Financial pundits have a tendency to assign prescient directionality to the market. When prices rally or decline, commentators describe it as if an all-knowing market was moving collectively in unison. The reality is that stock and bond markets are comprised of a wide spectrum of different investors with a range of human emotions, differing goals, and varied professional backgrounds. Each of these investors is making decisions on their own, and the nuance among those decisions is obscured by the simple summaries published daily.
Over the long-term, investors’ decisions as a whole often follow predictable patterns based on economic circumstances and human behavior. In the short-term, financial markets commonly have phases of directionless wandering as investors await more information. We think we are in one of those moments right now.
Ebb and Flow
After two weeks of rallying, the stock market hit a speedbump this week, falling by nearly -3% before recouping some gains on Friday. Bond prices, on the other hand, have held onto their recent growth as the Fed signals an eventual end to the current cycle of rate hikes. Together these two data points augur a more conventional relationship between bond prices and stock prices for 2023. Beyond that, there is less clarity about what comes next for financial markets and the US economy.
Inflation jumped higher last year but is continuing a cooling trend. On a headline basis, the CPI increased at an annual rate of 6.5% in December, down from 7.1% in November. Core CPI, which excludes food and energy, climbed at an annual clip of 5.7%, which is below the 6% rate in the previous month. Fed officials have been encouraged by this progress, but recently reiterated that inflation remains “unacceptably high.” Fed Governors unanimously indicated there will be no rate cuts in 2023 — which is at odds with financial markets that are pricing in small rate cuts later this year if the US economy slips into a recession. This disconnect can be confusing for investors in the short-term, and the result is a market that appears to ebb and flow without any solid direction.
Economic data has also been weakening, and whether an official recession will arrive or not remains an open question among economists. The New York Fed’s “Empire State” index, which measures current business conditions, plummeted to -32.9 this month from -11.2 in December. That was the lowest level since May 2020 and the fifth worst reading in the survey’s history.1 The report also showed that new employment has stalled, while input prices were down notably. This is good news for inflation, but bad news for the economy. This is the kind of mixed data that investors and the Fed will have to interpret as we move further into 2023.
When we look under the surface, recent stock market activity provides further evidence that investors lack consensus. The market declined this week, which generally signals that investors are less optimistic about future, but relative sector performance didn’t suggest that investors are focused on recession fears.
For example, on Wednesday, all eleven S&P 500 sectors closed lower. The price declines were led by a -2.7% drop in the consumer staples sector and a -2.4% slide from utilities. Consumer discretionary and technology sector stocks each fell by -1.3%.2If investors were fleeing stocks because they were worried about a recession, stocks of companies that sell electricity, toilet paper, or Cheerios should be doing better than riskier companies in tech and more discretionary areas. These relative comparisons suggest to us that investors are currently feeling a sense of confusion about the next chapter for the US economy.
This lack of clarity extends into the political arena as well, and investors are anxious that political dysfunction may impact markets this year. The key issue in 2023 will be raising the debt ceiling, allowing the US government to continue paying its bills and obligations. This is a problem that could be solved by a routine vote in Congress. That said, there is nothing routine about Congress these days, and threats have already been made about using the debt ceiling as a negotiating tool. Due to the narrow margin held by each party in the Senate and House, power dynamics are distorted, with a few swing votes holding outsized power on both sides of the aisle. The market is unsure how to price this risk, but historically US Treasury prices have counterintuitively increased during periods of debt ceiling uncertainty. With the actual deadline for the debt ceiling still months away, we are hopeful that a resolution will be reached. Either way, we expect more volatility — both in prices and political headlines — until this issue is resolved.
Awaiting More Information
These periods of market uncertainty are common when there is a lack of clarity about major political and economic issues — inflation trajectory, recession concerns, the US debt ceiling, and the ongoing Ukraine war are current examples. Once the market sees a path to resolution, prices will cease their volatile wandering and immediately adjust upward or downward based on the new information. Waiting for perfect clarity can limit your risk, but doing so also limits the upside and growth that most investors are seeking. Short-term uncertainty is a cost that patient investors pay for long-term growth.
For most investors, these periodic stretches of market confusion should be viewed as short-term noise and shouldn’t impact your investment strategy. It can be tempting to consider taking decisive action, such as timing the market or jumping out of stocks ahead of a recession. Remember that it is ok to be patient. In fact, for investors with a diversified portfolio and long-term goals, it is usually the best strategy.
Disclaimer: This commentary on this website reflects the personal opinions, viewpoints, and analyses of the North Berkeley Wealth Management (“North Berkeley”) employees providing such comments, and should not be regarded as a description of advisory services provided by North Berkeley or performance returns of any North Berkeley client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. North Berkeley manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.