Posts filed under ‘economy’
Fight the Fed… Or Risk Your Account Going Dead!
Throughout history the prominent Wall Street mantra has been, “Don’t fight the Fed.” In essence, the credo instructs investors to sell stocks when the Federal Reserve increases its Federal Funds interest rate target and buy stocks when the Fed cuts its benchmark objective. The pace of interest rate increases since early 2022 has increased at the fastest rate in over four decades (see chart below). Unfortunately for those following this overly simplistic guidance of not opposing the Fed, investor portfolio balances have been harmed dramatically during 2023 by missing a large bull market run. Despite this year’s three interest rate hikes and an 87% probability of another increase next month by the Federal Reserve, the S&P 500 index surged +6.5% last month and has soared +15.9% for 2023, thus far.
Source: TradingEconomics.com
The technology-heavy NASDAQ index has skyrocketed even more by +31.7% this year, thanks in part to Apple Inc. (AAPL) surpassing the $3 trillion market value (+49.3%), thereby exceeding the total gross domestic product (GDP) of many large individual countries like France, Italy, Canada, Brazil, Russia, South Korea, Australia, Mexico, and Spain.
But Apple’s strong performance only explains part of the technology sector’s impact on stock returns this year. The lopsided influence of technology stocks can be seen through the performance of the largest seven mega-stocks in the S&P 500 (a.k.a., The Magnificent 7), which have averaged an eye-popping return of +89%. Artificial intelligence (AI) juggernaut, NVIDIA Corporation (NVDA), has led the way by almost tripling in value in the first six months of the year from $146 per share to $423.
GDP & Profits Growing
Economists and skeptical investors have been calling for a recession for well over a year now, however GDP growth and forecasts remain positive, unemployment remains near generationally low levels (below 4%), and corporate profit forecasts are beginning to creep higher (see chart below – red line). You can see, unlike previous recessions, profits have not collapsed and actually have reversed course upwards.
Source: Yardeni.com
These factors, coupled with the cooling of inflation pressures have contributed to this bull market in stocks that has soared +27% higher since the October 2022 bottom in the S&P 500. With this advance in stock prices, we have also seen green shoots sprout in the Initial Public Offering (IPO) market for new publicly traded companies (see chart below) like Mediterranean fast-casual restaurant chain CAVA Group, Inc. (CAVA), which has catapulted +86% in its opening month and thrift store company Savers Value Village, Inc. (SVV) which just recently climbed over +31% in its debut week.
Source: The Financial Times (FT)
Dumb Rules of Thumb
Wall Street is notorious for providing rules of thumb and shortcuts for the masses, but if investing was that easy, I’d be retired on my private island consuming copious amounts of coconut drinks with tiny umbrellas. Case in point, following the guideline to “sell in May and go away” would have cost you dearly last month with prices gushing higher. And although the “January Effect” has been documented by academics as a great period to buy stocks, this so-called phenomenon has failed in three of the last four years. Which brings us back to the Fed. It is true that “not fighting the Fed” worked well last year, given the shellacking stocks took after a steep string of Fed interest rate increases, but following the same strategy this year would have only resulted in a large bath of tears. As is the case with most things investing related, there are no cheap and easy rules to follow that will lead you to financial prosperity. The best recommendation I can provide when it comes to investing advice squawked by the media masses is that the true path to wealth creation often comes from ignoring or disobeying these unreliable and inconsistent rules of thumb. Therefore, contrary to popular belief, fighting the Fed may actually lead to knockout returns for investors.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 3, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in NVDA, AAPL, and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in CAVA, SVV, or anyother security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
AI Revolution and Debt Ceiling Resolution
On the surface, last month’s performance of the stock market as measured by the S&P 500 index (+0.3%) seemed encouraging, but rather pedestrian. Fears of sticky-high inflation, more potential Federal Reserve interest rate hikes, contagion uncertainty surrounding a mini-banking crisis, along with looming recession concerns led to a -3.5% monthly decline in the Dow Jones Industrial Average (-1,190 points). The good news is that inflation is declining (see chart below) and currently the Federal Reserve is expected to pause from increasing interest rates in June (the first time in more than a year).
Source: Calafia Beach Pundit
Overall stock market performance has been a mixed-bag at best. Adding to investor anxiety, if you haven’t been living off-the-grid in a cave, is the debt ceiling negotiations. Essentially, our government has maxed out its credit card spending limit, but Republicans and Democrats have agreed in principle on a resolution for an expanded credit line. More specifically, the House of Representatives just approved to raise the debt ceiling by a resounding margin of 314 – 117. If all goes well, after months of saber rattling and brinksmanship, the bill should be finalized by the Senate and signed by the President over the next two days.
Beyond the Washington bickering, and under the surface, an artificial intelligence (AI) revolution has been gaining momentum and contributed to the technology-heavy NASDAQ catapulting +5.8% for the month and +23.6% for 2023. At the center of this disruptive and transformational AI movement is NVIDIA Corp., a leading Silicon Valley chip manufacturer of computationally-intensive GPUs (graphics processing units), which are used in generative AI models such as OpenAI’s ChatGPT (see NVIDIA products below). Adoption and conversations surrounding NVIDIA’s AI technology have been spreading like wildfire across almost every American industry, resulting in NVIDIA’s stratospheric stock performance (+36% for the month, +159% for the year, +326% on a 3-year basis).
Source: NVIDIA Corp. – the computing engines behind the AI revolution.
Why Such the Fuss Over AI?
Some pundits are comparing AI proliferation to the Industrial Revolution – on par with productivity-enhancing advancements like the steam engine, electricity, personal computers, and the internet. The appetite for this new technology is ravenous because AI is transforming a large swath of industries with its ability to enhance employee efficiency. By leveraging machine learning algorithms and massive amounts of data, generative AI enables businesses to automate repetitive tasks, streamline processes, and unlock new levels of productivity. A study released by MIT researchers a few months ago showed that workers were 37% more efficient using ChatGPT.
If you have created an account and played around with ChatGPT at all you can quickly realize there are an endless number of potential applications and use-cases across virtually all industries and job functions. Already, application of generative AI systems is disrupting e-commerce, marketing, customer service, healthcare, robotics, computer vision, autonomous vehicles, and yes, even accounting. Believe it or not, ChatGPT recently passed the CPA exam! Maybe ChatGPT will do my taxes next year?
Other industries are quickly being disrupted too. Lawyers may feel increased pressure when contracts or briefs can be created with a click of the button. Schools and teachers are banning ChatGPT too in hopes of not creating lazy students who place cheating and plagiarism over critical thinking.
At one end of the spectrum, some doomsday-ers believe AI will become smarter than humans, replace everyone’s job, and AI robots will take over the world (see Elon Musk warns AI could cause “civilization destruction”). At the other end of the spectrum, others see AI as a transformational tool to help worker productivity. As generative AI continues to advance, its impact on employee efficiency will only grow, optimizing processes, driving innovation, and reshaping industries for a more productive future. Embracing this transformative technology will be critical for businesses seeking to thrive in the new digital age.
2023 Stock Performance Explained – Index Up but Most Stocks Down
Although 2022 was a rough year for the stock market (i.e., S&P 500 down -19%), stock prices have rebounded by +20% from the October 2022 lows, and +9% this year. This surge can be in large part attributed to the lopsided performance of the top 1% of stocks in the S&P 500 index (Apple Inc., Microsoft Corp., Amazon.com Inc., NVIDIA Corp., and Alphabet-Google), which combined account for almost 25% of the index’s total value. These top 5 consumer and enterprise technology companies have appreciated on average by an astounding +60% in the first five months of the year and represent a whopping $9 trillion in value. It gets a little technical, but it’s worth noting these larger companies have a disproportionate impact on the calculation of the return percentages, and vice versa for the smaller companies. To put these numbers in context, Apple’s $2.8 trillion company value is greater than the Gross Domestic Product (GDP) of many entire countries, including Italy, Canada, Australia, South Korea, Brazil, and Russia.
On the other hand, if we contrast the other 99% of the S&P 500 index (495 companies), these stocks are down -1% each on average for 2023 (vs +60% for the top 5 mega-stocks). If you look at the performance summary below, you can see that basically every other segment of the stock market outside of technology (e.g., small-cap, value, mid-cap, industrial) is down for the year.
2023 Year-To-Date Performance (%)
S&P 500: +8.9%
S&P 500 (Equal-Weight): -1.2%
S&P Small-Cap Index: -2.3%
Russell 1000 Value Index: -2.0%
S&P Mid-Cap Index: -0.7%
Dow Jones Industrial: -0.7%
While most stocks have dramatically underperformed technology stocks this year, this phenomenon can be explained in a few ways. First of all, smaller companies are more cyclically sensitive to an economic slowdown, and do not have the ability to cut costs to the same extent as the behemoth companies. The majority of stocks have factored in a slowdown (or mild recession) and this is why valuations for small-cap and mid-cap stocks are near multi-decade lows (12.8x and 13.0x, respectively) – see chart below.
Source: Yardeni.com
The stock market pessimists have been calling for a recession for going on two years now. Not only has the recession date continually gotten delayed, but the severity has also been reduced as corporate profits remain remarkably resilient in the face of numerous economic headwinds. Regardless, investors can stand on firmer ground now knowing we are upon the cusp of an AI revolution and near the finish line of a debt ceiling resolution.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in NVDA, AAPL, MSFT, GOOGL, AMZN and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Motel 6 or Four Seasons? Preparing, Not Panicking, for Retirement
Stock prices go up more often than down, and that was the case again last month. The S&P 500, Dow Jones Industrial Average, and the NASDAQ were all up in April. For the year, the S&P has gained +8.6%, Dow +2.9%, and NASDAQ +16.8%. What’s more, these increases are built upon the appreciation experienced in the fourth quarter of last year – the S&P 500 index has rebounded more than +19% since the last lows seen in the middle of last October.
Even when the unemployment rate currently stands at 3.5%, and GDP continues to grow for the third consecutive quarter, there is never a shortage of concerns (see also A Series of Unfortunate Events) as evidenced by worrying questions like these:
- Is the Federal Reserve going to increase interest rates again?
- Has inflation peaked?
- Are we going into a recession?
- Is Silicon Valley Bank and First Republic Bank the beginning or the end of bank failures?
- Will Vladimir Putin use nuclear weapons in Ukraine?
- What is going to happen with the Debt Ceiling deadline and will the U.S. default on its debt?
- How will elections affect the economy?
- Will AI (artificial intelligence) take all our jobs?
Hope is Not a Strategy
We have lived through an endless number of scary headlines in some shape or fashion throughout our lifetimes. These are all interesting and important questions, but preparation for retirement is much more important than panicking over issues you have no control over. For many investors, however, the more important questions to ask and answer relate to your retirement strategy. The answers to your questions should not contain the word hope – hope is not a strategy. Just guessing and waiting out of fear is unlikely to produce optimal results.
Many Americans spend more time planning a vacation than they do preparing for retirement or planning their finances. Rather than constantly scrolling through headlines on your mobile phone news app, here are some areas of focus and questions you should be asking yourself:
· Investment Strategy: What type of investment strategy should you be utilizing to reach your retirement goals? A passive investment strategy with low-cost index funds and ETFs (Exchange Traded Funds)? Or an active investment strategy with individual stocks, bonds, and mutual funds?
· Diversification: How diversified are your investments? Are you overly concentrated in one asset class, sector, or individual security? If you are over-tilted on one side of your financial boat, it could tip over.
· Risk Tolerance: What is your asset allocation? If you are close to retirement, and you have too much exposure to equities, a retrenchment in the stock market could delay your retirement plans by years. This concept highlights the importance of rebalancing your portfolio as you get closer to retirement.
· Fees: What are you paying in advisor fees and/or product fees? Fees are like a leaky faucet. You may not notice a leak over a day or week, but over a period of a month or longer, you are likely to receive huge water bills. Over the long-run, even a small pin-hole leak can cause extreme water damage to floors, ceilings, and walls just like fees could delay retirement or dramatically reduce your nest egg.
· Tax Planning: Are you maximizing your tax-deferred investment accounts? Whether you are contributing the limit to your IRA (Individual Retirement Account), 401(k) retirement plan at work, or pension (for larger business owner contributions), these are tremendous tax-deferral savings vehicles. By squirreling away savings during your prime earnings years, your investments can enjoy the snowballing effect of compounding over the long-term.
· Retirement Timing: When do you plan to retire? Do you have enough money to retire, and what type of liquidity needs will you need during retirement? Figuring out the timing of Social Security can be another variable that may factor into your retirement timing decision (see also Can You Retire? Getting to Your Number).
· DIY or Hire Advisor: When it comes to managing your investments, do you plan on doing it yourself (DIY) or hiring a financial advisor? Many people are not adequately equipped to manage their own investments, however identifying a proper financial advisor still requires significant legwork and research as well. Check out a recent webinar I produced with key questions to ask when looking for a financial advisor (Click here: Questions to Ask When Looking for a Financial Advisor).
In summary, there are a lot of frightening news headlines, but you will be better off focusing on those things you can control. The harsh reality is Americans are not saving sufficiently for retirement. It is true, you can survive off a smaller nest egg, if you plan to subsist off cat food and live in a tent, but most Americans and retirees have become accustomed to a higher standard of living. Also worth noting, we humans are living longer. Thanks to the miracles of modern medicine, lifespans are expanding, with the pandemic caveat. But inflation remains stubbornly high, and you do not want to outlive your savings. Drained savings during retirement may just land you a job as a greeter at Wal-Mart in your 80s.
Although the summer travel season is fast approaching, if you feel you are not satisfactorily prepared for retirement, this is a perfect time to invest attention to this important area. Do yourself a favor and devote at least as much time to answering the key retirement questions above as you do in planning your summer vacation. You may be partying like a rock star now, but if you have not been properly saving for retirement, I will ask you the following question: During retirement, do you want to vacation at the Motel 6 off a local freeway or would you prefer vacationing at a Four Seasons somewhere in Europe? I know what my answer is.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 1, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Air Bags Deployed to Cushion Bank Crashes
In recent years, COVID and a ZIRP (Zero Interest Rate Policy) caused out-of-control inflation to swerve the economy in the wrong direction. However, the Federal Reserve and its Chairman, Jerome Powell, slammed on the brakes last year by instituting the most aggressive interest rate hiking policy in over four decades.
At the beginning of last year, interest rates (Federal Funds Rate target) stood at 0% (at the low end of the target), and today the benchmark interest rate stands at 5.0% (at the upper-end of the target) – see chart below.
Source: Trading Economics
Unfortunately, this unparalleled spike in interest rates contributed to the 2nd and 3rd largest bank failures in American history, both occurring in March. The good news is the Federal Reserve and banking regulators (the Treasury and FDIC – Federal Deposit Insurance Corporation) deployed some safety airbags last month. Most notably, the Fed, FDIC, and Treasury jointly announced the guarantee of all deposits at SVB, shortly after the bank failure. Moreover, the Fed and Treasury also revealed a broader emergency-lending program to make more funds available for a large swath of banks to meet withdrawal demands, and ultimately prevent additional runs on other banks.
Investors were generally relieved by the government’s response, and the financial markets reacted accordingly. The S&P 500 rose +3.5% last month, and the technology-heavy NASDAQ index catapulted even more (+6.7%). But not everyone escaped unscathed. The KBW Bank Index got pummeled by -25.2%, which also injured the small-cap and mid-cap stock indexes, which declined -5.6% (IJR) and -3.5% (IJH), respectively.
Nevertheless, as mentioned earlier, slamming on the economic brakes too hard can lead to unintended consequences, for example, a bank failure or two. Well, that’s exactly what happened in the case of Silicon Valley Bank (SVB), the 2nd largest bank failure in history ($209 billion in assets), and cryptocurrency-heavy Signature Bank, the 3rd largest banking collapse in history – $110 billion in assets (see below).
Source: The Wall Street Journal
How did this Silicon Valley Bank failure happen? In short, SVB suffered a bank run, meaning bank customers pulled out money faster than the bank could meet withdrawal requests. Why did this happen? For starters, SVB had a concentrated customer base of financially frail technology start-ups. With a weak stock market last year, many of the start-ups were bleeding cash (i.e., shrinking their bank deposits) and were unable to raise additional funds from investors.
As bank customers began to lose confidence in the liquidity of SVB, depositors began to accelerate withdrawals. SVB executives added gasoline to the fire by making risky investments long-term dated government bonds. Essentially, SVB was making speculative bets on the direction of future interest rates and suffered dramatic losses when the Federal Reserve hiked interest rates last year at an unprecedented rate. This unexpected outcome meant SVB had to sell many of its government bond investments at steep losses in order to meet customer withdrawal requests.
It wasn’t only the large size of this bank failure that made it notable, but it was also the speed of its demise. It was only three and a half weeks ago that SVB announced a $1.8 billion loss on their risky investment portfolio and the subsequent necessity to raise $2.3 billion to fill the hole of withdrawals and losses. The capital raise announcement only heightened depositor and investor anxiety, which led to accelerated bank withdrawals. Within a mere 24-hour period, SVB depositors attempted to withdraw a whopping $42 billion.
Other banks, such as First Republic Bank (FRB), and a European investment bank, Credit Suisse Group (CS), also collapsed on the bank crashing fears potentially rippling through other financial institutions around the globe. Fortunately, a consortium of 11 banks provided a lifeline to First Republic with a $30 billion loan. And Credit Suisse was effectively bailed out by the Swiss central bank when Credit Suisse borrowed $53 billion to bolster its liquidity.
While stockholders and bondholders lost billions of dollars in this mini-banking crisis, financial vultures swirled around the remains of the banking sector. More specifically, First Citizens BancShares (FCNA) acquired the majority of Silicon Valley Bank’s assets with the assistance of the FDIC, and UBS Group (UBS) acquired Credit Suisse for more than $3 billion, thereby providing some stability to the banking sector during a volatile period.
Many pundits have been predicting the U.S. economy to crash into a recession as a result of the aggressive, interest rate tightening policy of the Federal Reserve. So far, Mark Twain would probably agree that the death of the U.S. economy has been greatly exaggerated. Currently, the first quarter measurement of economic activity, GDP (Gross Domestic Product), is estimated to measure approximately +2.0% after closing 2022’s fourth quarter at +2.6% (see chart below). As you probably know, a definition of a recession is two consecutive quarters of negative GDP growth.
Source: Trading Economics
Regardless of the economic outcome, investors are now predicting the Federal Reserve to be at the end or near the end of its interest rate hiking cycle. Presently, there is roughly a 50/50 chance of one last 0.25% interest rate increase in May (see chart below), and then investors expect at least one interest rate cut by year-end.
Source: CME Group
Last year was a painful year for most investors, but stocks as measured by the S&P 500 have bounced approximately +18% since the October 2022 lows. Market participants are still worried about a possible recession crashing the economy later this year, but hopefully last year’s stock market collision and subsequent banking airbag protections put in place will protect against any further financial pain.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Apr. 3, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in SIVB, FCNA, UBS, FRB, CS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
From Hard Landing to Soft Landing to No Landing?
I haven’t received my pilot’s license yet, but in trying to figure out whether the economy is heading for a hard landing, soft landing, or no landing, I’m planning to enroll in flight school soon! With the Federal Reserve approaching the tail end of an aggressive interest rate hiking cycle, investors have been bracing for a hard landing. However, with near record-low unemployment (3.4%) and multi-trillion dollars in government stimulus still working its way through the system, others see an economic soft landing. More recently, economic data has been flying in at an accelerating pace, which could mean the economy will stay in the air and have no landing.
For those waiting for an imminent recession, it looks like there could be a delay. In other words, bearish pessimists may be waiting at the gate longer than expected. As you can see in the chart below, economists at the Atlanta Federal Reserve are currently forecasting economic growth (GDP – Gross Domestic Product) to increase to a respectable +2.8% rate for the first quarter.
How have investors been interpreting this confusing array of landing scenarios? The stock market has stabilized and risen since last October (S&P +13.7%) but has also hit a temporary air pocket last month (-2.6%). Similarly, the Dow Jones Industrial Average has rebounded +13.9% since October, but pulled back further in February (-4.2%). As mentioned earlier, investors are having difficulty reading all the economic dials, instruments, and controls in the cockpit because there is no consensus on interest rates, inflation, economic growth, corporate earnings growth, and employment.
At the one end of the spectrum, you have a consumer who remains employed and willing to spend his/her savings accumulated during the pandemic. Case in point, air travel has hit pre-pandemic levels of 2019, despite business travelers staying at home conducting business on Zoom (see red line on chart below).
At the other end of the spectrum, we are witnessing the crippling effects that 7% mortgage rates can have on the $4 trillion real estate industry. As you can see from the chart below, sales of existing homes have plummeted at the fastest rate since the beginning of the 2008 Financial Crisis.
With all of that said, there is a consensus building that inflation is steadily coming down. Even the very skeptical and hawkish Federal Reserve Chairman, Jerome Powell, acknowledged that the “disinflationary process has begun.” We can see that in this inflation expectation chart below (green line), which measures the average anticipated inflation over the next five years by comparing the difference in yields between the five-year Treasury Notes and the five-year TIPS (Treasury Inflation Protection Securities).
Although, currently, there are many financial crosswinds swirling, the good news is that in the near-term, the economy has been maintaining its elevation and there is no imminent sign of a hard landing. We certainly could face the potential of turbulence and changing weather conditions, but that is always the case when you invest in the financial markets. If, however, inflation continues to move in the same direction, and growth continues to surprise on the upside, there may be no landing at all. Under this scenario of maintaining a comfortable altitude, I guess I can put my pilot training on hold.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Mar. 1, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Recession Storm Fears Reign Supreme as Stocks Gain Steam
Commentators continue to shout the doom-and-gloom forecasts of a hard landing recession, but after an economic hurricane in 2022 there are some signs the financial clouds have begun to lift this year. The stock market has reflected this positive fundamental shift during January, as the S&P 500 catapulted +6.2%, NASDAQ +10.8%, and the Dow Jones Industrial Average +2.8%.
Last year, a major influencing cause to the -19% downdraft in the stock market (S&P 500) was due to the highest inflation readings experienced in four decades, compounded by a Federal Reserve hell-bent on slamming on the interest rate brakes. A big contributing factor to the surge in inflation was the spike in consumer spending fueled by trillions in government stimulus, coupled with widespread shortages in goods triggered by supply chain disruptions.
Fortunately, the headwinds of inflation now appear to be abating. Recently released inflation figures showed core inflation dropping from a peak of 9.1% last year to 3.5% in the fourth quarter (see chart below). Although the Fed will likely raise its interest rate target by 0.25% up to 4.75% this week, the downward reversal in inflation has raised the probabilities of the Federal Reserve “pausing” or “pivoting” on the direction of previous rate hikes. The odds of a halt or cut in rates will likely only increase if the descending trajectory of inflation persists and other upcoming economic data weaken further.
No Signs of Recession…Yet. Investors Waiting for Another Flood
While the calls for a hard economic landing remain, healthy GDP growth (+2.9% in Q4), generationally low unemployment (3.5%), and relatively stable earnings (see chart below) all point to a stable economy with the ability to navigate a soft landing. China’s new reopening of the economy and Europe’s seeming ability of dodging a recession provide additional evidence for a soft landing scenario.
As you can see further from the 25-year earnings chart above, the drop in S&P 500 earnings in recent months has been fairly modest compared to previous downturns, and the forecast for 2023 earnings is currently estimating a modest gain on a year-over-year basis. Over the last 25 years, we have arguably experienced three 100-year floods (2000 Tech Bubble, 2008 Financial Crisis, and 2020 COVID pandemic), so investors have been bracing for another enormous financial hurricane.
Although the bursting of the 2000 Tech Bubble had an outsized impact on the technology sector, the effect on the overall economy was more muted, as you can observe from the shallow decline in the earnings. As the earnings show, during the Financial Crisis (2008) and COVID (2020), the crash in earnings was much more severe. Thus far in 2023, there has been no earnings plummet or sign of recession, and if financial conditions continue to soften, there is no reason we couldn’t undergo a more vanilla, garden-variety recession like we did in 1990 and 2000.
Stairs & Elevators
While the future always remains unclear, nobody knows for certain whether a recession will occur this year or if the 2022 bear market will endure into 2023. However, as you can notice below, history over the last 70 years shows the duration of bull markets (average of about 6 years) are much longer than bear markets (approximately 1 year). I like to compare bull markets to walking up stairs in a tall building, and bear markets to going down an elevator. The main difference is that the stock market elevator generally never goes to the bottom floor and the stairs keep growing to record heights over the long-run. Since World War II, Americans have experienced 13 economic recessions (see also Recession or Mental Depression?). Not only are investors batting 1,000% in successfully surviving these recessions, they have thrived. From 1956 until the present, the S&P 500 has vaulted approximately 80-fold.
Presently, economic skies might not all be clear, blue, and sunny, but the fact that inflation is dropping, our economy is still growing, labor markets remain healthy, China has reopened for business, and Europe hasn’t cratered all leave room for optimism. It may not be time to bust out the sunscreen quite yet, but the dark economic clouds of 2022 appear to be lifting slowly.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Feb. 1, 2023). Subscribe Here to view all February articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
New Year, New Clean Slate
Stock and bond market returns in 2022 were disappointing, but we now get to start 2023 with a clean slate. Before we turned the page on another annual chapter, Santa Claus chose to finish last year by placing a lump of coal in investor stockings, as evidenced by the S&P 500 index decline of -5.9% during December.
Good News & Bad News
There is some good news and bad news as it relates to this year’s underwhelming stock market results (-19.4%). The bad news is last year turned out to be the 4th worst year in the stock market since World War II (1945) and also marked the worst year since 2008. Here’s a summary of the S&P 500’s worst years over the last eight decades:
2008: -38.5%
1974: -29.7%
2002: -23.4%
2022: -19.4%
Source: CNBC (Bob Pisani)
The good news is that the stock market is up 81% of the time in subsequent years following down years. The average increase in bounce-back years is +14%. In another study of down years, the analysis showed that after the stock market has fallen -20% or more, stock prices were higher on average by +15% one year later, +26% two years later, and +29% three years later. Nothing is guaranteed in life, but as Mark Twain famously stated, “History does not repeat itself, but it often rhymes.”
2022: The Year of No Shock Absorbers (Worst Bond Market Ever)
The stock market receives most of the media glory and reporting, however the bond market is the Rodney Dangerfield of asset classes, it “gets no respect.” Typically, during weak stock markets (i.e., “bear markets”), the bond or fixed income investments in a diversified portfolio act as shock absorbers to cushion the blow of volatile stock prices. More specifically, in a typical bear market, the economy generally slows down causing demand to decelerate, and interest rates to decline, which causes the values of bonds to increase. Therefore, as stock prices decline, the gains from bonds in your portfolio usually help offset stock losses. Unfortunately, this scenario didn’t happen in 2022, but rather investors experienced a double negative whammy. Not only did stocks experience one of its worst years in decades, the bond market also suffered what many pundits are describing as the “Worst Bond Market Ever” – see chart below.
Why in particular did bonds perform so poorly this year, when they commonly outperform in slow or recessionary economic conditions? For starters, interest rates spent most of 2022 increasing at the fastest pace in more than four decades (see chart below). An unanticipated rise in inflation was the main culprit, which was caused by spiking energy prices from Russia’s invasion of Ukraine; COVID-related supply chain disruptions; unprecedented fiscal stimulus (trillions of dollars in infrastructure spending and incentives); record monetary stimulus (QE – Quantitative Easing); and extended years of ZIRP (Zero Interest Rate Policy). For these reasons, and others, bonds collapsed in sympathy with deteriorating stock prices.
Room for Optimism in 2023
Last year was challenging, however, not all is lost. The Federal Reserve, inflation, interest rates, Ukraine, and cryptocurrency volatility (e.g., Bitcoin down -64% in 2022) dominated headlines this year, but many of these headwinds could abate or reverse in 2023. For example, there are numerous indicators pointing to peaking and/or declining inflation, which, if true, could create a tailwind for investors this year. Bolstering this argument are the current weakening trends we are witnessing in the housing market, which should ripple through the economy to cool inflation (see chart below).
And if it’s not declining home prices, lower energy prices have also filtered through the global economy to lower transportation and shipping costs (e.g., freight rates from China to West Coast are down -90%). What’s more, a stronger dollar has contributed to declining commodity prices as well.
Although inflation still has a long way to go before reaching the Federal Reserve’s 2% target rate, broad inflation measures, such as the GDP Deflator, are showing a significant decrease in inflation (see chart below). By analyzing the various disinflationary tea leave markers, we can gain some confidence regarding future interest rates. Observing the fastest rate hike cycle by the Fed in decades informs us that we are likely closer to an end of rate hikes (i.e., pause or cut), rather than the beginning. If correct, tamer inflation means 2023 could prove to be a better environment for both stock and bond investors.
In summary, last year was painful across the board, but investors are starting this year with a clean slate and signs are pointing to a potential reversal in inflation and interest rate headwinds. With the change of the calendar, a messy 2022 could turn into a spick-and-span 2023.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Jan. 3, 2023). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Feasting on a Full Plate of Concerns
Investors and Thanksgiving feasters alike had a full plate to consume last month – and there has been a lot to digest. The buffet of issues includes the Federal Reserve’s fastest rate hike cycle in decades (see chart below), spiking inflation, a slowing economy, an unresolved war between Russia and Ukraine, declining home prices, and a volatile stock market to boot.
Source: Visual Capitalist (*Note: Current year line estimated to reach midpoint of 4.00% – 4.50% this month)
Let’s not forget the bankruptcy of Bahamas-based cryptocurrency exchange (FTX), and the downfall of its 30-year-old, billionaire founder Sam Bankman-Fried. Unfortunately for Fried, he has essentially lost his whole $16 billion fortune, and after his recent resignation he will be spending the subsequent years in court fighting charges of fraud and misappropriated funds.
Nevertheless, despite the laundry list of concerns swirling around, this year’s Thanksgiving feast was quite delicious with the S&P 500 surging +5.4% last month. It’s hard to believe for many, but after a strong performance in October and November, stock market losses during 2022 have registered in at a mere -4.8%, as measured by the Dow Jones Industrial Average. This reasonable drawdown in stock prices is not too shabby, considering the meteoric gains of 2019-2020-2021 (+90% cumulatively), as I have highlighted on numerous occasions (see my July Newsletter, Winning Teams Occasionally Lose).
Part of the credit for the current market surge can be attributed to the dessert Federal Reserve Chairman, Jerome Powell, just served up to investors. In a statement yesterday, Powell suggested interest rate hikes would likely slow from an aggressive 0.75% pace to a slower 0.50% rate after an unprecedented string of increases. Bets are changing daily, but after starting the year at a 0.0% Federal Funds target rate, the Fed is likely to exit the year at 4.5%. Whether this will be the peak rate (or near the peak rate) will depend on the direction of economic data, especially as it relates to inflation and employment. We get a fresh helping of unemployment figures this Friday, which could provide clues regarding the direction of future Fed policy.
While the Federal Reserve is sucking a lot of wind out of the present news outlet airwaves, there are other factors contributing to the latest stock market upswing. For starters, the broadest measure of U.S. economic activity, GDP (Gross Domestic Product), was just revised higher for this year’s third quarter from +2.6% to +2.9%. But wait, there’s more! The latest growth forecast for the fourth quarter of 2022 is expected to accelerate to +4.3%, which was also revised higher, recently. Ever since the Fed started hiking interest rates this March, all we have been hearing from the so-called pundits has been the doom-and-gloom discussion of a definite, looming recession knocking at our door. I freely acknowledge there can be a negative economic lag effect from the significant rise in interest rates this year, however, the bark could prove much worse than the bite as everyone waits for the R-word, which may or may not arrive at all.
Another positive development supporting climbing stock prices relates to what I have been writing about for quite some time – peaking and declining inflation numbers. Scott Grannis at Calafia Beach Pundit has done a great job of explaining how monetary policy (M2 – see chart below) and fiscal stimulus, during the peak-COVID era (combined with supply chain disruptions), have fed the explosion in monetary supply growth, which directly relates to the spiking inflation we all have experienced. Thankfully, the shift from a looser COVID monetary policy to a tighter monetary policy (i.e., Quantitative Tightening and rate hikes), in conjunction with less government spending (i.e., improving government deficit), has led to a dramatic drop in money supply growth (actually negative growth), hence creating a better outlook for inflation.
Source: Calafia Beach Pundit
Inflation Picture Improving
You can clearly see the improving inflation picture breaking through in the Producer Price Index (PPI – see chart below), a measure of wholesale inflation that has come down dramatically in recent months.
Source: Calafia Beach Pundit
Thanksgiving often involves a lot of gorging, but for investors, digesting a full plate of concerns has caused some indigestion in the stock market this year. The good news is inflation appears to be peaking, the economy and the consumer remain on solid footing, despite the Federal Reserve’s rate-hiking rampage, and the unemployment rate remains near generationally low levels. If a steep recession doesn’t come to fruition, as many expect, you may be able to toast for a better 2023 with champagne rather than Pepto Bismol.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Bad Weather Coming: Hurricane or Drizzle?
It was a stormy month in the stock market, but the sun eventually came out and the Dow Jones Industrial Average rallied more than 2,300+ points before eking out a small gain (up +0.04%) and the S&P 500 index also posted an incremental increase (+0.005%). But there are clouds on the horizon. Although the economy is currently very strong (i.e., record corporate profits and a generationally low unemployment rate of 3.6% – see chart below), some forecasters are predicting a recession during 2023 as a result of the Federal Reserve pumping the brakes on the economy by increasing interest rates, in addition to elevated inflation, supply chain disruptions, COVID lockdowns in China, and a war between Russia and Ukraine.
UNEMPLOYMENT RATE (1997 – 2022)
But like weather forecasters, economists are perpetually unreliable. While some doomsday-er economists are expecting a deeply destructive hurricane (deep recession), others are only seeing a mild drizzle (soft landing) developing. The truth is, nobody knows for certain at this point, but what we do know is that the correction in stock prices this year (-13% now and -20% two weeks ago) has already significantly discounted (factored in) a mild recession. In other words, even if a mild recession were to occur in the coming months or quarters, there may be very little reaction or negative consequences for investors. Similarly, if inflation begins to be peaking as it appears to be doing (see chart below), and the Fed can orchestrate a soft landing (i.e., raise interest rates and reduce balance sheet debt without crippling the economy), then substantial rewards could accrue to stock market investors. On the flip side, if the economy were to go into a deep recession, history would suggest this stormy forecast might result in another -10% to -15% of chilliness.
INFLATION RATE (%)
Due to trillions of dollars in increased stimulus spending and Federal Reserve Quantitative Easing (bond buying), we experienced an explosion in the government deficit and surge in money supply growth (i.e., the root cause for swelling inflation). Arguably, some or all of these accommodations were useful in surviving through the worst parts of the COVID pandemic, however, we are paying the price now in sky-high food costs, explosive gasoline prices, and expanding credit card bills. The good news is the deficit is plummeting (see chart below) due to a reduction in spending (due in part to no Build Back Better infrastructure spending legislation) and soaring income tax receipts from a strengthening economy and capital gains in the stock market.
MONEY SUPPLY GROWTH% (M2) VS. GOVERNMENT DEFICIT
For many investors, getting used to large multi-year gains has been very comfortable, but interpreting downward gyrations in the stock market can be very confusing and counterintuitive. In short, attempting to decipher the reasons behind the short-term zigs and zags of the market is a fool’s errand. Not many people predicted a +48% gain in the stock market during a global pandemic (2020-2021), just like not many people predicted a short-lived -20% reduction in the stock market during 2022 as we witnessed record-high corporate profits and unemployment rates hovering near generational lows (3.6%).
Stock market veterans understand that stock prices can go down when current economic news is sunny but future expectations are too high. Experienced investors also understand stock prices can go up when the current economic news may be getting too cloudy but future expectations are too low.
Apparently, the world’s greatest investor of all-time thinks that all this gloomy recession talk is creating lots of stock market bargains, which explains why Buffett has invested $51 billion of his cash at Berkshire Hathaway as the stock market has gotten a lot more inexpensive this year. So, while the economy will likely face a number of headwinds going into 2023, it doesn’t mean a hurricane is coming and you need to hide in a bunker. If you pull out your umbrella and rain gear, just like smart investors do during all previous challenging economic cycles, the drizzle from the storm clouds will eventually pass and blue skies shall reappear.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2022). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in BRK.B/A or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
No Pain, No Gain
Long-term success is rarely achieved without some suffering. In other words, you are unlikely to enjoy gains without some pain. Last month was certainly painful for stock market investors. On the heels of concerns over the Russia-Ukraine war, Federal Reserve interest rate hikes, China-COVID lockdowns, inflation/supply chain disruptions, and a potential U.S. recession, the S&P 500 index declined -8.8% for the month, while the technology-heavy NASDAQ index fell -13.3%, and the Dow Jones Industrial Average weakened by -4.9%.
For long-term stock investors who have reaped the massive +520% rewards from the March 2009 lows, they understand this gargantuan climb was not earned without some rocky times along the way. As you can see from the chart below, there have been no shortage of issues and events to worry about over the last 15 years (2007 – 2022):
- 2008-2009: Financial Crisis
- 2010: Flash Crash (electronic trading collapse)
- 2011: Debt Ceiling – Eurozone Collapse
- 2012: Greek Debt Crisis – Arab Spring (anti-government protests)
- 2012: Presidential Elections – Sequestration (automatic spending cuts) – Cyprus Financial Crisis
- 2013: Federal Reserve Taper Tantrum (threat of removing monetary policy accommodation)
- 2014: Ebola Virus Outbreak
- 2015: China Economic Slowdown
- 2018: China Trade Tariffs – Federal Reserve Interest Rate Hikes
- 2020: COVID-19 Global Pandemic – Recession
- 2022: Russia-Ukraine War -Federal Reserve Interest Rate Hikes – Inflation/Supply Chain – Slowing China
So, that’s the bad news. The good news is that after the stock market eventually bottomed (S&P 500) around each of these events, one year later, stock prices rebounded on average approximately +32%, and prices moved even higher in the following two years. Suffice it to say, in most instances, patiently waiting and taking advantage of heightened volatility usually results in handsome rewards for investors over the long-run. As Albert Einstein stated, “In the middle of every difficulty lies an opportunity.”
There have been plenty of false recession scares in the past, and this could prove to be the case again. Although I have noted some of the key headwinds the economy faces above, it is worth noting that current corporate profits remain at/near all-time record highs (see chart below) and the 3.6% unemployment rate effectively stands at/near generationally record low levels. What’s more, housing remains strong, and consumer balance sheets remain very healthy as a result of elevated savings rates that occurred during COVID.
The S&P 500 is already off -14% from its highest levels experienced at the beginning of the year. Although there are no clear signs of a looming recession presently, if history is a guide, much of the pessimism is likely already discounted in current stock prices. Stated differently, even if the economy were to suffer a garden-variety recession, we may already be closer to a bottom than the potential gains from a subsequent rebound. The 15-year chart shows that stock prices have become significantly more attractively valued in recent months.
Panic is rarely a profitable strategy, so now is probably not the best time to knee-jerk react to the price declines. Peter Lynch, arguably one of the greatest all-time investors (see Inside the Brain of an Investing Genius), said it best when he stated, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Market corrections are never comfortable, but successful, long-term investing comes with a price…no pain, no gain!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 2, 2022). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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