Forget stock market pessimism: Here's five reasons why

An old investing adage holds that what everybody knows isn’t worth knowing. A corollary to this is that what everyone thinks will happen in investment markets often doesn’t.

This probably applies to views of the economy and the stock market this year. For nearly a year now, doomsayers have been predicting near-term recession for the U.S. economy, largely because of interest rate increases by the Fed to counter persistent inflation by suppressing the business activity that fuels it.

For various reasons, rate increases tend to push down stocks, especially tech stocks, for the short term. The rate increases and anticipated recession have resulted in glum forecasts for stock performance this year. Yet this view may prove no more accurate than the expectations of fervent fundamentalists, for whom the apocalypse is always right around the corner.

Indefinitely Imminent

The most widely predicted recession ever may turn out to be similarly apocalyptic—imminent but not arriving, not this year at least. More likely than not, if a recession does begin this year, it will be far too mild to justify the longstanding recessionoia in the financial community and the media sphere.

Economic growth slowed in the fourth quarter of 2022 and in January of 2023. But that’s only natural, considering that the Federal Reserve Board, seeking to tamp down inflation, reversed the pandemic-related monetary policy of near-zero interest rates to impose a series of rate increases. (By raising the rate for its loans to banks, the Fed pushes up all domestic rates.)

The ultra-low rates put the economy on jet fuel. So sure, the economy has been slowing now that rates are higher—but from an extremely high rate of speed. Slower growth doesn’t necessarily mean shrinkage, which is what a recession is.

Slimming Odds

Moreover, there are abundant indications that the odds of a recession this year, not overwhelming in the first place, are declining, with inflation falling like a rock while the U.S. economy keeps chugging along. Amid all this, there are promising signs for stocks and other investments for 2023.

Here are some indications that earlier negativity is weakening and grounds for optimism are clearly growing:

• The voices discounting the likelihood of a recession this year are becoming easier to hear as the din from the recession-obsessed abates. Some prominent analysts, such as Ed Yardeni of Yardeni Research, are predicting no recession for the U.S. this year, and Yardeni believes we’re now in a new bull market. Goldman Sachs, an investment bank many investors listen to, in January put the odds of recession this year at only 35%.
• And as of late January, global money managers collectively put these odds at 73%, compared with about 98% last year—a decline in pessimism. This metric comes from research by Hamilton Lane, which found that some investments, including five-year Treasuries in the U.S. and government bonds in Europe, US high-yield and high-grade bonds, had been assigned less than 50% odds of negative returns—a much improved outlook from last year.
• Such moderation of earlier, dire forecasts is spreading. Many financial people talked last year as though we should all hunker down in the storm cellar like Dorothy’s family in “The Wizard of Oz.” Yet this year, some of these same prognosticators have been sticking their heads out to see lightening clouds (that really weren’t so dark in the first place). Among the less subtle tonal changes are those of Jamie Dimon, the oft-quoted CEO of JP Morgan Chase. Dimon went from, “That hurricane is right out there down the road coming our way… You’d better brace yourself” in May to this in mid-January: “I shouldn’t have ever used the word ‘hurricane.’ What I said was there were storm clouds which may mitigate.” (He didn’t.)
• Judging from Dimon’s degree of certainty when speaking initially, you might have thought he had the sheepskin for an undisclosed doctorate in economics squirreled away in his storm cellar (unless Toto ate it). Then again, real economists characteristically qualify their forecasts to keep from having to backpedal like Dimon. And this year, many of these economists have been softening their earlier outlooks, despite having spent so much time in graduate school studying economic calamities.
• Many investors think rapidly declining inflation will probably forestall protracted Fed rate increases. Doubtless, this view was forceful in driving up the S&P 500 about 5.75% and the Nasdaq, up more than 10%, between Jan. 2 and Jan. 27. Dismissing these gains as just another bear market rally, some advisors from big firms can’t explain why these indexes are rising as though investors know something about the economy the Fed doesn’t.
• Renowned economist Jeremy Siegel believes they do. Siegel, who was way out front in predicting inflation for 2022, argues that, unbeknownst to the Fed, the critical metric of core inflation is actually declining. Siegel convincingly makes the case live on CNBC that the Fed goofed in calculating core inflation in January by using a highly inaccurate figure for housing. This basic error wasn’t obvious to the Fed but it was to Siegel when he compared it with figures from various authoritative housing indexes. Using accurate, up-to-date figures, Siegel found that instead of being positive, as the Fed says, core inflation was actually negative. When the Fed discovers its error, Siegel said, “it will be forced to realize [that] the inflation problem has been solved.” He said the market is rising because investors (presumably, professionals) know this.
• As Siegel’s analysis has gone largely unacknowledged in the national economic debate, recession hawks have continued to sound warnings while, at least through January, market bulls have invested undeterred.
• Market and economic history suggest that a recession in 2023 is highly unlikely. One of the best predictors of recession is credit spreads. Recessions are consistently preceded by widening credit spreads (aka yield spreads) on junk bonds. But this isn’t happening now, not even close. Instead, this indicator is signaling a soft landing—inflation coming down without the crash of a recession. For months, the recession crowd has been rejecting a soft landing as an implausible fairy-tale ending.
• Since 1950, a recession has never started in the third year of any presidential administration. The reason may be that the third year is when presidents in their first term are doing everything they can to prevent downturns to enhance their chances for re-election and second-termers, to burnish their legacies. Though presidents have limited power over the economy, they can take actions to postpone problems.
• If historical patterns hold true, the poor market year of 2022 will be followed by a bright one in 2023. Since 1950, after every midterm election year when the market declined, the S&P 500 posted double digit returns the following year. In four of those years, this index returned more than 26% and in one, 1974, more than 30%. And “every” is a word rarely used in citing market history.

The Months Ahead

For those in the chattering class who can’t help but indulge in Fedspeak, a scenario of significantly lower inflation and a still-robust economy seems unthinkable, despite signs that this is happening.

If this scenario becomes more distinct and stocks continue to rise, the interpretation that a new bull market has begun might become prevalent enough to severely depress career pessimists. But if the market turns sharply downward in February or in the ensuing months, the critical questions for investors will be: Is this decline greater than the gains this year to date? Would money invested Jan. 2 still be in the black?

If the answer is “no, would this decline be highly impactful for long-term investors in the context of the historical upward arc of the markets, driven by the unstoppable digital revolution? Probably not.

One thing is certain: There’s never a second chance to get the early gains of an infant bull market.

Dave Sheaff Gilreath, CFP®, is a 40-year veteran of the financial services industry. He is a partner and chief investment officer of Sheaff Brock Investment Advisors, LLC, a portfolio management firm for individual investors, and Innovative Portfolios, LLC, an institutional money management firm.Based in Indianapolis, the firms manage about $1.3 billion in assets nationwide.