The great debate rages on the news networks over whether the Fed will pull off a soft landing or we are heading towards a recession. It seems the talking heads all have valid points and can make a decent case for why their opinions will ultimately prove correct, but I can assure you that nobody knows the answer for sure.
What I do know is that the data continues to surprise all but the most optimistic on Wall Street and that historically bodes well for investors.
I plan to use this new format for my newsletters going forward as I’ve been asked to share more details of our research and work by some readers and received a lot of positive feedback about my last article which included major market charts. For those who just want the “skinny”, I’ll continue to provide our current strategy and summary at the end of each newsletter.
Key Market Data
Macro: “Improving” – Q4 GDP was better than anticipated at 2.9%, jobless claims are low and remain resilient despite the Federal Reserve’s quantitative tightening and recent corporate layoff announcements, and inflation metrics continue trending lower. Is the Fed pulling off a soft landing? There’s a lot of chatter about a mild recession in the near future but the data keeps beating the pundits estimates and China is finally reopening!
Monetary: “Restrictive” The Fed Funds rate has climbed from 0.00% at a historic clip to the current level of 4.25 – 4.50% with more rate hikes expected as the Fed seeks to bring down inflation. The futures market does expect this pace to slow and eventually end in late 2023 somewhere just above/below 5.00%. Expectations as measured by longer term bonds show the market believes the fed will stop raising rates and begin to “Pivot” towards a more accommodative stance sooner than the Feds own projections. Who will be right? The market usually wins these debates…
Fundamentals: “Neutral” – With 2023 earnings estimates of $225 for the S&P 500, markets are trading at 18x earnings. This valuation implies mild optimism and leaves some room to the downside should future data begin to soften yet leaves some room for multiple expansion on the upside. Valuations can be tricky as sentiment changes. More positive earnings surprises have been coming in lately, but that season is still early.
Technical: “Improving- Breaking Resistance/Downtrend Lines” – The S&P 500 has recently crossed above the downtrend line that’s been in place since the beginning of 2022. Furthermore, it has broken above both it’s 50 and 200 day moving averages (a very positive signal) at a time when the 50 day moving average is near crossing the 200 day moving average (a condition Wall Street calls the Golden Cross as it implies positive long term momentum). Can momentum and an improving Macro environment carry us through the next resistance level around 4100?
Sector Rotation: “Shifting”- Signs of a move to “Risk On” are prevailing. Our proprietary “Essentials” (Defensive) sector appears to be losing ground relative to our Non-Essentials Index and our Pro Technology & Cyclicals Indices. Further evidence of an improving risk appetite is being witnesses by the fact that the high beta stocks are significantly outperforming the low volatility complex since the turn of the calendar year while smaller companies are gaining more traction than the blue chips recently. It appears a rotation into the more cyclically sensitive areas of the market is underway.
Market Internals: “Improving”- Measures of market Breadth (or participation) are improving with both NYSE and NASDQ advance decline lines and their associated volume metrics making a series of higher highs and higher lows- Read: Positive trend! New 52-week highs have finally begun to outpace new 52 week lows which creates the necessary building blocks for a bull market to ensue. Bullish “Breadth Thrusts” are being witnessed following critical support levels holding for the first time in a while. It appears that the Market Internals are confirming the positive price action!
Sentiment: “Neutral” According to Investors Intelligence Sentiment Survey Bullish advisors stand at 45.1% as of their January 25 release. The lack of bullish advisors suggests there is still ample cash on the sidelines waiting to be put back to work while the NAAIM Exposure index shows an increasing percentage of professionally managed funds going into stocks but nowhere near historically high levels that would signify “irrational exuberance”- I love that phrase from our former Federal Reserve Board Chairman, Alan Greenspan.
Seasonal: “Bullish” – We are now in the middle of the Best 6 Months of the year, We got our Santa Clause Rally and a solid start to January which historically bodes well for the rest of the year. February can be a little soft historically but has proven to be a great dip buying opportunity in past pre-election years which have tended to be quite strong (read my last article for more on that).
Charts of interest:
- Since peaking in January, a downtrend line has formed on the S&P 500 price chart and has acted like a barrier. Recent price action has finally breeched this psychological barrier and is attempting to make a series of higher highs and higher lows (HH/HL)- Is a positive trend beginning?
- No doubt about it, interest rates have been trending up over the longer term.
- Intermediate term does show lower lows and lower highs (LL/LH)- a down trend?
- The recent pullback has brought rates back to where they were in June.
- Rates appear to be stabilizing in this area.
- Recent data shows improving mortgage activity.
- All things being equal, as yields rise, Bond prices fall.
- Bond investors certainly felt the pinch last year, but we are now seeing a positive trend with HH/HL pattern.
- Have bonds prices finally turned the corner?
- Upward pressure on the US Dollar has finally given way as the uptrend has been broken.
- The Dollar Index below 105 is a healthy sign for earnings and trade in my opinion.
- The volatility in our currency this past year is unprecedented.
- Industrial metals broke out of the large base I discussed in the last newsletter.
- China’s reopening has improved demand.
- Are the metals telegraphing economic improvement?
- This does not look like an impending recession to me.
- With the softening dollar and the pullback in longer term yields, Gold has surged some 20% off its recent lows.
- Gold still has room to run technically but a parabolic rise such as the one playing out typically needs to slow down and do some backing and filling before going to new highs.
Summary/Strategy Notes:
I am happy to put 2022 in the rearview mirror. I came into last year feeling skeptical and uncertain and was forced to get very defensive early on. That is never a comfortable environment, but we stuck to our guns, followed our research, and adapted to the times as best we could. Our efforts significantly reduced volatility relative to the markets and I believe we achieved our objective of allowing our clients to sleep at night (most nights!)
Happily, I come into this year much more optimistic. We began adding exposure back to our portfolios and reducing cash in the last quarter of 2022 and have continued with that theme so far into 2023. While I do not expect a parabolic rise in the markets and recognize the environment is still fragile, I believe we have returned to an environment where we can continue buying weakness and be rewarded with returns in the future while exercising prudent risk management should the data begin to turn.
Should you wish to discuss the current markets, our strategy, or just touch base to see how things are going, please don’t hesitate to reach out to our office @ 843-651-2030. Also, feel free to share these newsletters with your friends and family via email and visit us on our website at www.sabowealth.com or www.facebook.com/sabowealth.
Important Disclosures: Past performance is not a guarantee of future results. The statements contained herein are solely based upon the opinions of Edward J. Sabo and the data available at the time of publication of this report, and there is no assurance that any predicted or implied results will actually occur. Information was obtained from third-party sources, which are believed to be reliable, but are not guaranteed as to their accuracy or completeness.