· First and foremost, after the most challenging year since the Great Recession for the stock market and the most challenging in fifty years for bonds, a sincere thank you for your patience during 2022 as we turn the calendar to a new year with cautious optimism. As long-term investors we realize that years like 2022 are bound to occur, but if history is any guide they provide springboards to future gains.
On a personal note, we wish all of our clients and readers of the “Snapshot” a Happy, Healthy, and Prosperous 2023. On the first day of 2023, we are mindful of those who suffered personal setbacks during 2022, those who lost loved ones and those who are experiencing pain in their lives. We are also hopeful that 2023 will bring some relief to this pain as we count our own blessings and look forward to the future.
· Stocks once again drifted to the downside during this second consecutive holiday shortened week as investors continued to sell off growth stocks, perhaps in part as investors harvest capital losses for future use or to offset realized capital gains incurred earlier in 2022. Either way, in our minds the last two weeks historically provide little insight in predicting the near-term future of equity prices as volume is low and as noted above, trading can be motivated by factors other than what is the norm.
Over the short-term, expect the financial markets to remain in limbo, directionless, some weeks pushed higher by the same data (economic, corporate, Fed, interest rates) that push it lower during others. That said, as we noted last week, we believe that regardless of the short-term direction of stocks, the landscape over the intermediate-term which we would define as six to twenty-four months is becoming more favorable as the tightening of monetary policy has definitely slowed economic growth which if not too damaging will ultimately pair lacking supply with demand. The bottom line – a new bull market is most likely forming/evolving, but not imminent.
· Given the recent trajectory of inflation at both the wholesale and retail level, unless there is an uptick, we expect that the Fed is toward the end of tightening monetary policy vis a vis raising interest rates. Perhaps 50-75 bps of additional rate hikes over the next two meetings of the Open Market Committee of the Federal Reserve (January 31 – February 1, March 20-21) are in the cards and then a pause. Fed Chair Jerome Powell along with his lieutenants will also most likely ease up on the harsh rhetoric. That said, given the Fed’s concern with making certain that the inflation fire is completely extinguished, don’t expect a pivot anytime soon, perhaps not until 2024.
· The recent reopening of the Chinese economy has been accompanied by a surge in COVID cases and subsequent fatalities along with new travel restrictions from other countries into and out of China. The progression of the virus has been difficult at best to predict for the medical community as well as for economists in regard to the economic repercussions.
· The energy department recently put out bids to begin replenishing the Strategic Petroleum Reserve (SPR) with the first purchase being up to three million barrels. The refilling of the SPR, the volume of which has dropped to a 38-year low, may put a floor under the price of oil.
· In our opinion, inflation will fall relatively quickly to the 4%-5% range. However, the next 2%-3% will take a long time, measured in years rather than quarters or months. The result should be meaningful yields on bonds and eventually include, Certificates of Deposits as well as money market accounts. With this in mind and if history is any guide, we consider the period 2010-2020 as more of an aberration rather than the norm with respect to the yields on 10-year US Treasury Notes.
· The onslaught of economic data begins in earnest this coming week. Reports include, on Tuesday, November Construction Spending; on Wednesday, the Job Opening and Labor Turnover Survey (JOLTS); on Thursday, the Weekly Report of Initial Claims for Unemployment Insurance and the November Trade Balance. Finally, on Friday November Non-Farm Payrolls, November Unemployment and November Factory Orders.
· Consider this week the calm before the Q4-Earnings Storm. However, there are a few companies scheduled to report earnings. These include Schnitzer Steel (SCHN), Duck Creek Technologies (DCT), Angiodynamics (ANGO), Constellation Brands (STZ), Walgreen Boots Alliance (WBA), Conagra Foods (CAG), and Greenbrier Companies (GBX).
· LONGER-LASTING ISSUES TO KEEP AT TOP OF MIND
o We are excited about the recent rise in the yield on fixed-income securities, especially U.S. Treasuries. With yields above three and one-half percent all along the curve, should the Fed succeed in reigning in inflation without inflicting too much long-term damage on the economy, real returns on treasuries will turn positive. This will provide conservative investors with a viable alternative to equities and allow them to reduce portfolio risk.
o We liken the aggressive policy of the Fed to rain. The ground (economy) can absorb a couple inches of rain over an extended period of time. However, it cannot absorb it over an hour or two. We believe that after another 0.50% to 0.75% (50-75 bps), it would behoove the Fed to pay more than just lip service to their claim of data dependency or run the risk of cooling off economic growth more than what is needed to quell inflation.
o Unlike the past couple of bear market where investors witnessed a V-shaped bottom, this should be more of a “U,” or a process rather than an event. Not to worry, as we believe this bottom will usher in a new, longer-lasting, more durable bull market, one in which the Fed will not be the center of attraction. However, prior to that, we will need to see inflation ebb and the Fed pivot.
o The yield curve has continued to invert meaningfully. The curve, historically a predictor of an economic slowdown, measures the relationship between like bonds of different maturities. In fact, an inverted yield curve has predicted every recession since 1955. That said, it has also predicted recessions when one did not occur. This past week, the yields on the two- and five-year Treasury Notes were inverted or higher when compared to the ten-year U.S. Treasury Note at 4.41% and 3.99% versus 3.88%. Many market pundits will point to this as evidence of a looming recession. At this time, a technical recession brought about by the Fed raising interest rates is likely, the depths of which are most likely shallow as it will not have been caused by a collapse in the credit markets a la 2007—early 2009.
o Keep in mind that the stock and bond markets are anticipatory in nature, historically moving six to nine months ahead of the confirming data. It is precisely for this reason that investors hoping to “buy when things look better” never get the chance to do so. Unfortunately, by the time the economic data turns for the better, stock prices have already taken this into account. For example, during the pandemic, the stock market bottomed on March 23, 2020, just as the economy was shutting down. Three months later stocks had risen forty percent!
o A component to traditional, longer-lasting bear markets is the emotional strain it places upon the investor. Just as bull markets place pressure on investors sitting on the sidelines, bear markets exert the same force on those that have money in the market. Should the market remain choppy as we believe it will at least throughout the autumn, you can count on a steady drumbeat from talking heads questioning the validity of long-term investing. We have regularly noted that unlike recent pullbacks, the recovery from this one will most likely be more of a process rather than an event and recommend that our clients ignore the short-term and focus on your long-term objectives.
o The Fed has become too important in regulating the economy. Hopefully, when this is over, we can get to a more normalized economy with less overt Fed intervention. Recessions are necessary as they bring back into balance supply and demand. In addition, vis a vis creative destruction, recessions revitalize the economy, positioning it for a new era of growth.
o We continue to monitor the returns of the Vanguard Balanced Index Fund (VBAIX) to illustrate the extent of the selloff even in balanced accounts, including the bond market. VBAIX, somewhat of a proxy for balanced investors fell 16.87% during 2022, as in addition to the pullback in stocks, bonds, which comprise nearly 40% of the portfolio, have been under pressure. For example, the Vanguard Total Bond Market Index Fund (VBMFX) fell 13.26%. In fact, even the Vanguard 2020 (VTWNX), a mutual fund designed for “investors planning to retire or leave the workforce in or within a few years of 2020 (the target year)” fell 14.15%.