Strong Investing Start to 2023

Most global stock markets enjoyed a strong start to 2023 as central banks have been indicating they’re near the end of the interest rate hiking cycle. In fact, at the recent Fed’s press conference, Chair Jerome Powell’s comments were viewed as somewhat dovish as he did not say firmly that the fed funds rate would go above 5%. As we’ve seen from the markets’ strong January performance, investors have had a hard time believing the Fed’s signals that there will be no cuts this year.

But, after a shockingly strong jobs report (and a surprisingly robust reading from the services sector), the Fed has been reminded that their job is not done.

We’ve felt like a 25-basis point hike is “in the cards” for each of the months of February, March, and May before the Fed hits the “pause” button. That prediction appears to have an excellent chance of becoming reality. The next most likely result is only one more hike in March which keeps the fed funds rate just below the magic 5% level. Either way, investors will get relief from the constant pressure of higher interest rates over the summer and get to see whether the “soft landing” scenario develops.

The big debate continues to be whether the economy will slow enough to fall into recession and will the Fed reverse course and begin cutting interest rates later in 2023 to encourage growth. We have been firmly in the “no” camp on 2023 cuts, and last week’s hot jobs and services reports have bolstered our case.

Recently, we’ve had a market driven by investors who don’t trust the Fed’s messaging and who expect interest rate cuts to start later this year. The result was gains of more than 6% in the benchmark S&P 500 in January. But if the Fed maintains its resolve as we expect, this will cause additional volatility as expectations are forced to adjust. A fed funds rate at or near fiver percent shouldn’t derail the economy or the markets, but given recent expectations, it will cause a stir along the way.

The most important story for investors is not the spy balloon but the re-opening of China after three years of oppressive zero-Covid policy. According to Williams Blair’s Vivian Lin Thurston the Chinese government has re-pivoted to growth quickly, among other things, to avoid social unrest. She cited a 20%+ unemployment rate amongst young people as key factor.

Regarding other emerging markets (EMs), broadly speaking many EMs are further ahead than developed markets in terms of monetary tightening and stock price corrections. The emerging markets’ bear market is a little “long in the tooth” according to Blair’s Todd McClone. This line of thinking goes along with the adjustments we have been making recently in portfolios.

We feel the investing environment is “on the mend,” but the road to recovery will be long and bumpy. In the short-term, more opportunities overseas than in the U.S.