My father, otherwise a very accomplished man, never learned how to type properly. However, he compensated for a lack of skill with an intensity of application. As children, we would hear him behind the door of his study, pecking away at his Remington typewriter using only his two index fingers. In the afternoons, it would be a gentle, relaxed clicking, interrupted every 20 seconds or so by the merry chime of the carriage return bell.
But when the Muse was with him or a deadline loomed, the clicking took on an urgent tone, accelerating to a frantic pace as his thoughts spilled out onto the paper. At such times, he would attack the typewriter with violence, and I seem to remember the most commonly used letters, the “e” and the “a” and the “s” looking sadly faded on the keyboard. The “!” was also subject to abuse. But not the “?”. The “?” was pristine. My father was a man who expressed strong opinions and few doubts.
Such could not be said of market strategists today—or at least of the honest ones.
The economy still appears to be barreling past traditional estimates of full employment while inflation has risen to 40-year highs. However, at the same time, both growth and inflation should slow due to fiscal drag, a too-high dollar and slumping confidence. It is not clear how much growth will slow, how quickly inflation will fall, whether the economy could slip into recession or, for that matter, how bad a recession might be, were it to occur. This gathering of worries and uncertainties will take time to be resolved and could easily be blamed for the slide in financial markets this year which has seen 10-year Treasury yields double and the S&P500 make an inter-day visit to bear market territory before rallying last week.
However, investors should also remember that less uncertainty surrounds some fundamental principles of investing, namely:
• Volatility is the price you pay for the better long-term returns on equities.
• Diversification reduces risk – particularly when recession threatens.
• Valuations are a bad guide to short-term returns but a better indicator of long-term gains, and,
• Good investment decisions are based on logic rather than emotion and the best decisions often take advantage of the emotions of others.
Economic data still generally point to a growing economy with a tightening labor market. While last week’s GDP report showed an even steeper-than-originally-reported 1.5% annualized decline in real first-quarter output, this was more than accounted for by lower inventory accumulation which should boost output in the current quarter. Other numbers, such as April data showing a sharp improvement in the goods trade deficit and strong momentum in consumer services spending, suggest real GDP could be growing at a 4%-5% annualized pace in the current quarter.
That being said, the economy is encountering strong headwinds:
• Last week, the Congressional Budget Office projected a decline in the budget deficit from 12.4% of GDP in fiscal 2021 to just 4.2% of GDP in fiscal 2022, representing the sharpest fiscal drag seen since the demobilization following World War II.
• A high dollar, combined with global weakness from the war in Ukraine and China’s attempts to battle Covid, should slow the growth in U.S. exports.
• 30-year fixed rate mortgage rates have risen from 3.11% at the end of last year to over 5%, contributing to a sharp decline in both new and existing home sales in April.
• Consumer sentiment remains in the doldrums with the May reading of the University of Michigan Consumer Sentiment Index falling to its lowest level since 2011.
However, two factors act as strong counterweights to these recessionary impulses.
First, pent-up demand appears to be at levels unprecedented in the modern era. Chronic supply chain issues and labor shortages have suppressed production with very low inventories of vehicles, homes and consumer goods for sale. In top of this, there is a pent-up demand for travel and entertainment after the pandemic as well as all the spending involved in long-postponed family celebrations. This should help sustain overall consumer demand even as budgets tighten.