Weekly Market Pulse: Welcome Back To The Old Normal

Importantly for investors, the weak growth in the decade prior to COVID was not an impediment to generating acceptable returns. And if we are indeed returning to that environment of low growth and low inflation (admittedly the former seems more likely than the latter at present), bond returns would seem likely to improve after the brutal bear market of the last year. As for stocks, the correction so far is just run of the mill for the S&P 500, the 13% loss from the peak almost exactly the average of corrections that we’ve gotten every 18 to 24 months throughout history. There are some areas of the market that have been hit harder – NASDAQ and small-cap – and maybe the S&P has more to go, but absent a near-term recession history says that most of the correction is likely behind us.

Stock valuations have been reduced in this correction but the S&P 500 – which we declared persona non grata for our portfolios last year – is still not exactly cheap. The growth stocks that dominate the index have pulled back but the S&P 500 growth index still trades for 25 times earnings. I think it makes sense to maintain a defensive posture in the equity part of your portfolio. We continue to emphasize value and dividend factors which have outperformed this year (S&P 500 value -5.1% and Select Dividend +1.5%; we own IVE, DVY and SDY). Global stocks are also much cheaper than the US alone, with the ACWI trading at a P/E of about 16 (versus 20 for the S&P 500).

I don’t know for sure that we will avoid recession in the near term or if the S&P 500 will ultimately fall into a full-blown bear market. But I also don’t find today’s markets or economy surprising in the least. Corrections happen, on average, every 18 months and the average fall is 14%. The economy was growing at 2.1%/year for a decade prior to COVID and we did nothing to change the long-term trajectory of the factors that affect growth. No one should be surprised that we find ourselves right back where we started. Welcome back to the Old Normal.

The rising rate, rising dollar environment continues with the dollar accelerating to the upside last week. It is, from a technical perspective, overbought right now and a pullback would not be surprising at all. But a correction of the trend back to 100 would be nothing more than that – a correction. The volatility we’ve seen in markets recently is evidence that liquidity is somewhat constrained right now – volatility is the market expression of low liquidity. There is an obvious correlation between a rapidly rising dollar and prior EM crises so, of course, we’re monitoring this closely. But the dollar’s gains this year have been primarily against the Euro and Yen while EM currencies are more mixed with Latin American currencies outperforming their Asian counterparts (which makes sense given commodity prices). The commodity dollars (Aussie and Canadian) are essentially unchanged YTD.

The 10-year Treasury rate is at the high of this move and only 27 basis points from the pre-COVID high of 3.25%. I am doubtful that rates will exceed that level and if that is true, the vast majority of the bond bear is probably behind us.