Stock markets are off to a strong start in 2023 following a dismal performance in 2022. Notwithstanding sharply higher interest rates and fears of a forthcoming recession, the bulls, at least for now, are in control.
There are several arguments to be made for being bullish or bearish in this environment. The bullish argument relies upon the fact that the extreme froth in the market was largely eradicated last year with many former high-flying stocks falling 80% or more. China is reopening its economy and the US labor market remains remarkably resilient. In addition, we are entering the third year of the Presidential cycle and the stock market tends to exhibit above average returns from October 1st of the 2nd year to April 30th in year three of a President’s term. The data from the last 90 years shows that the returns in this narrow period equal those of the remaining 41 months of the cycle, according to Grantham Mayo Van Otterloo & Co (GMO). Lastly, inflation has come down with expectations that the Fed can engineer a soft landing.
Source: Global Financial Data, GMO
The bearish case argues that stocks are still expensive from a historical perspective. In addition, we never saw a true selling capitulation that ordinarily accompanies an ultimate bear market low. Sentiment is currently positive whereas bear market lows typically embody severe pessimism. The stock market also seems to be ignoring the fact the interest rates may need to be raised higher than expected and for longer to bring inflation down as history shows inflation persists through multiple waves. Few new stocks have emerged to lead the market higher as nearly 60% of the gains in the S&P 500 year to date can be attributed to only eight stocks (see chart below). Lastly, when looking back at historical bubbles, the stock market typically bottoms after the Federal Reserve begins cutting rates in response to a recession despite investors’ hope for a quick pivot in interest rates.
FAANG + MNT Stocks Impact on S&P 500
Source: Bianco Research
We find the bearish case more likely and convincing anchored by historical evidence. However, despite our belief that it may be premature to declare that the ultimate low in stocks has been reached, we will never argue with the broader market trend as the collective intelligence of market participants is more valuable than any individual opinion. The early stages of a new uptrend are evident and, as such, we will be increasing our exposure to stocks in the coming days and weeks.
Whether or not the market remains in an uptrend from here or eventually turns back down, we intend to implement our discipline of controlling risk. We will never buy at the bottom or sell at the top but instead attempt to capture the bulk of the market return in the middle while controlling for risk at the extremes.