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I had the opportunity to moderate a panel at the eighth Annual Private Wealth New England Forum this month. The following are the bullet points on the consensus views from my panelists and other speakers. These aren’t necessarily my views, but the zeitgeist of this esteemed collective—including former Massachusetts governor, Bill Weld, and co-owner of the Boston Celtics, Steven Pagliuca.
- The Doomsday/Terminator Hype regarding artificial intelligence is overblown.
- Lawmakers will reach an agreement before the debt ceiling X-date (currently estimated to be June 8, 2023).
- Commercial real estate will endure more pain and adjust to a lower level of profitability.
- Undervalued stocks can remain undervalued for a long time.
- The U.S. economy is going into recession soon. (Allen’s note: For 17 months, the consensus has been that a recession is around the corner. At some point, an “early” call is no longer early—it’s just wrong.)
- The Federal Reserve has finished raising interest rates for this cycle. They will cut interest rates when the stock market panics about an expected recession. (Allen’s note: The Fed doesn’t care about the stock market.)
- There is no consensus on the outperformance of growth stocks vs. value stocks. However, a higher cost of capital favors large capitalization stocks relative to small-cap stocks. The weaker U.S. dollar justifies broader international exposure. However, remember that many large U.S. stocks already have significant foreign revenue.
- Bonds are in vogue again, particularly those with shorter maturities and higher credit quality.
- Despite the federal government’s implicit guarantee of all bank deposits, more banks will fail this year. (Allen’s note: I tried hard to find investors willing to buy bank stocks now and found no one. The KBW Bank Index dropped 36 percent in three months. The only other two times it has done that in the previous three decades were during the Great Financial Crisis and the COVID Crash. At some point, it will become a good contrarian play.)
- Despite the S&P 500 running at an annualized rate of return of 16 percent for 2023, investors remain more bearish than typical.
- Inflation will continue to trend lower but remain higher than the Federal Reserve’s 2% target rate over the long term.
I’ll drop the moderator’s microphone next month to present at the Private Wealth Management Summit. It will be interesting to get a sense of bearishness or bullishness at this conference. At that conference last year, professional investors were so bearish that I was practically booed off stage when I suggested the stock market could return 10 percent by June 2023. With just a couple of weeks to go, the S&P 500 is up a whopping 1.5 percent (he said, sarcastically). Admittedly, it doesn’t seem likely that the market will experience an additional 8.5 percent of return by the time I hit the stage again. Not that it’s a competition (not officially, anyhow), but I wonder if the crowd will still insist that the stock market is poised to evaporate. Improvement in the inflation situation may put my colleagues in a better mood.
Year-over-year headline inflation, measured by the Consumer Price Index (CPI), rose 4.9 percent over the last 12 months through April 2023. That was its smallest increase in two years, down from its cycle peak of 9.1 percent for June 2022. (The June 2022 reading was the CPI’s most significant year-over-year increase since November 1981.)
It may not feel it, but inflation is falling faster than it increased. This was the CPI’s 10th consecutive decline. Headline CPI has dropped 4.2 percentage points from its June 2022 summit. In the 10 months prior to June 2022, CPI increased by 3.8 percentage points. It took 28 months from the COVID-19 shutdowns for inflation to top out. It seems realistic to take a similar amount of time to get inflation back to the Federal Reserve’s target of 2 percent (that would be November 2024).
It shouldn’t take too many more months to see the year-over-year CPI down over five percentage points from its recent peak. Historically, when CPI declined by that much, stock market returns were positive.
The table below shows the six prior instances in which CPI declined by five or more percentage points over 12 months (with no occurrences in the previous year).
The median one-year return for the S&P 500 was 14.94 percent. There was one negative year (1947). In each of those periods, the S&P 500 was up by at least 13 percent at some point. And of those six occurrences, only one period (1947) experienced a 5 percent decline. Not that history repeats, but if it does this time, a 14.94 percent return from current levels will bring the S&P 500 close to its previous record levels.
The Federal Reserve Expects a “Mild Recession”
Given the recent banking stress, the latest Senior Loan Officer Opinion Survey (SLOOS) on Bank Lending Practices was highly anticipated. It was closely watched to assess the repercussions of the recent closures of four large banks (Silicon Valley, Signature, First Republic, and Credit Suisse).
According to the survey, 46 percent of banks tightened credit for commercial and industrial loans in the first quarter of 2023. That is up from 44.8 percent in the prior survey and is the highest since the third quarter of 2022. Additionally, banks are more highly scrutinizing household loans, such as mortgages, home equity lines of credit, and credit cards.
The loan officers expect more banking trouble for the next year and further tightening across all categories of loans. The reasons for changing future loan standards include “an expected deterioration in the credit quality of their loan portfolios and in customers’ collateral values, a reduction in risk tolerance, and concerns about bank funding costs, bank liquidity position, and deposit outflows.”
The Federal Reserve had access to this report when they raised the federal funds rate on May 3, 2023, which is possibly why their forecast is for a “mild recession” this year.
However, the risk of a mild recession is not dependent solely upon the supply side of loans. There has been softening demand for commercial real estate loans. Banks reported record-low applications for multifamily, nonresidential, and land development. That isn’t surprising, considering that the NFIB Small Business Optimism Index dipped by 1.1 points to 89.0. That was the 16th consecutive month below the survey’s 49-year average of 98.
Interestingly, labor quality was cited as the top business problem at 24 percent, with inflation closely behind at 23 percent. It appears as if businesses and households are getting used to high inflation. That is corroborated by a Gallup poll citing inflation ranking as only the third most important problem (at 9 percent, compared to 20 percent in October 2022).
If persistent inflation becomes embedded into expectations, it will show up in price and wage setting. In an upward “chicken-or-egg” type of spiral, high prices drive wages higher, and higher wages fuel higher prices. When this happens, it takes more than a “mild recession” to keep inflation reasonable. When it comes to the saying, “the only thing to fear is fear itself,” that’s not true when it comes to inflation—complacency (in the form of expectations) is like kerosene to the trash fire that is persistently higher prices.
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.
