnings (P/E) ratio of the S&P 500 is 17.1. That is below the 5-year average (18.5) and the 10-year average (17.3).
But that doesn’t tell us if the stock market has priced in an economic recession (or an earnings recession) back to the lows of October 12, 2022, when the S&P hit 3,577 points. However, it gives us some guidance. Dropping back to those lows would be a painful drop of around 10 percent—and that’s after an already rough year. At that point, the P/E would be a comfortable, if not attractive, 15.5. And that would likely occur as inflation broke closer to the Federal Reserve’s target. Admittedly, that silver lining is hardly solace. That is why last week I wrote, “I am considering hedging my investment portfolios a bit more.”
Between last week’s column and this one, I sold some of my hedges and split the proceeds. I replaced some of my defined outcome “buffer” funds with others that provided more protection. I also introduced two new fixed-income funds. Those two funds were the Vanguard Short-Term Bond ETF (symbol: BSV) and the SPDR Bloomberg 1-3 Month T-Bill ETF (symbol: BIL).
I am taking some action now and am examining my next options. Fortunately, I will be able to exchange ideas with a few hundred professional investors this week: I will be traveling to an investors’ conference called the MA RIA Summit to moderate the kickoff panel. The session is titled “Market Outlook and Opportunities: How are Registered Investment Advisors positioning, managing, risk, and growing clients’ portfolios in domestic and global markets.” Unfortunately, that means there will be no “Capital Ideas” column next week. The goal is to come back with ideas to share with you when appropriate.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
