Market View
The 26th Annual Milken Institute Global Conference took place this week (May 1 to 3), and the consensus outlook on the current macroeconomic environment was almost uniformly negative, in our view. This translated into fairly bearish calls on risk taking, with many financial industry leaders arguing that recession fears have not been properly priced into equity valuations, for example. We believe the situation is more nuanced than that and see a great deal of uncertainty in both the economic landscape and the potential market outcomes.
Among the two most challenging stories to disentangle this year are the path for disinflation and the magnitude of a forthcoming recession - both of which could ultimately drive investment theses for this year. Take inflation - the risk of inflation resilience is very real. Core CPI still looks very sticky, and the labor market appears to be strong with wages still rising albeit slowly. This favors consumption and thus elevated prices. The counterpoint to this is that job openings have peaked, and we think shelter costs – which make up a large part of expenditures in the CPI basket – may start to come down in earnest amid the current process of lease renewals.
Moreover, the US is currently undergoing a credit crunch propelled by the turmoil in US regional banks. If this becomes more severe, that could also hurt the housing market, impacting the economy and thus bring inflation down faster. But that leaves us with the issue of recession. So far, the economic data hasn’t pointed to anything more than a mild recession in the near term, but we believe the credit crunch could disturb that, particularly as commercial real estate loans may be at risk in the next wave. That pressure could ultimately lead the US Federal Reserve to start cutting rates before year end (most likely in 4Q23 in our view), which is an extension of the pause they signaled at the May 3 FOMC meeting where they hiked 25bps but removed language on “additional policy firming.”
Expectations of that could move discount rates for forward earnings expectations lower, supporting higher asset valuations and thus a market rebound, possibly as early as mid-to-late 3Q23 – assuming the credit crunch doesn’t materialize into a full blown financial crisis. In other words, we’re constructive on risk over the longer term as the end of the monetary tightening cycle should ultimately help bitcoin and ether prices, alongside endogenous factors like technological advancements or bitcoin’s block reward halving event at the end of April 2024.
The trickiest part, however, will be the next few months. The US regional banking situation is serious and threatens to spread. At the same time, the US government is struggling to overcome a stalemate on the debt ceiling issue. How digital assets perform amid this backdrop is anyone’s guess, as we expect countervailing factors may offset some of the positives. The volatility that a banking crisis and debt ceiling showdown could generate also make it hard to see past the horizon to the better market environment that we think is on the other side. Moreover, it’s precisely why we may have heard such limited dispersion in terms of economic and investment views.
