Asset Allocation
2023 market trends in 5 charts

This year has been full of surprises, prompting investors to reset their expectations more than once.

In January, the mood was solemn as markets were still recovering from 2022’s sharp decline, and a recession felt inevitable. But then an AI-fueled tech rally lifted the U.S. stock market, while returns in Europe and Japan proved to be stronger than expected. The lesson? Market surprises should not be surprising.

What’s next for investors as we grapple with higher-for-longer interest rates and slowing-but-persistent inflation? Here are five of the most important trends to watch as the year unfolds:

1. A rolling recession may have already begun

Many economists predicted an imminent recession when the U.S. Federal Reserve first increased interest rates more than 18 months ago. Eleven hikes later, a broad economic downturn hasn’t materialized.

But what if the recession already happened? Just not all at once.

A rolling recession occurs when industries rise and fall at different times, creating pain in certain sectors while others flourish. For example, the travel and energy sectors cratered in 2021, but have since rebounded strongly. Likewise, housing and semiconductor stocks slumped in late 2022 before picking up in recent months.

In such an environment our portfolio managers seek to take advantage of these “mini-recessions” by looking for potential opportunities in industries on the rebound, rather than focusing too much on the timing or magnitude of a broad recession.

Different sectors have experience downturns at different times

The image shows how rolling recessions have impacted travel, manufacturing, oil prices, chemical production, housing and semiconductors at various stages of the pandemic and over the following years. The TSA checkpoint travel numbers show that the number of monthly airline passengers declined by roughly 2 million between February and April of 2020, before gradually recovering over the following three years to reach 2.6 million in July 2023. In manufacturing, the U.S. ISM Manufacturing PMI Survey data shows the sector experiencing a sharp fall-off in the early stages of the pandemic, when the index declined by 15% between February and March of 2020 to a low of 41.8, before building back up to a peak level of 63.8 in March 2021, and then gradually declining for the next two years to a level of 46 as of June 2023. The WTI crude oil spot price shows a decline in 2020 around the start of the pandemic, falling from $45 per barrel in February 2020 to a low price of roughly $19 per barrel in April 2020, before gradually recovering to a peak price in May of 2022 of $115 per barrel, and moderately declining through most of 2023 to a price of $82 per barrel as of July 2023 in USD. The U.S. Industrial Production Index for Chemical Manufacturing shows a couple of sharp drops in production levels in the early part of the pandemic and through 2021, falling from an index level of 98 to 92 between February and March of 2020, and from 97 to 90 between January and February of 2021, before gradually recovering and maintaining relatively steady levels through 2023, to reach a level of 104 as of June 2023. The Philadelphia Stock Exchange Semiconductor Index shows a steady increase from 2019 to 2022, growing by roughly 210% between January 2019 and December 2021, followed by a sharp decline throughout most of 2022, falling by 42% between December 2021 and September 2022, before rebounding in 2023, growing by roughly 67% between September 2022 and July 2023. In housing, the U.S. S&P CoreLogic Case-Shiller 20-City Composite Home Price Index shows U.S. housing prices surged during the early part of the pandemic and continued to expand, consistently growing between 1 and 2% per month between May 2020 and June 2022, before turning negative in July 2022, hitting a low in August 2022, turning positive again in February 2023, and then growing consistently on a monthly basis through May 2023.

Sources: Travel: Capital Group, Transportation Security Agency (TSA), U.S. Department of Homeland Security. Data is a 30-day moving average. As of July 26, 2023. Semiconductors: Capital Group, Philadelphia Stock Exchange, Refinitiv Datastream. As of June 30, 2023. Data represents cumulative price return in USD since January 1, 2019. Housing: Capital Group, Refinitiv Datastream, Standard & Poor's. Latest available monthly data is May 2023, as of July 27, 2023. Manufacturing: Capital Group, Institute for Supply Management (ISM), National Bureau of Economic Research. Refinitiv Datastream. Figures reflect the seasonally adjusted survey results from ISM's Manufacturing Purchasing Managers’ Index (PMI). A PMI reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. As of June 30, 2023. Chemicals: Capital Group, U.S. Federal Reserve, Refinitiv Datastream. Data indexed to 100 in 2017. Figures are seasonally adjusted. As of June 30, 2023. Oil: Capital Group, Refinitiv. As of July 26, 2023. Past results are not predictive of results in future periods.

2. Resilient consumers could lead a strong economic recovery

Whether a rolling recession is already underway or a more traditional one is on the horizon, many investors are wondering what’s next.

The good news is that there are several reasons an eventual recovery could be relatively strong.

For one, the U.S. consumer appears to be in relatively good shape. Household debt was only 9.8% of disposable income as of June 30, 2023 — much lower than during the global financial crisis and other typical recessions. Supported by a strong labour market, resilient consumer spending could boost a range of industries including travel and leisure.

Secondly, a number of U.S. companies have cleaned up their inventories and balance sheets. The average interest coverage ratio — a measure of earnings over interest payments — is higher than it was during the past three recessions.

These factors combined could paint an optimistic long-term picture for investors during this period of uncertainty.

Consumers put their houses in order as companies cleaned up balance sheets 

The chart shows how U.S. household debt as a percentage of disposable income has declined across the recessions from 2000 through 2022 while median interest coverage ratio (a measure of earnings over interest payments) for U.S. investment-grade issuers has increased. Household debt stood at 9.7% of disposable income at year-end 2022, down from nearly 13% at its 2008 peak. Company interest coverage stood at a high of 13x  at year-end 2022, up from 7x in 2002 and about 12x in 2012.

Sources: Capital Group, Federal Reserve Bank of St. Louis, Morgan Stanley, National Bureau of Economic Research. As of March 31, 2023.

3. Mountain of cash could be a bullish sign for investors

One of the most notable trends of the year has been investors’ flight to cash and cash equivalents. Money market fund assets in the U.S. ballooned to a record US$5.6 trillion as of September 27, according to the Investment Company Institute.

Our analysis reveals that levels of cash have tended to peak around market troughs and shortly before market recoveries. The S&P 500 Index surged after both the global financial crisis and COVID-19 pandemic, returning at least 40% in U.S. dollar terms within three months of each market bottom.

Investors who stayed on the sidelines would have missed these market recoveries, potentially impacting their ability to achieve their long-term goals.

Investors' flight to cash has been followed by strong returns

The image shows the fluctuation of ICI money market fund assets from 2007 to May 26, 2023, including large increases during the global financial crisis from 2007 to 2009 and the COVID pandemic starting in March 2020. On January 9, 2009, cash levels peaked at $3.9 trillion. On March 9, 2009, the S&P 500 Index hit a trough. Three months later, the S&P 500 was up 40%, and six months later, it was up 55%. On May 20, 2020, cash levels peaked at $4.79 trillion. On March 23, 2020, the S&P 500 hit a trough. Three months later, the S&P 500 was up 41%. Six months later, it was up 46%. As of May 26, 2023, money market fund assets stood at $5.39 trillion. Returns and dollar values are in USD.

Sources: Capital Group, Bloomberg Index Services Ltd., Investment Company Institute (ICI), Standard & Poor’s. As of May 26, 2023. Past results are not predictive of results in future periods. Returns are in USD.

4. There have been windows of opportunity between a Fed pause and cut

While many investors may be planning to remain on the sidelines until the Fed starts cutting rates, our research shows that could be a mistake.

That’s because there have been windows of opportunity between the Fed’s last rate hike and first cut. We looked at asset class returns in the year after the Fed stopped hiking rates across the last four cycles. Our analysis revealed that cash had the lowest average returns during such periods, soundly outpaced by stocks, bonds and balanced portfolios.

In these instances, the first interest rate cut has been, on average, 10 months after the final rate hike. Investors who wait too long risk missing out on potential gains. Although the central bank’s most recent projections signaled one more rate increase before year-end, it appears the Fed is nearing the end of its current hiking cycle.

After Fed hikes ended, long-term results outpaced cash, with the first year contributing most

The chart shows how various asset classes on average have outpaced cash, as represented by 1-3 month U.S. Treasuries, in the 12-month periods following the last four U.S. Federal Reserve hiking cycles. Over the last four hiking cycles since 1995 as of April 30, 2023, investing after the last Fed rate increase has generated strong returns for both stocks and bonds. For the averages of the 12-month periods, U.S. equities as represented by the S&P 500 Index grew 16.15%, a 60-40 portfolio comprising the S&P 500 and the Bloomberg U.S. Aggregate Bond Index respectively grew 14.37%, U.S. bonds as represented by the Bloomberg U.S. Aggregate Bond Index grew 11.70%, international equities as represented by the MSCI Europe, Australasia and Far East (EAFE) Index grew 10.21%, and U.S. short-term bonds as represented by the Bloomberg U.S. 1-3 Years Government/Credit Index grew 8.80%, while cash as represented by the Bloomberg U.S. Treasury Bills 1-3 Month Index only grew 4.80%.

Sources: Capital Group, Morningstar. Chart represents the average returns across respective sector proxies in a forward extending window starting in the month of the last Fed hike in the last four transition cycles from 1995 to 2018 with data through 6/30/23. The 60/40 blend represents 60% S&P 500 Index and 40% Bloomberg U.S. Aggregate Bond Index, rebalanced monthly. Long-term averages represented by the average five-year annualized rolling returns from 1995. Past results are not predictive of results in future periods. Returns are in USD.

5. Bull markets have dominated bear markets

Bulls defeat Bears, 67 to 12. While that might sound like the lopsided score in a sporting event, it highlights an important fundamental truth about the stock market.

Our analysis of U.S. market cycles since 1950 revealed that while the average bear market has lasted 12 months, the average bull market has been more than five times longer.

The difference in returns has been just as dramatic. Even though the average bull market has had a 265% gain (versus a 33% decline for the average bear market), recoveries are rarely a smooth ride. Investors often face unsettling headlines, significant market volatility and additional equity declines. But those able to move past the noise, take a long view and stay invested through market cycles stand a better chance of scoring long-term gains.

Every bull market has been longer than the bear market that preceded it

The chart shows the cumulative price return of all U.S. bull and bear markets since 1949. It also includes the average total return and duration of the average bull and bear market during that period. There are 12 bull markets and 11 bear markets displayed on the chart. Completed bull markets had returns ranging from 48% to 582%. Completed bear markets had returns ranging from –21% to –57%. The average bull market had a 265% total return and a duration of 67 months. The average bear market had a –33% total return and a duration of 12 months.

Sources: Capital Group, RIMES, Standard & Poor’s. Includes daily returns in the S&P 500 Index from 6/13/49–6/30/23. The bull market that began on 10/12/22 is considered current and is not included in the “average bull market” calculations. Bear markets are peak-to-trough price declines of 20% or more in the S&P 500. Bull markets are all other periods. Returns are in USD and are shown on a logarithmic scale. Past results are not predictive of results in future periods.



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