Market Navigator – June 2023 edition

Monthly letter

Neutralizing tactical positioning

Every week I challenge my team to begin again – to consider our investment strategy a blank slate. Setting aside our current positioning, how would we invest today?

Our conclusion currently is to neutralize tactical positioning between stocks, bonds, and cash to account for mixed signals in our work. In essence, we’re upgrading equities from less attractive to neutral and downgrading fixed income and cash from more attractive to neutral to account for a wide range of potential outcomes.

Equivocal evidence

Several crosscurrents and divergences in the economic and market environment are complicating the strategy setting.

The bearish case includes:

• S&P 500 valuations at the top end of the historical range
• Manufacturing data that remains in contraction
• Leading economic indicators that are pointing to weakness ahead as the Fed’s sharp interest rate hikes and tighter credit conditions filter through the economy
• Earnings assumptions for the second half still appear high relative to economic growth estimates
• Very narrow market leadership
• Sharp underperformance by the average stock and economically-sensitive sectors

The bullish case includes:

• U.S. and global forward earnings estimates are trending higher
• Valuations outside of technology are reasonable as many other market segments have already pulled back
• To see a meaningful decline, tech/growth stocks would need to be revalued lower; even in a slowdown, corporations are likely to continue to spend on technology, such as the cloud and artificial intelligence, or risk being left behind. Thus, the tech sector is likely to maintain a premium valuation
• The market’s ability to shake off bad news and still depressed investor positioning
• Easing inflation trends expected in the summer months
• A labor market that remains relatively strong and an economy that’s showing some signs of slowing but not yet in recession Our House view still expects a recession, but there’s a greater degree of uncertainty around the timing and depth.
• Our economic team has slightly increased our 2023 GDP forecast. 

Our House view still expects a recession, but there’s a greater degree of uncertainty around the timing and depth.

• Our economic team has slightly increased our 2023 GDP forecast

Relative opportunities and sector shifts

Below the market’s surface, we see several areas that are discounting at least some of the anticipated economic slowdown and likely have more near-term upside.

Indeed, the S&P 500 Equal Weight Index is relatively flat for the year and still down more than 7% from its February peak.

• Over the past three months, it’s lagged the more commonly followed market cap-weighted S&P 500 by roughly 10%, the most in the history of our data, going back to 1990, which includes the tech bubble. It’s trading at a forward P/E of just under 15x.

At the sector level, we still see technology and communication services as longer-term leadership and remain overweight. This also continues to support our long-standing U.S. large cap preference. However, we expect relative trends to moderate near term after such hefty gains.

Upgrading industrials and consumer discretionary to overweight

• Industrials have trailed the market by a wide margin this year, up only about 3%. The sector is now showing signs of price and earnings stabilization and continues to have secular tailwinds in the form of defense and infrastructure spending and onshoring.
• Consumer discretionary, which has a mix of growth and economicallysensitive sectors, has greatly improved in our quantitative work.

Downgrading consumer staples to neutral

• Consumer staples, where relative prices have deteriorated sharply recently in part due to some weaker earnings announcements in the sector over the past month, looks less attractive.

We still see value in fixed income and remain focused on high-quality bonds.

• Our downgrade here is just a reflection of neutralizing our overall tactical positioning until the weight of the evidence shifts more decidedly. We wouldn’t hesitate to put cash to work in fixed income for those who are underweight, especially as yields have rebounded recently.

Coming into the year, we were expecting an S&P 500 range of 3400 to 4300. We’re shifting that range up to 3800 to 4500, given the better-thanexpected earnings, our updated view that technology – by far the largest sector – is likely to stay at an elevated valuation level, and depressed investor positioning.

We continue to keep an open mind and could easily shift back to a more defensive posture. But, for now, these shifts reflect the mixed evidence in our work.

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