November 13, 2022



· Stocks and bonds rallied sharply as inflation at the retail level as measured by the Consumer Price Index (CPI) came in better than expected and as of today, Republicans winning a narrow majority in the House. However, the latter will not come without the risk of partisan infighting not unlike the current Senate, one in which Senator Joe Manchin of West Virginia wields an inordinate amount of political influence. Should this occur, arriving at a bipartisan consensus as it pertains to business could become more difficult.

Keep in mind that many fierce rallies come within bear markets so we wouldn’t get too excited yet. We will continue to focus on the long-term and add to bonds on weakness rather than strength. Of note this coming week will be the following:

o Inflation at the wholesale level for the month of October as measured by the Producer Price Index (PPI) will be released this coming Tuesday. Analysts are expected prices to rise by 0.50%. Investors will watch this closely to see if this number will help to continue the rally or present a headwind.

o Information Technology and Communication Services, two of the larger components to the S&P 500, but recent laggards, spiked this past week as Growth At A Reasonable Price (GARP) investors responded to inflation perhaps peaking.

o Bond yields plummeted on the better than expected CPI data with the yield on the 10-Year U.S. Treasury Note falling from 4.14% to 3.82% over the past week, a decline of 7.73%. Investors will be watching closely if the rally continues or yields climb a bit. We would consider the latter more likely. However, a measured rise in rates would most likely not be too much of a headwind for investors.

· For those that are considering selling at this point, according to data analytics firm YCharts, over the past seventy years, the S&P 500 has always been higher three years after it has fallen 25% from all-time highs. What many investors do not realize is that stocks bottom well ahead of the economy.

· 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.

· In regard to COVID policy, the Chinese government cut quarantine requirements for arrivals into the country from seven to five days. In addition, state media reported that China would no longer track people beyond those that had close contact with those infected. This easing of policy will hopefully help to bring back into balance the supply chain as well as increase economic demand within China.

· To those that are fortunate enough to have a Cash Balance Pension Plan and are nearing retirement, one must take into consideration the fact that, given the recent rise interest rates the lump-sum figure will decline substantially the next time it is recalculated. We would anticipate this number dropping 15% to 25%. However, the monthly income will not be affected.

· Welcome to the fourth quarter. Please note that for clients with non-qualified accounts, when beneficial, Fagan Associates will begin tax loss harvesting through realizing unrealized losses to include sales into cash, sales and waiting thirty days to avoid the wash-sale rule or swaps to similar but not exact securities (for example, FedEx to UPS). Given the rise in interest rates, when appropriate we will also take a similar course of action with fixed income.

· This week will be chock full with inflation as well as data related to the housing market. Of note will be on Tuesday, inflation at the wholesale level as measured by the Producer Price Index (PPI); on Wednesday, October Retail Sales along with September Business Inventories; on Thursday, October Housing Starts and the Weekly Report of Initial Claims for Unemployment Insurance; and on Friday, October Existing Homes Sales and the Index of Leading Economic Indicators (LEI).

· The earnings season rolls on and this week many retailers will be reporting. Of note are reports from Walmart (WMT), Home Depot (HD), Nvidia Corp (NVDA), TJX (TJX), Target Corp (TGT), Cisco Systems (CSCO), Lowe’s Companies (LOW), Siemens (SIEGY), Palo Alto Networks (PANW), Applied Materials (AMAT), Alibaba (BABA), and Ross Stores (RST).


o We are excited about the recent rise in the yield on fixed-income securities, especially U.S. Treasuries. With yields above three 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 this upcoming hike it would behoove the Fed to pay more than just lip service to their claim of data dependency or once again, 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 4.34% and 3.95% versus 3.82%. 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 has fallen 15.23% through the close of business Friday, 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) has fallen 14.40%. 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)” has dropped 13.57% year-to-date.

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