“Confidence is contagious. So is lack of confidence.” – Vince Lombardi
The bear market continues, though with no new market low since the fall. The labor market continues to mostly surprise to the upside. Unemployment has stayed low. Nearly two unfilled positions remain for each person seeking employment. Stock markets in the first quarter mirrored 2021 with a rush to the largest Tech stocks and the NASDAQ Index jumping. But the recent sudden collapse in confidence in several regional banks casts a new pall over the economy and over the actions of the Federal Reserve and the other regulators.
The FDIC’s recent extension of insurance protection to all depositors of two failed banks renewed focus on bailouts. What received less press is that the potential Mother-of-All-Bailouts may have gotten a recent boost: Medicare and Social Security are projected to run out of money in four and fourteen years, respectively. In January, the Administration declared reform of either program “non-negotiable.” That may change, but fixes to each are limited to raising eligibility ages, reducing benefits, or increasing taxes – each of which is now “off the table.” Since letting those programs default is not really an option, the only implication could be an intended federal bailout of these programs when the cash runs out by issuing Treasury bonds. That much bond issuance could not be well absorbed by the market, so the Fed would likely have to buy most of those new bonds, resulting in more money creation and more inflation. That may be a few years in the making and the next Administration and Congress may choose to address these problems. But for now, refusal to do anything to address the fiscal problems of those two behemoth programs means the prospect for higher long-run inflation has clearly increased. Portfolio planning must account for that.
But that’s down the road (that is: past the next “election cycle.”) Much closer is the looming debt-ceiling battle which is all but certain to get increased attention over the next couple of months. Most expect this to ultimately get resolved, but not without some short-term market pain along the way.
Geopolitical tensions are high and rising: China and the US have seldom been on worse terms, Russia and Ukraine are each expected to launch spring offensives soon, and Putin just announced he is sending tactical nuclear weapons to Belarus. Iran is said to be days or weeks away from having enough material for a nuclear warhead. Geopolitically, the world is unsettled. On the other hand, Finland is now part of NATO, strengthening defense in Europe, which may allow the US to shift a bit more attention to the East.
In spite of the perhaps not fully resolved bank crisis, the Fed recently raised interest rates again, as did the European Central Bank. Each hike now increases the risk of pushing banks into tighter lending which could depress both economic activity and corporate earnings. Yet stock valuations in this still ongoing stock bear market have only somewhat improved and don’t yet discount possible recession levels of earnings.
With the S&P 500 Index 14% below its previous bull market high set on 1/3/22, and 15% above its bear market low of 10/12/22, stocks are in the middle: well up from recent lows yet short of breaking out into a new bull market. We wish we could offer a brighter prospect for long-term returns this far into a bear market, but this continues to be a time that warrants diligent caution.
If a recession does not develop within the next few months and inflation allows the Fed to signal a pause in interest rate hikes, markets would likely cheer, and valuations may get stretched more. But in that event, such a pause may more likely signal concern for the economy than “all clear” and would not resolve underlying economic issues of lingering inflation and tighter monetary conditions. With even short-term interest rates now well above the lows of recent years, we are closer to a point that offers materially better long-term return prospects for most asset classes, but that still appears to be in the future.