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The Elephant in the Room

The Elephant in the Room

June 07, 2023

Dear Clients & Friends,

I was hoping to start my June client letter writing about the “official” start of a new bull market today, but no such luck. The S&P 500 Index closed at 4,283 on Tuesday, June 6 (and is trading around that level as of this note), falling just a whisker short of closing at least 20% above the October 12, 2022, low of 3,577.  In the grand scheme of things, there isn’t much difference between 4,283 and 4,292, but it does mean that our celebration of the new bull market will have to wait a little longer, but we hope stocks will achieve that milestone soon.

However, when you look closer at what has been driving the market rally this year—it has been just a handful of stocks.  Technology giants Apple, Alphabet, Microsoft, Amazon, Tesla, Nvidia, and Meta have contributed to nearly 90% of the market gains so far this year according to FactSet.  That is what we call “narrow market leadership”—which is not ideal for the overall health of the market.  According to a note from LPL Research last month “the narrow market leadership in the S&P 500 reflects a less healthy rally than one with broader participation.” 

However, we did see a very positive market signal last week when Russell 2000 Index (the barometer for small-cap stocks) jumped up 2.7%, which may be a hint that investors are starting to embrace more risk and suggests we may start to see better breadth soon—which could be a very positive sign that the new bull market is probably not far off.  

But before we start popping the champagne, the elephant in the room amid this latest rally is that recession still appears likely within the next six to 12 months.  Certainly, a soft landing is still possible—last week’s blowout jobs report for May certainly helps make the case.  But the economy has started to show some cracks, the bond market is pointing to recession with the yield curve still inverted (short-term interest rates are higher than longer term rates), leading economic indicators are strongly signaling recession based on history, consumer spending appears poised to slow as post-pandemic pent up demand dwindles, and the effects of higher interest rates and tightening financial conditions flow through the economy with a lag.  In other words, the cards are stacked against this economy continuing to grow over the next year or so.

If we assume recession is coming fairly soon, though it will likely be short and shallow, then what does that mean for stocks?  The real answer is nobody really knows.  However, when you look back at all the recessions in the last 50 years to see how the S&P 500 Index performed in the months before those economic downturns began you can gain some historical perspective.  In the 12 months before an official recession, the S&P 500 Index was negative 0.9% on average, with a median return of positive 3.5%.  On average, in the six months before the recession, the index was down 1.4%, though the median is slightly positive at 1.0%.  Three months before recessions began, performance was a bit weaker, with an average and median decline of 1.6% and 3.8%, respectively (see accompanying chart).

Those aren’t horrible numbers.  Some comfort can be taken from the fact that the worst returns were around the 2001 recession, which we would argue experienced a more severe bubble in the dotcom boom and was hit multiple times with the accounting scandals that followed.  Also consider the milder recessions in the early 1980s and 1990s saw stocks do quite well.  On the other hand, stocks have historically bottomed during recessions, so gains leading up to the economic peak don’t necessarily mean stocks are out of the woods.

But keep in mind we won’t know until well after the fact whether an official recession has begun.  Remember the National Bureau of Economic Research (NBER) is the arbiter of recessions and typically doesn’t date them until at least six months after they start.  So, perhaps watching where stocks go over the summer may provide an early warning signal.

Bottom line, it won’t be surprising to see stocks to take a breather at this point.  Nevertheless, for long-term, goal-focused, planning-driven investors like you and me this shouldn’t be cause for concern.  The market has provided some solid returns so far this year and if a mild recession occurred and stocks backed up a bit, that would only mean the outlook for stocks from that point on would be very compelling.  It is important to remember that we cannot time the markets or forecast the economy.  The best we can do is to create a sensible plan and stick with it through the ups and downs of the market.

As always, thank you for your continued trust and confidence.  It is our privilege to serve you!  Please reach out to me directly with any questions or if you wish to discuss your finances in more detail—that’s what we are here for.


Important Information

Nick Enzweiler, CFP® is a registered representative with, and securities offered through LPL Financial.  Member FINRA/SIPC.  Investment advice offered through Mariner Independent Advisor Network, a registered investment advisor.  Mercer Partners Wealth Management and Mariner Independent Advisor Network are separate entities from LPL Financial.

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

All data is provided as of June 6, 2023.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.

All index data from FactSet.

The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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