In our business, we use statistics as a guide. However, as the old adage goes, “there are three kinds of lies, lies, damned lies, and statistics.” This quote suggests that statistics can sometimes be manipulated or misrepresented to support a specific point. However, it is worth noting that this year’s record market advance seems to be accurately explained by the U.S. Bureau of Labor Statistics. They found that stocks have historically advanced by an average of 17% over the one-year period following peaks in inflation. Coincidentally, June 2023 marked a year since inflation peaked, and the price return of the S&P 500 was exactly 17% through the end of last month. So, maybe not all statistics are untrue.
So do statistics give us any indication of where we are headed? Stocks have outperformed bonds this year, which usually signals an improvement in growth expectations. The Federal Reserve may be closer to an end of its rate-hiking crusade as inflation moderates. The stock market seems to reflect an increasingly optimistic view about the likelihood of a “soft landing” in the economy. So if the market bottomed in October of 2022, perhaps the worst is behind us. Historically, the S&P 500 has tended to outperform in the middle stages of an economic expansion.
As we have discussed in recent letters, this year’s market returns have been heavily concentrated in a handful of names. The top five holdings have made up a significantly greater percentage of the total market capitalization of the S&P 500 index, and it currently stands at an all-time high. This narrow leadership casts doubts on the durability and strength of the market’s rebound. However, on the bright side, this narrow market looks different than the stock market bubble of 1999. The good news is that today’s valuations do not compare to those of the top Nasdaq companies in early 2000. Indeed, market participation historically has tended to broaden as economies recover from weak environments. So we are hopeful that this trend plays out over the coming quarters.
What could derail all of this cheer? The recent U.S. credit rating downgrade surprised and rattled markets. Stocks sold off after Fitch Ratings cut the U.S.’s credit rating to AA+ from AAA, citing repeated debt limit standoffs and last-minute resolutions. Despite the initial shock, it seems unlikely the downgrade will have a meaningful impact beyond the short-term. The downgrade does have the potential to move U.S. bond yields higher. In fact, when asked about the downgrade, famed investor Warren Buffett said, “Berkshire bought $10 billion in U.S. Treasuries last Monday. We bought $10 billion in Treasuries this Monday. And the only question for next Monday is whether we will buy $10 billion in 3-month or 6-month T-bills.” If anything, the downgrade may create short-term volatility and serve as an opportunity for the stock market to digest some of its year-to-date gains.
So, what does all this mean for our investment strategy? Not much. By focusing on valuations and seeking out high-quality companies with strong management, we are positioning our portfolios to navigate a constantly changing investment environment. We have always found that it is important to have a clear strategy and stick to it. Please contact us to schedule a personal review of your portfolio.