Such stuff as bull markets are made on

Upside surprises, spending rises, and other revels

At its midpoint, 2023 is already a year of contrast and confusion. Linger on the following list:

A cumulative 500 basis points of rapid Fed rate tightening.
A severely inverted yield curve.
China’s economy, six months after re-opening, still beleaguered by weak consumer spending and a slumping property sector.
Silicon Valley Bank mismanaging itself into insolvency. SBF, once the golden boy of crypto, ignominiously under house arrest (at his parent’s home of all places).

These are all now immoveable facts of the last year – and, deeply negative stuff.

But look around. Bull market vibes are everywhere. Artificial intelligence (AI) has entered the public consciousness, reawakening animal spirits in the tech sector. Apple’s new “mixed reality” headset promises to transport users into digital utopia (if the goggles don’t make you dizzy, the eye-watering price of $3,499 will).

Against all predictions, recession flatly refuses to show up. Supporting this is the remarkable run of expanding U.S. payrolls, with an average monthly gain of 370,000 jobs this year. All the more remarkable is that 7% mortgage rates not only didn’t deflate the American housing market, but engineered a boom in homebuilding stocks. Regional bank failures have also not led to broader financial system contagion. Even Beyonce’s sprawling Renaissance World Tour sold out within minutes. And, now, the S&P 500 has just registered a 20% bounce off its October 2022 low.

This is the stuff of bull markets. But what lies ahead? The key question is whether a durable market uptrend is underway. First, some perspective: a rally has hardly begun. All the S&P 500’s gains this year have come from seven over-hyped tech stocks, largely buoyed by the AI theme. This is not yet a broad-based bull market with widespread participation.

New global economy emerging from the pandemic

Looking ahead, the challenge is that “textbook macro” would suggest that a recession and associated stock market downturn is in the cards. Hawkish central banks, inverted yield curves, and tightening financial conditions all support this. And, crucially, nearly everyone will point to “long and variable lags” from tighter monetary policy. Surely it is only a matter of time before higher rates crush the economy?

On the surface, all that seems intuitive. But there is another argument that may stretch minds: We are entering an early-cycle environment based on an entirely different set of macroeconomic conditions. A new bull market based on new investment leadership is unfolding.

Stay with us here. To start, and at the risk of stating the obvious, the current business cycle is not a natural one. There is nothing textbook about today’s environment. Economic shutdowns and re-openings were fully coordinated by government, rather than traditional market forces. Different nations opened at different times and with different velocity. The current world economy remains highly desynchronized.

This, of course, is new territory. Ever since globalization gathered pace in the early 2000s, world trade and business cycles had become far more correlated, not less. But there is now evidence everywhere that pandemic distortions are rapidly normalizing. Supply chains have eased. The labour market is coming into balance. The global auto industry, which was rocked harder than almost any part of the economy, is showing swift improvement in production bottlenecks.

All of this is underappreciated, in the context of supporting economic growth. But, even given post-pandemic healing, the question remains: Where will global growth come from to drive the next bull market? Consider the last few decades. The abundance and positive supply shocks of the 2000s (moving 40% of global manufacturing offshore to China, the U.S. shale boom, etc.), set up a slow growth and disinflationary decade in the 2010s.

The opposite is now occurring. A chronic lack of investment in the 2010s has led to shortages today, and a revival in aggregate demand is taking hold simply because the world has underinvested in the real economy for years. Everywhere you look, companies, facing higher interest rates and labour costs, are spending money to lift productivity – in ways that extend far beyond betting the farm on AI and ChatGPT. Capital expenditure (capex) in the U.S. has soared, showing a 14% year-over-year growth rate in the first quarter of 2023.

Underpinning higher demand is higher government spending. The structural changes in advanced economies mean more resources will go to things that are, in the words of economic historian Brad Delong, “state responsibilities” (i.e., healthcare because of aging, education because of the knowledge economy, decarbonization because of climate change, and lately, defense spending because of renewed conflicts).

This is also not just a Western trend. A global capex boom is unfolding in international energy and transport projects as the world fillets itself into continental and mega-regional hubs. Countries across Asia, Latin America, Africa, and the Middle East are embracing new infrastructure spending plans, while disposable incomes rise and populations grow.

All the above means that the appetite for more government spending is here to stay. It also means that any downturn will be mild and short-lived, given robust fiscal policy. This is also the exact opposite of the 2010s, which was characterized by austerity and retrenchment of public finances.

Next time: The wrong call on recession and where to look for the new bull market.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

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