July 18, 2023
Wellspring Investment Outlook - 3Q'23
U.S. Business Cycle Indicator
: The U.S. economy shifted into a "Slowdown" phase in April 2022, with economic activity decelerating. A weakening labor market and consumer balance sheets suggest continued economic softness. The deceleration in economic activity and potential recession suggests a cautious approach to portfolio construction.
: During the "Late Cycle" phase of the business cycle, asset allocation favors the U.S. over International stocks, Growth over Value, and longer-duration government bonds over corporate credit. If/when the market resets lower, portfolios will be positioned for “Recovery” with tilts toward Value, Growth, Emerging markets, and corporate bonds. The market typically discounts business cycle phases 6 to 12 months before occurring.
Investor Sentiment & Earnings Growth
: The U.S. Macro Regime Indicator suggests transitioning from "Risk-off" to "Risk-on" around Q1 or Q2'2024. Earnings growth plays a crucial role in equity market valuations, with the S&P 500 Earnings Indicator providing directional guidance. We believe Wall Street estimates for S&P 500 earnings may be optimistic, impacting market valuations. The S&P 500 is reporting a year-over-year decline in earnings of -7.1% for the second quarter, marking the largest earnings decline since Q2 2020 and the third consecutive quarter of earnings decline.
Leading Economic Index (LEI)
: The LEIs have experienced a significant decline in economic activity, suggesting a worsening economic outlook and forecasting a recession in Q3/Q4 2023. Coincident economic indicators have not followed the LEIs lower. Resilient consumption and employment conditions have stalled a recession. While challenges remain, opportunities exist in sectors like industrial real estate, small-cap stocks, and specific technology-driven markets.
: Municipal bonds offer after-tax return advantages and downside protection during rising interest rate environments. Private credit provides resilience and attractive risk-adjusted returns. Private equity investments offer enhanced returns, long-term growth, and access to unique opportunities.
Wellspring remains cautious yet opportunistic in the second half of 2023. Opportunities remain in specific asset classes to construct resilient portfolios at reduced valuations and position accordingly for potential market movements.
Click "Market Outlook" to download our Q3 2023 investment outlook.