Last year saw one of the most synchronised cross-asset sell offs in decades, and recession is now widely expected in many advanced economies. Despite this, Fathom Consulting’s allocation toolbox suggests that investors may not only have shrugged off recessionary fears, but appear on the verge of embracing a Goldilocks scenario, consistent with low inflation and stronger growth.
According to our inflation surprise Fathom Macro Portfolio (FMP), assets tracking inflation surprises have fully reversed the significant gains accumulated over the course of 2021 and 2022. At the same time, a positive trend in our macro cycle FMP — a portfolio of assets tracking global economic activity — has been discernible since the end of 2021. The combination of disappearing inflationary concerns and improving macroeconomic conditions would suggest that a Goldilocks environment may be within reach.
Further confirmation comes from consumer staples stocks — an equity investor staple during uncertain times — which so far in 2023 are down 12% relative to consumer cyclical stocks, which are generally preferred by investors in times of plenty.
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Also, notoriously macro-sensitive stocks such as copper miners have gained about 40% more than the broader S&P500 index since the start of September 2022, including a 10% relative rise in 2023 alone. All this could indicate that the market believes that the worst of the macro news may be behind us.
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However, there is evidence to argue that the market upswing since last summer was driven mainly by hopes of a Fed pivot. One example is the performance of gold mining stocks, which showed little variation relative to copper mining stocks in 2022, despite their much lower sensitivity to macro conditions. In other words, copper mining stocks ought to have significantly outperformed gold ones if improving fundamentals had been the main driver of their recent strong performance.
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Company earnings offer more direct evidence that investors may be failing to price in weaker fundamentals. Decomposing US equity returns between cash flow (i.e., the fundamental part) and discounting effects (i.e., the rate-sensitive part) highlights how the latter has shown signs of a rebound while the former has not.
With markets on the verge of a Goldilocks scenario, the risks for investor disappointment seem particularly elevated, as hard economic data indicate that recession is still on the cards. US earnings expectations continue to be revised lower by analysts, with the growth rate in expected earnings from US companies over the next twelve months having reached zero. There is room for further downside revisions, as earning expectations have not yet reached levels consistent with previous recessions.
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Recent economic data have supplied more evidence that conditions could take a turn for the worse. Last week, the US reported a drop in real spending driven by higher savings, and this week German GDP was reported to have unexpectedly contracted by -0.2%.
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Even if the US swerves a recession, or experiences only a mild one, a negative surprise for investors may well end up materialising from rates rather than from weaker economic activity. In either case, we continue to advocate a more cautious stance. Our Fathom Risk-Off Gauge (FROG) remains in risk-off territory, a signal that has stood us in good stead over the course of a tricky 2022.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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