“I think there are some groups of stocks that are highly vulnerable because they’re in cuckoo land in terms of valuations.” These words from the controversial but always entertaining Marc Faber1 could not be more succinct given current equity market conditions. The post-pandemic rally in global stocks has the All-Country World Index (ACWI) up almost 150% from the lows in 2020. The S&P 500 has been even stronger over the same timeframe leaving stocks in expensive territory. Some would argue that valuations don’t matter because global stocks have been expensive for years and they keep marching higher. Further, the S&P 500 is especially overpriced relative to the rest of the world according to numerous indicators including the Cyclically Adjusted Price-to-Earnings Ratio (CAPE2), but the U.S. market has generally outperformed since the end of the 2008/2009 financial crisis (Chart 1). It’s important to note that valuations should not be looked at in isolation. Sometimes higher valuations are warranted by higher growth prospects.

“Fall down seven times, get up eight” is a Japanese saying of resilience and perseverance. It also succinctly describes the pattern of the Japanese economy over the last 35 years. The Japanese real estate and equity bubble burst in December 1989, and since then the domestic economy has fluctuated between deflation and reflation with 45% of monthly inflation readings indicating falling prices. This situation is unique to Japan, which has been one of the weakest economies among the G7 countries over this timeframe. Japan has repeatedly experienced “false dawns” over the last 35 years where its economy appeared to be escaping the cycle, only to have economic recoveries fizzle out.

What a difference a year makes! According to the Merriam-Webster dictionary, the word of the year for 2023 was “authentic,” which is certainly a major improvement over “gaslighting,” which was the 2022 word of the year. Transitioning from the negativity of “gaslighting” in 2022 to the positivity of “authentic” in 2023 was mirrored in the global economy and financial markets.

The recent trend in U.S. residential housing conditions is downright discouraging for those trying to buy a new home, and even worse for those looking to buy their first home. Ongoing supply shortages in the housing market have pushed the median price for an existing single-family home 50% higher than pre-pandemic levels. Meanwhile, the Federal Reserve has been lifting interest rates for 18 months in its effort to cool inflation, which has resulted in a 23-year high in mortgage rates. Rising house prices coupled with rising mortgage rates mean housing affordability has become very unaffordable.

Whatever happened to the old saying “don’t fight the Fed”? Typically, when the Fed and other central banks raise interest rates to cool inflation, an associated and necessary result is economic activity and corporate earnings slow, so equity markets sell off in response. But year-to-date the global benchmark All Country World Index (ACWI) has returned almost 10% and has largely ignored the fact that we are still in the midst of the most aggressive monetary tightening cycle since the 1980s. Starting in the first quarter of 2022, the central banks of the G10 largest economies have increased policy rates by a whopping 24% in aggregate. Meanwhile, central banks are also withdrawing stimulus through their quantitative tightening programs. But all the while stock markets have spent 2023 so far merrily (or recklessly?) marching higher.