by David Picton and Team, Picton Mahoney Asset Management
Overview
As the third quarter begins, the economy and stock markets appear to be nearing an important juncture. On the positive side, inflation continues to decline, and the U.S. Federal Reserve (Fed), encouraged by this progress, has paused its campaign of rate hikes. Markets have responded bullishly, as they have done historically when such a pause occurs. Now the debate turns to whether the economy will experience a soft landing or a recession. There are myriad arguments for both possibilities, but our reading of the data suggests that the latter is the more probable outcome at this point.
With that in mind, the setup for equities at the start of the second half of 2023 looks challenging. What currently appears to be a āGoldilocksā economy ā not too hot and not too cold ā could quickly give way to a recession as the impact of previous central bank tightening continues to work its way through the system. Meanwhile, stock markets are up significantly from their lows and are expensive by most measures, especially a select number of U.S. high-tech stocks that have been buoyed by the generative artificial intelligence (AI) boom. Positioning and investor sentiment have both turned much more bullish, leaving little room for error, and creating the potential for a wave of selling should data and sentiment begin to erode. Finally, investors seem convinced that the Fed will deliver interest rate cuts into 2024, apparently tuning out the central bankās own projections. We believe this constellation of factors suggests that caution is warranted.
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