In last year’s fourth quarter webinar, we discussed the odds of a better year for investors in 2023 based on the improvements we saw in our macro models late last year and the bullish message from several key bear market analogs of the past.
While this bullish outlook for 2023 has been accurate, the manner in which it played out in the first half was somewhat unexpected. The first-half gains were relatively narrow and primarily driven by a handful of large-cap tech stocks caught up in the frenzy surrounding Artificial Intelligence (AI). This is not a great backdrop for a sustainable bull market since a market dominated by a few stocks can only last so long.
The good news is that many of the issues holding back the broader market in the first half appear to be passing.
1) The regional banking crisis was resolved (or at least ring-fenced) by the Fed’s actions.
2) A resolution to the US debt ceiling showdown was reached.
3) Inflation continued to decline.
4) Corporate earnings remained strong.
Presenters:
Tom Samuelson, CFA, CMT, Chief Investment Officer, Vineyard Global Advisors
Kendall Dilley, CFA, CMT Portfolio Manager, Vineyard Global Advisors
Sam Caylor, Investment Analyst & Senior Trader, Vineyard Global Advisors
Original Broadcast: Wednesday, July 26th, 2023
Most of our strategies declined less than their benchmarks in 2022, and as of July 25th, 2023, they are either back to making money for clients or on the cusp of doing so, highlighting the importance of a risk-managed investment framework.
Dividend stocks are an important focus in several Vineyard Strategies. After gaining 26% in 2021, our Russell 3000 Enhanced Dividend Strategy fell only 0.5% last year versus the S&P 500's 18% decline and the Nasdaq's 33% loss. After a solid July, the Russell 3000 Enhanced Dividend Strategy has fully recovered from last year's drawdown and is back to making money for its investors.
It's important to understand the math of volatility. If you lose 50%, it takes a 100% gain to recoup that loss since the gain required is now on a smaller base value. For example, the Nasdaq lost 33% last year, and now needs to gain 49% to recoup that loss. Because of that, it's still down 11% from the start of last year.
This demonstrates the negative impact of extreme volatility on your wealth and what it takes to recover from a large loss. If you're into your retirement years and withdrawing 3 or 4% per year from your account, you’ll have an even tougher time recouping from a significant loss.
That’s why VGA embraces a risk-managed approach to investing, and we endeavor to give our clients greater peace of mind by delivering steadier returns over time.
While we still expect pullbacks, we think the probability of another 20% plus bear market is relatively low at the current time. With solid earnings and broadening market participation, the odds favor continued bullish momentum. In addition, inflation has improved, with the Consumer Price Index (CPI) declining for 12 months in a row after its peak in June of last year.
With the S&P 500 index now in a new bull market, some may ask, is it too late to get back in? Since 1929, the average bull market has gained 114% over 1104 days, a little over three years. Since the lows in October last year, the S&P 500 has rallied 27%, which suggests it’s still early days for this new bull market.
One of the most significant data points in the first half was the dawn of investor awareness of the transformative power of Artificial Intelligence (AI). Demand for AI across all industries is expected to drive a multi-year spending boom from $67 billion spent this year to 1.3 trillion by 2032, a 39% compound annual growth rate.
AI may strengthen the Bull Case by causing the market to look past any near-term earnings shortfall due to the longer-term positive impact on earnings from enhanced productivity. VGA has owned several key beneficiaries of this multi-year spending boom in our strategies and added several less obvious, reasonably valued players during the second quarter.
With the resolution of the banking crisis and the US debt ceiling showdown in the first half, we think the main case for a bear market boils down to a potential recession. If inflation reaccelerates, the Fed will have to continue raising interest rates, and this will increase the odds of a recession.
Liquidity concerns are also part of the Bear Case. The Fed continues to drain $1.1 trillion from the financial system through its "quantitative tightening" program, and the US Treasury will also drain about $800 billion in liquidity by selling Treasury bills to replenish the funds it drew down to pay the country's bills during the debt ceiling showdown. The large $1.3 trillion US budget deficit will also require more Treasury issuance, which may push up interest rates to a level that spooks markets.
We continue to monitor many indicators for signs that these concerns are escalating to levels associated with severe corrections and bear markets.
After being thrown a few curveballs in the first half, our macro models (that drive our investment process) re-asserted their bullish message in the second quarter. We continue to expect a good year for investors in 2023 and those favoring a value discipline (like us).*
*All data sourced through Bloomberg.
