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Here Comes the Sun...

Anybody remember the Beatles hit released in 1969? Last month (May 11) it became the only Beatles song to hit a billion downloads on Spotify. I could not think of a better phrase as the last of the major issues that have hindered our economic system for several years, disappear into the horizon. Investors have had to endure a downpour of historically difficult systemic events since the beginning of 2020 that have had us doubting economic growth and whether stock market returns could ever return to long-term averages.

  • The world lost 7M lives to COVID, over 1M in the USA plus an additional 1M Baby Boomers permanently retired during COVID.

  • With 2M fewer workers, and most of the world experiencing rolling blackouts in employment from the COVID, almost every good or service skyrocketed in price because of supply chain disruptions.

  • To add to inflation, in 2020-21 our leaders introduced new money creation stimulus in the $8-10 TRILLION range (depending on who you ask).

  • In 2022, Russia invaded Ukraine and halted nearly all production of parts used in cars, trucks, electric switching, and threatens to shut off power to Europe indefinitely, making global inflation even worse.

  • In response to out of control inflation, our Federal Reserve increased cost of borrowing over 500% (from below 1% to now over 5%) to attempt to slow demand for goods and services.

  • And, in 2023, the political debate about values and government spending threatened to have our US Treasury default and loose our position as the risk-free currency in the world.

These were not just small passing storms. These major impact systemic events overshadowed economic growth in every nation in the world for nearly 3 years. The fallout from these storms has left investors using all sorts of expensive hedging techniques, holding more hard assets, investing with one foot "in" the market and one foot "out" for so long now, that the lack-luster returns from these stances seems "normal" and acceptable. I feel like we are all so used to carrying around our umbrellas everyday, that all this stormy weather somehow seems normal. Some may not even remember what it looks like to put their umbrella away. It feels like it has been raining for so long now, without even a glimpse of sunlight.

A FUNDAMENTAL SHIFT IS HERE For nearly 30 years, I have observed the cause and effect of economic and financial conditions on investor returns. Always seems to boil down to 3 major factors that drive stock prices: earnings growth, money supply, and consumer / investor confidence. Throughout this recent series of endless storms, surprisingly earnings growth has overall been positive (except for a brief decline in early 2022).

Source: CompuStat, FactSet, Standard & Poors, JPM Asset Management as of 3/31/23 Our money supply has been restricted by the Federal Reserve's aggressive monetary restraint and dramatically increased interest rate policy over the past 18 months, which has been a significant headwind for earnings growth, capital spending, and consumer spending on big-ticket items. However, we are now hearing rhetoric from Federal Reserve officials that the Fed "may take a pause" in their June meeting from further rate hikes. This represents a significant shift in direction for monetary policy, as the Fed has raised rates in 10 consecutive meetings since March 2022.

Source: Forbes, May 3, 2023 Most economists believe the Federal Reserve will "pause" in their June meeting, which seems logical as inflation data suggests that we are falling back into ranges not far from Fed targets, and the impact of raising rates is historically proven to be a lagging effect. We may see even lower inflation data in the months ahead, even if the Fed is done raising rates altogether. Why does this matter so much? It matters because stabilizing interest rates allows investors to make more predictable assumptions about their investment choices. As example, if an investor has to borrow at 5% to grow a business that is expected to grow at 10%, that bet makes sense if the investor has the means to carry the debt during a business slowdown. But, if the same investor starts borrowing at 5% and that rate is rising to an unknown higher amount over the next few years, it becomes a major deterrent to making the investment. When the Federal Reserve formally ends its rate hike campaign signaling that inflation is back in an acceptable range, coupled with the fact that these incredibly difficult storms we have been living trough seem to now be in the rear view mirror, consumer/investor confidence can return. Here is the impact of changes in investor confidence over the last 50 years. Notice how much the markets have performed when coming off lows in confidence.

Source: FactSet, Standard & Poors, University of Michigan There is a fundamental shift taking place as we say goodbye to the last of the storms that have been wreaking havoc on our economic system over the past 3 years. There are always going to be minor concerns for growth enthusiasts, like "how fast can the market actually grow with 5%+ interest rates". But overall, I think we are all going to be happier as we acknowledge that the historic challenges that our world has faced in the past 4 years are behind us. We have been making a few adjustments in portfolios to reflect a more positive bias on the markets. Please feel free to call or email us if you have any questions.

Bottom Line: As of this writing, there are no large systemic risks visible on the horizon. We now have closure on the government debt-ceiling debacle; COVID is all but a thing of the past; supply chains around the globe have been repaired; inflation readings are falling back to ranges that are close to Fed targets, and the Fed is finally saying, "we may take a pause." It's fair to say, "Here Comes the Sun!" Finally. I encourage you to download the great Beatles song and play it a few times. It might even help you have a better day. 😊


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