Markets Can Correct, but Another Bear Market Seems Unlikely
It’s noteworthy that markets can undergo corrections at any time, resulting in a 10% decline. However, the prospect of a full-fledged bear market with a 20% decline is not likely on the horizon. While seasoned market experts like Jeffery Gundlach and Bob Doll predict a forthcoming recession based on the inverted Treasury yield curve, it is crucial to recognize that the financial crisis has already occurred. Consequently, the economy has moved forward, except for those who cling to the idea of an economic “hard-landing.” Furthermore, market interest rates have decreased, alleviating pressure on the credit system. The Federal Reserve is also expected to begin cutting rates at the short end, further supporting the trend. To gauge potential trouble, keep an eye on business activity which serves as a canary in the coal mine, signaling an economic downturn. Currently, there are no indications of trouble, as the economy continues to perform well with improving prospects and decreasing inflation, all while unemployment remains low.
Consumer Spending and the Economy’s Resilience
Consumer spending plays a vital role in driving the economy. If consumers decide to forgo spending due to exhaustion of their pandemic savings, it could have detrimental effects. However, several factors support ongoing consumer spending. Workers who were previously dormant due to the pandemic are rejoining the workforce, leading to increased labor force participation and disposable income. U.S. employment remains high, while jobless claims are low. Additionally, factors such as retiring baby boomers utilizing their net worth and record-low mortgage rates for homeowners contribute to consumer spending. When examining the unemployment rate and inflation as an overall indicator called the “misery index,” it fell to 7.1% in December, below the historical average of 9%. Therefore, there is no evidence suggesting a decline in consumer spending.
The Battle Against Inflation
The resistance against inflation proves to be another concern for stock-market bears. However, history demonstrates that inflation tends to decline as rapidly as it initially surges. Furthermore, China continues to export deflation globally, which exerts downward pressure on prices, specifically oil prices and the price of goods. Rental vacancy rates are increasing, lowering rent costs and decreasing inflation. Declining inflation rates also lead to decreased cash yields, historically prompting investors to shift their money from cash into stocks. Currently, money market funds have a record cash reserve of $6 trillion, indicating investors’ high cash levels.
Bullish Sentiment and Potential Pullbacks
When bullish investor sentiment reaches extreme levels, it becomes a contrarian indicator and exposes the market to pullbacks. Cash held at stock mutual funds is one standard deviation above average. Hedge funds have low exposure to discretionary stocks, while investment fund exposure to defensive consumer staples remains higher than at the beginning of 2022. In addition, private equity funds have significant cash reserves, and households are holding $18 trillion in cash reserves. These factors indicate a level of fear among investors. However, Bank of America suggests that peak recession fears have likely passed, and current positioning reflects more fear than greed.
Uncertainty in Oil Prices and Investment Strategies
Fluctuating oil prices can impact the market, particularly by raising gasoline prices and affecting corporate profits. The ongoing conflict in the Middle East raises uncertainty about oil shipping lanes and the potential for a spike in oil prices. However, for a recession to occur, this disruption would need to persist over an extended period. It is worth noting that when Russia invaded Ukraine in February 2022, oil prices remained above $100 for six months without causing a recession. The weak Chinese economy and record US oil production also limit upward price pressure on oil. In conclusion, if the bearish predictions prove to be incorrect, it is advisable to remain invested in the market and consider overweighting cyclical sectors such as consumer discretionary, energy, materials, industry, and discounted small-cap stocks, as market breadth expands.