Dear clients and friends,
While perusing the recent NY Times list of “Things That Happened for the First Time in 2022,”[1] one item, in particular, caught our fancy – the public demonstration of a flying bike at the Detroit Auto Show last September. As fans of new technologies and, admittedly, a little bit nerdy when it comes to science fiction, we were tickled to see that the world’s first functioning hoverbike was inspired by the fictional landspeeder vehicles made famous in the 1977 Star Wars motion picture. The modern air bike’s manufacturer has even used life-size Star Wars robot props to promote the hybrid-fuel vehicle in Japan where it is already available for sale. Unfortunately, though new technologies and future modes of transportation are exciting to ponder (especially as potential investments, which this is sadly not), our musings and reminiscences soon turned to the harsh realities of the Star Wars era – notably the gasoline shortages and economically crippling inflation of the time – and their strong parallels around the world today.
At the beginning of last year, we shared with you our outlook for 2022, which touched upon the possibility of a stock market "correction" and the likelihood of rising interest rates during the year. While our expectations were directionally correct on both counts, we did not anticipate the magnitude of the impact caused by events unforeseeable at the time – Russia’s war against Ukraine, China’s uncompromising zero-Covid policy, the resultant acceleration in supply-chain-driven inflation, and the Federal Reserve’s (and other central banks’) heavy-handed efforts to slow the global economy and quell that inflation. We have discussed these and other related items in greater depth in our prior communications. In the interest of keeping this letter somewhat brief, we’ll refer you to the Evermay Newsroom Section of our website should you wish to revisit those topics.
Though the likelihood of recession is elevated as we begin the new year, questions abound as to the magnitude of such a recession, if one does indeed happen, and its effect on stock and bond markets. A Wall Street Journal article this week reports that 98% of CEOs in the US expect a recession in 2023, but that it will be short and shallow without widespread job cuts, followed by modest growth in 2024. [2] The labor market remains remarkably strong, with the unemployment rate at 3.5% in December, and labor shortages remain a bigger challenge than excess payrolls, according to the article. Inflation remains a top concern for business leaders, though this week’s CPI report shows inflation slowed for the sixth straight month in December, although the level remains high at +6.5% from a year ago. [3] Curiously, that was the full-year inflation rate in 1977, the year Star Wars made its debut! [4]
Thanks to the strong job market, the US consumer remains financially healthy – at least for now. With consumer spending accounting for roughly 70% of US economic activity,[5] personal consumption and consumer debt levels are key indicators to watch in 2023. Turning our focus briefly back to modes of transportation, albeit of a more mundane variety, we see that air travel in the first ten days of 2023 has surpassed pre-pandemic levels, according to the Transportation Security Agency (TSA). [6] This “high frequency economic indicator” shows TSA checkpoint numbers are 2.5% higher than the same period in 2020, and over 4% above 2019’s levels. Similar strength was evident in hotel bookings and broader consumer spending trends during 2022, suggesting that pent-up demand continues apace as we start the new year. However, household debt has recently risen at the fastest rate in the past 15 years, according to a Federal Reserve report cited by CNBC, as credit card usage surged during the second half of 2022. [7] This raises concerns about spending levels later this year as the consumer grapples with higher debt loads.
Every cloud engenders not a storm.
The long-term outlook for stock and bond market return has actually improved of late, even in the face of possible near-term recession. First, consensus earnings expectations for the S&P 500 have declined only modestly and are but a few percentage points below all-time highs set in 2021, even as stocks dipped into bear market territory last year.[8] Stock valuations – the price we pay for a company’s earnings – thus became relatively more attractive compared to the elevated levels we noted at the beginning of 2022. Consistent with our outlook, we have been overweight large US stocks and underweight relatively riskier small and international equities. Also, the effect of a recession on stocks need not be dire, as we noted in our mid-year 2022 missive:
… if a recession does occur, what is the likely impact? Forbes reports that, since 1945, the S&P has actually risen an average of 1% during post-WWII recessions.[9] If markets are indeed forward looking, it is possible they bottom well in advance of reported economic data.
Second, with interest rates having already climbed higher, and the Fed’s rate hike cycle possibly concluding over the next several months, short-term bond yields are near the most attractive levels of the past decade or more. The broader bond market had one of its worst years ever during 2022,[10] but we had positioned our clients with predominantly short-term fixed-income holdings that stood to benefit more quickly – and decline far less in price – when interest rates rose as they did.
A final thought on travel, but perhaps more appropriately considered with your personal financial objectives in mind:
If you don’t know where you’re going, you might wind up someplace else.
The important thing to keep in mind when looking ahead is that there are uncertainties to any outlook and surprises may happen, in the markets and in our personal and professional lives. As always, we encourage you to reach out at any time to discuss your portfolio to ensure your mix of assets is appropriate and aligned with your financial goals.
With best wishes for 2023,
Mitch Schlesinger
Chief Investment Strategist
Senior Portfolio Manager
[1] https://www.nytimes.com/2022/12/06/special-series/2022-firsts-year-in-review.html
[2] https://www.wsj.com/articles/ceos-say-they-expect-a-u-s-recession-but-most-think-it-will-be-short-11673500868
[3] https://www.wsj.com/articles/us-inflation-december-2022-consumer-price-index-11673485441
[4] https://www.minneapolisfed.org/about-us/monetary-policy/inflation-calculator/consumer-price-index-1913-
[5] https://www.investopedia.com/financial-edge/0512/the-spending-habits-of-americans.aspx
[6] https://www.tsa.gov/travel/passenger-volumes
[7] https://www.cnbc.com/2022/11/15/household-debt-soars-at-fastest-pace-in-15-years-as-credit-card-use-surges-fed-report-says.html
[8] https://www.spglobal.com/spdji/en/documents/additional-material/sp-500-eps-est.xlsx
[9] Forbes, “How Does the Market Perform During An Economic Recession? You May Be Surprised” 6/2/2022
[10] https://www.cnbc.com/2023/01/07/2022-was-the-worst-ever-year-for-us-bonds-how-to-position-for-2023.html
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