The impression that equity market volatility is somehow bad for stocks has gained rampant attention this year, a notion that was exacerbated over the past few weeks. The reality of upcoming interest rate hikes by the Federal Reserve, along with the potential for a more subdued economic growth backdrop, may have generated investor questions on their need for sustained equity market participation. Although questioning volatility is a healthy and positive occurrence, we want to urge caution in attempting to decipher it as anything more than a normal cycle.
The financial media’s headline announcement of ‘slowing growth’ builds a false connotation of weak growth, or a feeling of a pending recession in the near-term. The International Monetary Fund (IMF) recently downgraded global gross domestic product (GDP) growth from 5.9% in 2021 to 4.4% in 2022. Most of that downside attribution was tied to the United States. The issue with such growth estimates, however, is that they lack immediate perspective. This is something we extensively discussed in our December 10th, 2021, commentary where we focused on the need for absolute and relative comparisons – understanding the difference becomes paramount. For starters, we must recognize that sustained economic growth rates, like those exhibited in the later part of 2020 and for the full year of 2021, are highly unsustainable and carry the risk of hyper-inflationary pressures. The trend of economic growth due to COVID resulted in tremendous pent-up demand that sent the growth rate trajectory to downside extremes followed by upside extremes. To expect anything but a normalization cycle from the recent upside extremes remains irrational in our view, which means it is perfectly normal to witness growth revisions! Charts 1 and 2 help provide the needed perspective within the context of a return to normal. We introduced chart 1 within a previous commentary, yet it remains important for today’s discussion (all data has been updated). For reference, examples of core capital goods include buildings, machinery, equipment, vehicles, and tools. The staggering gains in such a segment of the economy provide an understanding of short-term excess demand, most of which is being met and supplied. The data exhibited in chart 2 also provides a working understanding of the pent-up demand posed by COVID (relative to the previously established trend). To assume, for example, that U.S. retail sales will maintain an absolute dollar trajectory like the one observed in 2021 is not sustainable. It is certainly possible that a new trend line may emerge, but the relative percentage increase in retail sales cannot be sustained at those levels. This is all to suggest a normalization to the previous trend, most of which will be announced in the form of “declining retail sales growth from one-year ago”. As such announcements gain more traction, we will be at the forefront of absolute and relative comparisons. At the end of the day, our main concern will be to address economic recessionary pressures and we currently foresee nothing in the interim to cause alarm. In fact, the New York Federal Reserve’s recession probability, through January 2023, remains at the lowest level since March 2018. This is occurring despite the almost guaranteed scenario of higher interest rates at the upcoming Federal Open Market Committee Meeting next month.
It’s important to note that our assessment of normalizing economic growth does not translate into declining or stagnant equity markets. Volatility will occur under any economic growth scenario and is not solely dependent on GDP. In fact, the economy and the stock market are separate entities that react differently to the same set of news. Given that one is consumption based, whereas the other remains more production-based, we believe we should anticipate a short-term period of data consolidation that may drive a wedge between investors’ perception of market movement relative to the reality of what will actually happen. This is not an unusual phenomenon and it’s something that may not make immediate sense.
With that in mind, the best risk management tool over the next six months is not what you do with your equity market participation; it’s what you don’t do.
Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg. All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations. Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan. Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.