Market Comment - January

Equity markets continue to grind higher, with fewer and fewer stocks participating in the rally. Barron’s magazine recently noted that the technology sector now accounts for a record 30.00% of the S&P 500 benchmark index, more than the next two largest components combined (healthcare and financials). UBS commented that perceived changes in technology are often associated with an equity bubble, and according to their research, five out of eight preconditions for being in a mid-cycle bubble are met. While there was a consensus call for a recession coming either in 2023 or 2024, we are now receiving a consensus call for a “soft landing,” also known as a minor economic contraction that will not lead to a recession. Despite policy errors, policymakers have got away with their mistakes, thanks to fiscal stimulus, but their luck may eventually run out. If there is further demand destruction from tight monetary policy, we are perhaps more likely to see aggregated job losses. In the extreme, this could set off a true recessionary dynamic. While the FED prepared markets around year-end for rate cuts, recently high inflation data has removed expectations that central banks will be able to cut rates before summer. This could also create further potential for pain in the residential property market as well as for small and medium-sized companies, which are facing a maturity wall that could squeeze profits. To secure the soft landing, central banks might need to cut interest rates soon to head off these problems. Recent consumer and producer price data do not justify an easier monetary policy, according to the central bank’s inflation target. Still, we see two options for 2024: a range-bound market until the beginning of Q3, or a relentless melt-up into 2025. With the current data, there is a high probability that for equities, the best is yet to come. Longer term, there are strong secular headwinds that sooner or later will take their toll: the high level of debt, stubborn inflation, as well as unfavorable demographics will start to weigh on the US economy. Short term, a recession would have unfavorable dynamics for the US government debt situation. On average, the US deficit increased by 7.00% during recessions. As the US is already running a 6.00% deficit, a ~13.00% annual budget deficit from 2025-27 would increase the debt/GDP ratio from the current ~124.00% to ~146.00%, catapulting the government debt situation into uncharted and unsustainable territory. In short, the US cannot afford a recession.