2023 has been an extraordinarily confusing year for portfolio managers. Investors have generally brushed off SPY’s +15% YTD rally, presuming it to be merely green shoots in a bear market with a seemingly inevitable correction coming. As Q2 comes to an end, however, it may be time to acknowledge some improvement in macro fundamentals and sentiment. We haven’t seen investors this bullish since 2H 2021 at the height of the post-pandemic rally. While leading indicators and the yield curve still forecast upcoming weakness, GDP, housing, and manufacturing indicators appear to be bottoming-out and, in some cases, starting to improve. We don’t recommend buying equities hands over fist just yet, but we do believe it is safe to add a couple risk assets (high-quality corporate credit, international equities, and other fixed income) to your portfolio if you are still positioned extremely defensively.
Recently released data shows promise in the housing market as leading indicators reached their highest levels since mid-2022. The NAHB / Wells Fargo Housing Market Indicator is a weighted metric of sales activity and buyer traffic; June’s reading of 55 exceeded the expected forecast of 50 and brings the index to its strongest level since July 2022. In the same vein, building permit and housing start totals each improved from last month and beat their projections (housing starts increased by a whopping 22%). Struggles do remain in the commercial real estate sector, as Fed chair Jerome Powell said he expects banks to incur losses from the disaster created in the wake of SVB’s collapse. However, the larger economic picture indicates an improving housing market despite rising mortgage rates.
Investor sentiment also continues to grow more positive as the current market conditions grow more likely to foster a legitimate market rally. MarketDesk’s US Sentiment Composite Inputs, which tracks stakeholders’ current stance on different sectors of the market, improved across the board for the third straight week. This was almost enough to bring investor sentiment to historical medians (50th percentile), according to the MarketDesk Long-Term Composite Indicator. The American Association of Individual Investors’ (AAII) Sentiment Survey also observed 45.2% “bullish” votes this week, a trailing 12M high and nearly 25% higher than the historical average of 37.5%. Bearish sentiment is at its lowest (22.7%) since July 2021.
While earnings revision breadth remains far from attractive, Morgan Stanley observes that it has started to gain stability and, more importantly, we are seemingly out of the “danger zone.” In early 2023, earnings revision breadth dipped to its lowest in 20 years outside of a recession; while we remain comfortably below the historical average, breadth is no longer red flagging a legitimate or prolonged recession. We continue to observe a similar story with hedge funds’ S&P 500 futures: the bearish tilt remains prevalent, but there has been some easing from the concerning lows we observed in late Q1 and early Q2. Finally, the S&P 500 is trading more than 400 bps over its 200-day rolling average; every bear market since 1950 has ended for good once the index surpasses this figure for more than eighteen consecutive days.
It is certainly easier to be more constructive now than it has been in the past year, but it’s important to note that we are not out of the woods yet. As far as breadth is concerned, the numbers look promising in a vacuum, but earnings revision breadth has historically peaked in June and troughed in November; in other words, what we believe to be improving earnings revision breadth could merely be a cyclical trend. In fact, we would argue that earnings revision breadth remaining historically weak at the peak of its cycle is more concerning than anything. Looking at the bigger picture, the yield curve remains inverted and in the 1st percentile of historical data; this has historically been one of the recessionary indicators with the strongest correlation. The CAPE Shiller P/E ratio remains at 20-year highs, lending standards continue to tighten, and fiscal support and liquidity are fading fast.
Ultimately, we still advise relatively defensive portfolio positioning, but we believe it is safe to start transitioning T-bills to fixed income such as municipals and corporates, while beginning to nibble on stocks particularly those in higher quality segments both in the US and international. We also recommend extending duration to longer than the benchmark. If there really is a slowdown, long-term bonds will outperform in the event of a market correction as the short-term end of the interest rate market will bear the brunt of the hit. We are bullish on international markets, some of which are up 10-15% YTD trading at half the P/E ratio of US markets. As always, we will preach Astoria’s True North: an allocation towards alternatives, a focus on high-quality and diversifying across factors.
Best,
John Davi
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