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Quarterly Review and Outlook: March 2023

"Too Late to Turn Back Now"

Loyd Johnson Photo

By Loyd Johnson, Chief Investment Officer
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A Look Back

The above song was released in 1972 and performed by the Cornelius Brothers and Sister Rose. It was the follow-up single to their debut 1971 hit, "Treat Her Like a Lady." It got all the way to #2 on the Billboard Top 100 charts, and has been featured in many movies and commercials over the years.

As we sat around a fire recently, with the trusty 70’s station playing in the background, the catchy, bluesy song came on. I had not heard it in quite a while, but it popped in my head the next morning as I was thinking about the markets, the Fed, and all of the other fun things a Monday morning brings.

Specifically, I believe it fairly accurately describes where the Fed finds itself now after a year of drastic rate increases. They have said all along that their number one priority was to bring inflation down…and back to the preferred target of around 2% annually. For reference, inflation had tracked at or below that level for years before Covid. It reached a peak of 9.1% in June of 2022, and has since backed off to around 6%. Some might say, “the rate hikes are working…just let it play out.” Others could say, “6% is still 6%...and that ain’t 2%.” And, they, of course, would be right. Thus, the dilemma of what to do…continue on with additional rate hikes and risk extensive economic pain, or stop and/or reverse course and risk inflation not being contained. More on that later.

Regardless of the headlines, the first quarter of 2023 was actually pretty good from a historical perspective. Large-Cap U.S. stocks were up 7.5% and core bonds were positive by nearly 3%, versus long-term averages of around 2.5% and 1.0%, respectively. In fact, other than Commodities, every other asset class shown above had positive performance to start off the new year. Another great reminder of how difficult it is to predict short-term market direction based on news of the day. With all of the same market/economic ills that were present for a decidedly down 2022, the first quarter of 2023 has surprised most forecasters.

Numbers, Numbers, Numbers! There are so many to digest on a daily basis as they relate to our economy and, ultimately, our financial markets. Interest rates and inflation we have already touched on. GDP growth, unemployment rates and job growth, retail sales are a few more…and many of the other numbers are stubbornly okay. The latest Jobs number, for example, showed employment rising by 236,000 in March and the unemployment rate staying unchanged at 3.5%. The latest estimate for first quarter GDP in the U.S. is around +2.5%. However, Retail Sales declined 1% in March, and has now been negative four out of the last five months. This shows that consumers have cut back on spending, and the detailed breakdown shows that is especially true when looking at bigger-ticket items such as automobiles and electronic items.

We show the table below because many have argued that although the unemployment rate has been surprisingly low, it has nowhere to go but up. Is it more likely for a 1% higher move to 4.5% or a 1% lower move to 2.5%? Most would say higher at these levels and the table gives an indication of what that higher move might look like if the employment numbers do in fact roll over.

The only time that the unemployment rate didn’t rise another 1% after the first rise was in 1980, and you could argue that was because the level was already extremely high at around 8%. So, if we do get a fairly precipitous rise in the overall unemployment rate, it is likely that a recession will follow. But, we just have not seen recessions in the past with the current jobs situation in the U.S…one where jobs are still being added on a monthly basis and there are still more jobs available than people looking. For a true wide-ranging recession, this most surely will have to change, and it is the one economic number that can shift pretty quickly if employers decide to universally tighten their belts.

The charts above show past market inflection points when unemployment rates had that kind of increase and what the S&P 500 did. The gray shading shows the subsequent recession that resulted, which includes the short one that was a result of the Coronavirus Pandemic in 2020. The spike there was historically high, as countries around the world shut
down their respective economies as we all navigated the early stages of Covid.

Before we look forward, it never hurts to look back. Our asset class table is as relevant as ever. Diversity did not play nearly as positive a role in 2022 as it normally does. Even though the -13.9% return for the white asset allocation box put it in the middle of returns, it was still substantially negative as Fixed Income was down by 13% itself. So far in 2023, normalcy has returned, and the white box is strong with a 4.3% return, which would imply around an 18% annualized number! We can still dream…it’s never too late for that.

A Look Forward

It is decidedly easier looking back…we know what happened. We may not always know why things happened, but we know they did. The interesting chart below shows how the typical consumer is feeling, and how the stock market performed in the following 12 months. The consumer was extremely negative coming into 2023. Although the sentiment index did improve in the quarter, it is still well below the longer-term average. The chart follows our long-held mantra that you need to zigging when most others are zagging. Trends work until they don’t.

This is certainly no guarantee that the 12 months following that low reading will be positive, but it is worth noting. It is also why it is so important to have a plan…and maybe more important that you stick to it, and take advantage of market opportunities…both good and bad. My dad used to always tell me, “when you hear hoof beats, don’t assume it’s a unicorn.” We have heard often about how things are different “this time”. We heard that in the Dot com bust in the late 1990s. We heard it again in 2007 and the lead-up to the Great Recession. We hear it now at times. The drivers change for sure, but human nature rarely does. For a variety of reasons too many to fully discuss here, investors are easily influenced by the masses. There is the fear of missing out (FOMO). There was there is no alternative (TINA). And, there are others. They are acronyms for a reason. They hold weight. It is our job as professional money managers to make sense of it all...to sift through the data and keep out the noise. Long-term money is made with long-term approaches. Consider the table below. It looks at all domestic active stock funds. It is an all-encompassing, data-driven look at fund managers across all equity asset classes…large, mid, small…value and growth etc. and how they perform versus a respective index. The longer-term numbers are quite telling. In fact, over 92% of all managers do not beat their respective benchmarks over 10, 15, and 20 year periods. It is the reason that we focus on the big-picture allocation between the major asset classes and not the newest candy in the store. It is terribly difficult to pick the right stock, or the right manager, or the right anything on a consistent basis. Focus on what you can control!

We will continue to do just that. We have a slight underweight to stocks right now. We are neutral with core bonds, as we expect returns there to get back to historical levels of 5-6% annualized. We have an overweight to Cash as we look for those opportunities mentioned earlier. Either way, the Fed is all-in on their fight against inflation, and it is too late for them to turn back now…for now.

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