May Day {Current Client Letter}

 “As full of spirit as the month of May, and as gorgeous as the sun in Midsummer”William Shakespeare .”

 

May Day 2023.

 

I’m began composing this note to you on May 1^st.In many European cultures this day marks the beginning of summer.It’s an ancient custom and is often celebrated with bonfires, maypoles and flowers.Early May’s a good time to take stock of where we are so far in 2023.My last letter to you was in January.Then the markets had just completed one of their worst years in history and the mood was about as bearish as I’ve ever seen.Few WallStreet investment strategists were positive back then for 2023.I didn’t agree with an outlook that had many calling for a retest of October’s lows. I was decidedly non-consensus when I wrote this to you then:

 

I still think investors have discounted most of 2023’s negative economic news.Probability suggests equity prices are still attractive for longer-term investors.I don’t think we’ll see asignificant economic downturn this year. I also think we’re further through this tightening cycle than most investors appreciate.I think this because many of the leading term inflation gauges are already showing this.Housing prices quit going up months ago.Construction has slowed significantly.Gasoline’s back to where it was over a year ago in most places.Supply constraints from Covid have eased while the era of Federal stimulus related to the virus is fast becoming a thing of the past.Historically when stocks have experienced significant declines, then one-, three- and five-year rates of return are uniformly and significantly better than the historical market’s annual return averages.

 

Here's what’s happened since.A recession has failed to materialize so far this year.If it comes, I believe it is unlikely to be as steep or severe as many feared back when there was snow on the ground. The Federal Reserve has kept tightening interest rates but has now indicated they might take a pause on future increases, preferring now to wait and see if they’ve done the devil’s work and put enough of a break on the economy to get inflation under control.Supply chain constraints are now a thing of past.The national average price of gasoline, while recently on the rise, is still 10% lower than a year ago and is trading at price levels seen between 2012 and 2014.Earnings estimates have not contracted as deeply as analysts believed last fall and may have already seen their trough for this cycle. First quarter 2023 earnings are currently ahead of most analysts’ expectations.Major market indices bottomed out last October; many stocks actually made their lows last June.Markets are considerably higher four plus months into 2023, collectively averaging about a 6% return.The Nasdaq is up nearly 17% in these first four months.Still, investor sentiment remains lousy as many call this a false dawn and still believe we could retest last fall’s lows. Time to get out the crystal ball and see where we might be going.

 

Here's the positives.The economy looks like it’s weathering this slowdown as of now.Markets are always looking towards the future and investors seem to have already discounted the worst back in 2022.Investors are already looking out twelve to eighteen months from now and are indicating they believe the economy will be improving by then.Corporate earnings should also be on the mend later this year.Then there’s investment history which says when stocks start off the year this strongly, there’s a higher probability of further advances down the road.Finally, we’re in year three of the current Presidential election cycle and the theory around this states that years three and four of a President’s term tend to be positive for stocks.

 

Now the other side of that coin.The market is the ultimate arbitrator of price and future events could change this analysis.The stalemated war in Ukraine could take a turn for the worse and the Chinese could become more belligerent towards Taiwan.It is always possible we’re on the cusp of a worse recession than I believe may occur.Perhaps the Federal Reserve won’t like what it sees in the economic tea leaves and continue raising interest rates.They may not like data like Friday’s stronger than expected job gains.Some or all of these events might occur, however, every one of these issues are now well known to investors, and I believe are likely currently discounted in the markets.We’ll monitor these events and adjust portfolios accordingly as needed.

 

Markets usually spend most of their time trading slightly below or slightly above what is deemed theircurrent fair value in terms of price.I get excited when I see assets trading at a significant discount to this numer as they seemingly were for much of 2022. I grow more conservative the closer we get to what I perceive my investments for clients are worth. Probability suggests there's a higher likelihood that we’re currently skating along the upper edges of that valuation zone.That doesn’t mean markets can’t move higher, and there’s a greater possibility of higher prices occurring in a year when stocks roar out of the gate as strongly as they have in 2023.However, probability also suggests we may need to spend some time now consolidating our recent gains.Markets correct themselves by price {meaning they decline in value}, time or a bit of both.We corrected by price in the first half of 2022 and now seem to be correcting by time.To that last point, equity markets are currently trading where they were last April.I’ll bet that statistic will surprise a few people.A period where markets churn back in forth and mainly go nowhere could be in the cards for the next few months.We could perhaps even retrace some of this year’s gains.That would also sync with the investment calendar.This tells us the next six months or so have historically been the weakest part of the year for share prices.Market indices have also now on average retraced about 50% of last year’s losses so traders could be tempted to lock in some of those gains.I do not see this as a long-term fundamental problem unless the international news becomes more pessimistic or the economic data starts to become worse than many currently believe. I view it more like the pause that refreshes before we potentially begin another move higher.

 

Now would be a good time for us to discuss your asset allocation if you’re worried about any of this, or there’s been a change in your circumstances. We’ve deployed most of client’s excess cash positions into Government money market accounts this year.These are currently earning about 4.5%.That seem like a nice place to hide until bargains appear.We did most of our buying months ago when equities were cheap and have largely been rewarded for that patience.

 

I like our investment portfolios and am happy to go over your accounts anytime you desire.

 

Very truly yours,