by Jordan Hucht, CFP®, ChFC®, AIF®

We’ve seen it over and over again. As the old saying goes, “the more things change, the more they stay the same.”

Wall Street “experts” love to make short-term market predictions, and they love to recite them confidently in whatever press they can get. There’s just one problem:

They’re not very good at it.

Look no further than the past 18 months for evidence. At the end of 2021, the average year-end price target for the S&P 500 among strategists from big Wall Street firms was 4,950, predicting a modest gain for the year. The consensus view seemed to be along the lines of this quote form one such prognosticator:

“In 2022, we’re going to be transitioning back to a more normal market. Normal price returns on the S&P 500 are in the 7% to 9% range.”

In other words, it was going to be a fine year. Not too hot, not too cold — a goldilocks, just-about-right year for the market.

But in reality, the S&P dropped 20%, and bonds had their worst year in decades. Goldilocks would not like that porridge.

Fast forward to the end of 2022, and the experts were at it again. Licking the wounds to their egos from getting 2022 completely wrong, they reversed course and told us how bad 2023 was going to be – specifically (and rather confidently) how bad the first half was going to be.  Quotes like these were everywhere:

“You’re going to make a new low sometime in the first half.”

“You should expect an S&P between 3000 and 3300 sometime in probably the first four months of the year.”

“We expect downside of 25% to 35% from current levels.”

“The market could drop as low as 3,000 [a 24% decline] as a recession unfolds,”

Instead, the market got off to a red-hot start, with the S&P 500 gaining nearly 15% in the first half (as of this writing), while the Nasdaq doubled that gain and booked its best start in 40 years. What do they say now? Here is a recent quote from one of the same seers:

“The market is more rational than it’s been in a decade.”

Huh?

To be clear, I’m not making the claim that it’s all roses for the rest of the year nor am I making the claim that I predicted what would happen so far this year. I’m making the point that investment decisions shouldn’t be made – or judged – based on short-term market predictions. It’s perfectly fine to have strong opinions of what comes next, but you have to have even stronger humility to not allow those opinions to drive your overall strategy. That’s not to say you can’t invest opportunistically – certainly, there are opportunities to do so – but investing based on short-term predictions of what the market will do (i.e., attempting to time the market) doesn’t work over the long term. What does?

Discipline. Patience. Proper asset allocation. Modeling based on non-linear growth rates. Success is more a product of prudent planning and thoughtful asset allocation than of making accurate market calls.

The question isn’t “what is the market going to do this year?” The question is “will you stay on track regardless of what the market does this year?”

The former gets all the attention, but the latter is what really matters.

With that speech out of the way, let’s examine what actually happened in the first half of the year. The bear narrative heading into the year was that the lagged effects of inflation-fighting monetary tightening would begin to take hold, consumers and businesses would start spending less, the economy would slow (or contract), earnings would decline substantially, and so would stock prices.

Admittedly, that was a very rational thesis, but it didn’t come to pass. That’s not to say it won’t happen, but – surprise, surprise – the timing was wrong.

So why did the market run in the opposite direction of where its handlers were calling it to go? From my perspective, there are three main reasons:

1. Earnings did not collapse. Long story short, it was widely expected that reported earnings and full-year earnings guidance would take a major hit in the first half of this year. But in reality, they have held up much better than feared, as the US consumer has remained resilient.
2. Inflation has continued to move down and the Fed seems near the end of its rate-hiking cycle. After peaking above 9% last summer, headline CPI has now fallen to 4%. Though still a ways from the Fed’s 2% target (which is measured by a slightly different metric, personal consumption expenditures or PCE), the downward trend has been consistent. With the Fed funds rate now over 5% (which is notably now above the inflation rate), the Fed chose to keep rates unchanged at its June meeting for the first time since the rate-hiking cycle began last year. Fed Chair Powell was careful, though, to make it clear that a pause isn’t the same as a stop. Whether it’s a pause or a stop, the bottom line is that it seems we’re at (or very close to) peak rates for this cycle.
3. The excitement around AI has gripped investors. The primary reason for the Nasdaq’s blistering start to the year is the massive gains in AI-focused tech companies as investors rush to get on board with what is being hailed as perhaps the most transformative technology in decades. As a result, a handful of mega-cap tech companies have outsized gains that have driven the major indices higher. To that point, it has been a relatively narrow rally, but it has widened in recent weeks.

The combination of these three factors has taken us to a point where the S&P 500 now trades at approximately 18 times forward earnings, which isn’t cheap, but also isn’t nearly as high as the 21 times earnings we had at the end of 2021. Perhaps more importantly, though not as exciting, is that bonds have stabilized after double-digit losses last year and are on pace to deliver solid, mid-single-digit returns this year. That’s hugely important from a financial planning and portfolio management perspective.

Does all this mean we’re in the clear and it’s smooth sailing ahead? Absolutely not. Very real risks remain in the near term (perhaps even more so in the longer term), and a reversal of the year’s great start can come at any time. That’s the nature of the markets and why being a successful investor calls for patience, discipline, and a plan to survive whatever comes next.

What, specifically, is of concern to me? Frankly, many of the concerns coming into the year remain concerns now. We still do no not know the full economic effects of the dramatic tightening of monetary policy. Remember that the Fed has not only been increasing rates but also decreasing the money supply by selling bonds off its massive balance sheet. However, in response the banking tumult a few months ago, the Fed actually added liquidity back into the system (i.e., a temporary reprieve in monetary tightening), which may account for some of the subsequent rise in stock prices.

The Fed has been attempting the tight-rope walk of raising rates to cool inflation without pushing the economy into recession (i.e., the optimal “soft landing”). Historically, this is very difficult to achieve. A year ago, it seemed very unlikely, and most economists expected a recession. That tone seems to have changed recently, as the soft landing seems to now be the base case for many. But I’d advise caution to jump to that conclusion just yet.

There are several cross-currents fighting for control of the economy’s direction, as tightening monetary policy pulls it back while a strong labor market and resilient consumer push it forward (pardon the dramatic oversimplification). The market is also assuming that we are at (or very near) peak interest rates. If inflation ticks back up or doesn’t continue to move down closer to the Fed’s target, the peak-rate assumption may prove to be wrong. It will take time for all of this to resolve, and I’d expect the stock market, which looks forward, to be volatile.

Longer term, and what concerns me the most, is where we are in the bigger cycle. The single most important advantage we have as the world’s leading economy is the US dollar’s standing as the world’s reserve currency. We are able to get away with running large deficits and carrying a huge amount of debt because we are able to issue bonds in the world’s currency of choice, and there is no shortage of demand for our bonds. In addition, having the world’s reserve currency allows us to monetize our debt by printing more money. Having the world’s reserve currency is a tremendous advantage, but also one that does not last forever, historically speaking. There’s a much bigger discussion to be had on this front, but that’s for another day.

For now, enjoy the start to summer, and try not to get too caught up in the market’s daily horoscopes.

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Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results.