"There are two types of economists," said famed economist John Kenneth Galbraith, "those who don't know, and those who don't know they don't know." This, along with movie producer William Goldman's assertion that "nobody knows anything" are two quotes that remind us to be humble when making forecasts about the future path of the economy and the financial markets. To the extent to which economics will always be a social science and never a hard science like, let's say, chemistry, it is incumbent upon the would-be forecaster to constantly adjust his assumptions for new information, or, at least, information that is new to him. * To wit, we have counted seven meaningful developments since the start of the year that are keeping us cautious despite the rally in risk assets:
1. Commercial real estate delinquencies and defaults, while low, are rising
2. State tax revenues are softer than the consensus expects and are likely to come in under forecast following April tax collections
3. Recently updated CBO projections forecast a surge in the servicing cost of the U.S. government for the first time in 30 years
4. The relationship between China and Russia appears to be getting closer; any hope of returning to the status quo ante in America's relationship with China appears dim
5. The effective corporate tax rate is likely to increase 200-300 basis points this year due to the 15% minimum tax, R&D tax credit and other expiring tax provisions
6. Profits shrank in the 4th quarter versus last year
7. The Fed is no longer expected to cut rates in 2023; rate hike expectations have increased by 50bps
One or two of these items might smack of confirmation bias, but all seven, taken together, lead us to believe that investors in both bonds and stocks should expect greater volatility and risk in 2023. We believe that while the rate of inflation may have peaked, the sheer amount of issuance and the absence of QE may keep long rates higher for longer than anticipated. If such an unhappy occurrence should come to pass, we see continued risk in long-duration equities. This, along with geopolitical developments that are worrisome but difficult to handicap, do not seem consistent with an S&P 500 trading at 18x 2023 earnings projections that, in and of themselves, are probably too high.
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by Refinitiv.
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