The best-case scenario for the financial markets and the economy may be a “continuation of the rolling recovery,” Schwab senior investment strategist Kevin Gordon told about 2,500 advisors at the custodian’s annual IMPACT conference in Philadelphia yesterday. The reason a soft landing “doesn’t make sense” is that the “soft part of the economy already went into recession,” he added.
A similar reasoning could be used to describe the equity market. Up until July 31, market participants were worried about the imbalance between the seven tech stocks dubbed the “Magnificent Seven” and the other 493 stocks in the S&P 500. For the first seven months of 2023, there were a record percentage of companies that “underperformed,” said Gordon, who spoke in place of Schwab chief market strategist Liz Ann Sonders, who was sidelined with Covid-19.
Since July, there has been a significant “breakdown in breadth,” he noted, with banks and small-cap stocks viewed as the most vulnerable to the Federal Reserve’s aggressive interest rate policy. “Small caps are reeling from interest rates.”
What most investors may not have realized is that international stocks have outperformed U.S. equities since the markets bottomed in October 2022, Schwab’s chief global strategist Jeffrey Kleintop told advisors. That oversight is understandable, given that foreign markets haven’t “outperformed for 15-plus years.”
Kleintop observed that both the U.S. and European economies have proved more resilient than many economists expected in early 2022, when the start of the war in Ukraine prompted many to predict a severe recession in Europe and a downturn in America. Ironically, that may dim the likelihood of a Santa Claus rally because “we haven’t seen the downside.”
The U.S. could see several more quarters of mediocre earnings, he said, adding that lackluster profits in Europe and Japan were also the base case. Kleintop said that the fact yields on fixed-income assets are at a 15-year record supports the argument that short-duration stocks, those that bring in lots of cash and pay it out in dividends, could outperform. “Yields are probably near a peak,” he said.
Gordon told advisors that this is an environment in which they “should be factor-focused, not sector focused. Some pockets of the stock market have become inversely correlated with yields.”
Since technology shares softened in the summer, energy has been the leading sector. “Normally you wouldn’t pair energy and technology,” Gordon said.
By many yardsticks, 2023 could be in for a turbulent finish with a war in the Middle East and the potential government shutdown looming. But one panelist noted that the S&P 500 has gone up during the last five government shutdowns.