The month of May has been a blockbuster so far for the bulls, as the major market indexes erase the April showers that shed more than 5% off the S&P 500 from its all-time high. Corporate earnings reports continue to impress, the dollar has started to weaken again, and both long- and short-term interest rates are pulling back from their April highs. Last week, I asserted that the 2-year Treasury yield was peaking at approximately 5%, and that it would serve as a lever for higher stock prices as it begins another decent. The 2-year yield is viewed as a proxy for where the market sees the Fed’s benchmark rate approximately one year out. Its decline would reflect a shift in the consensus view from as few as one rate cut by year-end to two or more starting earlier in the year.
Since then, the 2-year yield has fallen from its April high of 5.04% to its recent close of 4.83%, and the S&P 500 has rebounded to retake 5,200. I think investors should expect to see a continuation of the fall in rates that further fuels the demand for stocks. The lack of progress in bringing the inflation rate down during the first quarter was largely due to seasonality and the lagged impact certain categories have on the calculation of the gauges. This should abate in coming months, as the economic expansion slows but sustains, bringing the soft landing into view for the consensus. Markets are discounting this very bullish outlook well before it comes to fruition because that is how markets work. They are discounting mechanisms, so we should listen to them.
Regardless, I continue to see forecasts for recessions, stagflation, and bear markets. None of these ominous outlooks are reflected in the economic data, but they do serve as effective emotional triggers for many investors who want to see a different outcome from what the data indicates is most likely today. More than a decade ago, coming out of the Great Financial Crisis, I was angry. I can remember allowing my own political and ideological views about both fiscal and monetary policy to greatly impact my economic and market analysis in a way that skewed my outlook for the market. There was what, I thought, should happen, and then there was what was most likely to happen. I was more interested in what, I thought, should happen, and that is how I forecasted markets. As a result, I was horribly off base, missing out on a meaningful percentage of the secular bull market that didn’t care about my personal views. I swore to never make that mistake again.
There are always aspects of an economic expansion and bull market that raise red flags as both mature. For the economy, debt levels rise, and lower income consumers feel the pinch far sooner than other demographics, but that is part and parcel of the business cycle. As for markets, valuations for certain segments become stretched, while others lag well behind, but this is also the normal process of both a secular and cyclical bull run. Over the past three decades, we have seen debt accumulation transfer from corporate America to the consumer to the federal government. The first two resulted in the bursting of the technology bubble and the Great Financial Crisis. I have no idea how the federal government’s debt build up will resolve, but I intend to listen to the markets instead of my own biases when forecasting.
Today, the markets are telling me the coast is clear for now, which is why I remain in wealth accumulation mode for the rolling 6-12 month period that my forecast focuses on. When the facts on the ground change, and rates of change begin to deteriorate, so will my outlook. Until then, I recommend not being swayed by lions, tigers, and bears who keep forecasting recessions, stagflation, and bear markets. I see a lot more bias than I do fact-based analysis.