It's a New Bull Market Until Proven Otherwise

March 10, 2023

Our models and indicators point toward a better year for investors in 2023, with a caveat. Some volatility will continue as the downward path of inflation is unlikely to follow a straight line – nothing in economics or markets ever does.

Sure enough, we had some hotter inflation data in January that caused the market to pull back 6.5% from its February peak to its early-March low.

Hotter Inflation Numbers

In January, the Fed’s preferred measure of inflation came in higher than expected. The Personal Consumption Expenditure Price Index (PCE) rose 5.4% year-over-year vs. the expected 5.0% increase, while the core PCE rose 4.7% vs. the 4.3% expected.

These hotter inflation numbers indicate that the Fed will likely continue to hike interest rates, probably another 100 basis points, to 5.50-5.75% by the summer of 2023 to cool down the economy and give supply a chance to catch up with the demand. Positively, the US consumer remains healthy, with Personal Consumption rising 1.8% month-over-month in January.

US consumer health argues against a severe recession this year. If we see a recession, as some economists predict in the second and third quarters of this year, it will likely be mild or a “soft landing” vs. a deep and prolonged contraction like the 2008-09 Global Financial Crisis.

As supply chains re-open from Covid shutdowns, the positive impact on prices won’t be a straight line but rather a back-and-forth affair, with some months showing more improvement than others. For example, the Bloomberg Commodity Index has fallen 25% since the spring of last year and is down a further 7% in 2023. In addition, some key commodities like natural gas have plunged from their 2022 peaks (down 80% since peaking last August).

It will take time for these price declines to flow through to lower consumer prices. Overall, we believe inflation remains on its downward trajectory and that the Fed’s job is about 80% done. The good news for investors is that the 2022 bear market discounted a lot of bad news, and we expect a better year for investors in 2023.

The general inflation trend has remained downward since peaking last June (see chart below).

US Personal Consumption Price Index

An Expected Pullback

We anticipated continued volatility in 2023 and the 6.5% early-February to early-March decline in the S&P 500 is consistent with years in the past that have followed bear markets. For example, coming off the bear market low of March 2009 after the Global Financial Crisis, there were 6 pullbacks of 5-10% on the way to a +26% year.

The key for the Bull case in 2023 will be if we continue to see: 1) minimal deterioration in our indicators and macro models on pullbacks, and 2) a continued pattern of higher highs and higher lows on the major equity indices since bottoming last October.

The analogs below also highlight the likelihood for some bumps along the way to a better year in 2023. Notice after 20% drops over 2 quarters in the past, like we saw last year, the S&P 500 has been up 34% the following year since WW-II, but you have to be able to stomach a 13% average intra-year decline as evidenced by the second chart below.

Two Quarter DropMax Drawdown

Source: Bespoke

Risk to the Bull Case Outlook

Of course, that doesn’t mean there aren’t risks to the Bull case outlook, which we continue to monitor. One such risk is the increase in regulatory costs of the Biden Administration over the past two years. A recent WSJ article pointed out the 2-year total of $318 billion in new regulatory costs from 517 regulations passed since January 2021 *(see chart below).

In addition, another $191 billion of regulatory costs are in the pipeline, although a divided Congress may short-circuit some of these. Many of these new regulatory costs will be passed on to consumers, but corporations will absorb some too. For perspective, total US corporate earnings are $2.7 trillion, so these new regulatory costs represent 12% of total corporate earnings. As a result, they may contribute to downward earnings revisions in the months and quarters ahead.

Estimated Regulatory

As is often said, “earnings are the mother’s milk of stock price performance.” We will be watching earnings closely in the months ahead to see if regulatory costs, inflationary pressures, or slowing economic activity start to cause significant downward revisions. If confirmed by our macro models, we will adjust accordingly.

For now, it’s a new bull market until proven otherwise. Positively, we saw very little technical deterioration in our longer-term indicators and macro models during the February pullback. That said, we want to see the pattern of higher lows and higher highs on major equity indices since bottoming last October remain intact.

-VGA Investment Team

Vineyard Global Advisors offers a range of investment strategies designed to allow participation in the market's growth within a dynamic, risk-managed framework that seeks to protect against significant market declines. Our goal is to give our clients greater peace of mind by generating steadier returns over time. Contact us to learn more. 

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