We will continue to monitor financial markets very closely so that we can better determine the sustainability of the recent more broad-based rally. We could be quick to change our opinion depending on new developments. We expect many surprises are possible at any time. This is not the time for complacency. We find ourselves always returning to our view that the hallmark of the period since the onset of the pandemic is one of “rapidity of change.”
persistent and “sticky.” We trust that evidence of slowing wage growth and a “cooling” U.S. labor market has begun to emerge. In last week’s commentary, we highlighted the reasons why we thought that the Fed most likely would “skip” hiking the federal funds at its June 13-14 meeting. Financial markets mostly have priced in now this probability, and the consensus now is that a July hike is most likely. Nevertheless, a lack of conviction has fostered many divergent opinions. The minutes of the Fed’s last meeting continue to show that the Fed’s staff continues to “anticipate” a mild U.S. recession. Many analysts and investors seem to agree. Others – including Fed chair Powell – think a recession can still be averted.
We are inclined to give the benefit of the doubt as to the sustainability of the broadening out of the U.S. stock rally as shown on Friday. We will continue to monitor financial markets very closely for more “clues.” The “true” bottom line is that “No One Knows.”
We view NVDA’s narrative this week as a “game changer” in respect to a risk-reward analysis in evaluating growth stocks. This is especially true for AI related stocks. This could make many investors less willing to sell such stocks and more willing to buy such securities. This could also limit the downside to such stocks. Given the large capitalization of many of these securities, this could also limit the downside of many “cap weighted” stock averages.
After the U.S. debt ceiling is resolved we expect issuance of a very large amount of Treasury securities that should “drain” liquidity from financial markets. In our opinion, less liquidity should increase volatility. After analyzing Powell’s and Yellen’s comments towards the end of this week we now feel more strongly in our forecast that the regional banking crisis is not over and that we foresee further tightening of credit conditions.
Given all of the uncertainties surrounding economic growth rates and possible inflation trajectories, we were not surprised that the Fed decided to cease its forward guidance and substitute instead a data dependent approach that provides a “blank space” where the Fed can “write” its next policy decisions. The continuing instability of regional banks is but one of many uncertainties confronting investors.
We believe that we have not seen the end of “problems” emanating from regional banks. We continue to assume that lending standards will be further tightened and that credit will contract further in an uneven manner. We believe that these trends will lessen U.S. economic growth. We expect that high yield spreads will widen further later this year.
Due to the many distortions stemming from pandemic related developments, it is often difficult to “properly” decipher economic data. Changes in the economic environment are often subject to very rapid changes. We could soon be entering a period where changes might accelerate, leading to surprising outcomes. Investors should keep an open mind and maintain a “flexible” mindset.
For the time being we are maintaining our basic investment approach as expressed in last week’s commentary. We continue to prefer high quality stocks that offer good balance sheets, as well as relatively stable cash flows and profit margins. We prefer a global diversified portfolio for long term investors. We continue to stress that stock selectivity in this current environment is of paramount importance. We forecast continued financial markets volatility.
We continue to remain concerned that there could be more disruptions stemming from issues relating to smaller regional banks. Hopefully we will develop a clearer picture of credit availability as regional banks report their earnings, reserve allowances and their proclivity to lend. We found it striking that uncertainties surrounding consumers’ year ahead expectations appear to sometimes mirror fixed income volatility even while their longer term expectations remain well anchored generally.
We expect the Fed to hike the federal funds rate by 25 bps at its next meeting and then “pause” for quite “some time.”