Windows & Mirrors

With the benefit of hindsight (the mirror portion of our title) the near 20% stock market decline from October 3rd through December 24th of last year is something that might have been anticipated. The combination of a 25% increase in oil prices and the yield on the ten year US Treasury bond rising from 2.50% to 3.20% through the first three quarters of the year married to a notable slowing in both US and global economic growth rates tossed a dose of reality like a bucket of cold water onto a scenario that had grown a bit too rosy and a resulting disconnect between hope and reality.

For investors weighted 60% in equities and 40% in fixed income the 4th quarter stock market decline of 16.7% left them with portfolio losses for the quarter of approximately 8.50%. Fortunately Santa, while delivering gifts to put under our trees, also provided investors a stock market rally starting on Christmas Eve and which continued throughout the first quarter of this year and continues still. The market decline of the 4th quarter was the worst in over seven years. The market recovery in the 1st quarter was the best in almost ten years. Investors may have found themselves recalling Dicken’s quote from “The Tale of Two Cities” (“It was the best of times, it was the worst of times…”) or perhaps somewhat more evocatively they may felt themselves possessed of Jody Foster’s spinning head in “The Exorcist”. So as we step up to the window and gaze ahead through the remainder of the year what do we see?

First let’s affix our gaze a bit more firmly upon the 1st quarter. The market (we’ll be referring to the S&P 500 index throughout this commentary) high of last year was on September 20th when it closed at 2930.75. The market close on Friday, April 12th was 2907.41 so we have yet to recoup the entirety of the market decline. The 60% equity & 40% fixed income portfolio returned 8.50%, an amount almost identical to the 4th quarter decline leaving most investors very close to break even for the past two quarters and approximately 3% positive year over year. While the stock market has spent the past six months creating and filling the holes it created in investor’s portfolios corporate earnings have continued to grow albeit at a slower rate. The market is now valued at 17.4 times earnings versus a thirty year average of 16.9 leaving bubble hunting bears with the need to look elsewhere for potential sources of woe and mayhem.

Perhaps we’ll want to title the next commentary “The J Curve” (as in Jay Powell, the chairman of the Federal Reserve) with the letter J tilted at a 45 degree angle and representing the prospective future course of the S&P through year end. The curved portion of the letter represents the remainder of the recovery from the prior decline and the upward sloping straight line of the letter represents the course of the market as it finds its way to new highs through the remainder of the year. For the remainder of this year at least Jay Powell will not dare to utter a single note of caution about the prospect of future risks of inflation or the possibility of interest rates being too low. Like Switzerland the United States Federal Reserve has wandered off the playing field, declared itself to be neutral and it will allow the US economy to grow as it will. Already there is data showing that economic growth rates are preparing to accelerate. Spring has arrived and warmer and better days lie before us. The party shan’t last forever but the beer is cold and the band is playing so what’s not to like?