If you’ve spent more than 10 minutes with me, you likely know that winter is my favorite season of the year. Don’t get me wrong, I enjoy a beautiful summer day on the ocean, but I dream of powder covered snow fields. My snow obsession starts to kick in around October every year and by November, I am fully engaged… I begin and end every single day watching weather patterns and foolishly forming an opinion on what the winter is going to look like.
Sadly, heading into winter this year, El Nino is in place for the first time in four years, driving the outlook for warmer-than-average temperatures for my northern playground. Adding to my disdain, NOAA predicts drier-than-average conditions across the northern tier of the U.S., especially in the northern Rockies and near the Great Lakes. After reading this horrible information, I decided to do a little research. I went online and looked up all the recent El Nino years then went back in time on my phone to look at all my pictures from those winters. All I can say about my extensive research is, there is a strong correlation between El Nino and crummy snow conditions, so I filled out all the forms and submitted my passport application in case I need to spend some time further north (as in Canada) this winter.
Picture courtesy of the National Ocean Service
El Nino to me is like a poor economic backdrop. Where El Nino takes away my snow, a poor economic backdrop riddled with high inflation and a slowing economy robs the market of returns. La Nina, on the other hand, works in the opposite way. It tends to bring colder temps and boost precipitation to the north, just like lower inflation, stable employment, and a strong economy tend to boost the markets.
Somewhere around the beginning of this year, our economic “weather pattern” began to shift from El Nino to La Nina. Just as the trade winds bring cold, nutrient-rich water to the surface of the Pacific during La Nina, our data began providing some of the much needed “economic nutrients” to stabilize the markets and support higher prices. The better the data got, the higher prices went, and that momentum took some of the growthier sectors a little too far as is usually the case in the stock market. The mid-summer peak eventually gave way to profit taking and that profit taking took a toll on investor sentiment. These conditions, coupled with a few minor economic data points that missed investors’ lofty expectations, built momentum, and a three-month sell-off ensued.
Every epic winter has at least a thaw or two, but the snow eventually returns, and the base gets even better due to compaction. When the “weak holders” of investment positions get shaken out of the market, institutional buyers tend to step in as they understand the overall environment is still rich with opportunity and the markets get back on track. This has certainly been the case since the turn of the calendar into November.
On Monday, October 30th, I wrote the following in my Monday Morning Brief (an Internal note to other Portfolio Managers and Advisors):
“Again this week- The disparity between the Technicals and the Marcos are puzzling… 3 Legs down is now complete… RSI is very “oversold” and the S&P is in the consolidation area (volume point of control). Metals and the VIX might be showing signs of an upturn but would need some positive price action across the broader markets to say we’ve reached the end of this downside momentum… What will be the spark to get the markets in check? Lots of things on the calendar from the Fed to earnings could settle investors nerves.”
That day actually marked the beginning of the end of the downturn. Monday and Tuesday were up a little from the prior week’s close but relatively quiet as is typical ahead of Fed Day, and on Wednesday, we got the catalyst we were looking for! Federal Reserve Board Chairman Jerome Powell delivered an eloquently crafted speech following the release of a no interest rate hike meeting and since that moment, just about every single economic data point has been Goldilocks.
I’ve been a student of the markets for three decades and an active participant for 25 years. I’ve learned along the way that bull markets tend to work things out to the upside and that is what appears to be happening here. Now, I don’t want to sound overly optimistic about the environment as there are some little “cracks” that warrant attention. Specifically, geopolitical tensions are high, there is some underlying data that might be indicating the consumer is slowing down purchases of bigger ticket items, employment appears to be cooling off just a tad, and we have yet to see the longer-term effects of these higher interest rates. But we will be keeping an eye on these things and will make any necessary adjustments should they develop into more serious headwinds in the future.
From a technical perspective, a lot of good has been happening in the past few weeks. The “VIX” signal I mentioned in the memo above played out perfectly. The VIX is Wall Streets “fear gauge” and when it comes down, this signals investors’ appetite for risk is going up- and it has come way down… Longer term yields also came down by a good margin while credit spreads tightened dramatically. Lower interest rates are good for the economy, and rates came down for the right reason- lower inflation expectations. Tighter credit spreads (the difference in rates between riskier loans and safer ones) reinforce the notion that smart money (i.e. bond investors) are not fearing defaults. I could go on and on here but it’s safe to say, a major change in sentiment has been underway and it appears to have some staying power.
One of my favorite things to watch is the Growth vs. Value trade and I want to highlight the chart below which plots the year-to-date returns of the Vanguard Growth Index ETF (VUG) vs the Vanguard Value Index ETF (VTV). Value stock investors have been treading water all year (up a meager 0.10%) while those focused-on growth have seen explosive returns (up 39.40%) as of this writing. In all fairness, the growth trade has been a pretty wild ride, and most investors don’t have the stomach for it but for those with an oversized appetite for risk, it’s been extremely rewarding this year.
What’s interesting here is that if history holds true, the returns between these two should revert to the mean, and, with the positive economic backdrop and bull market underway, this scenario favors a rally in the Value stocks in the coming months. Adding to this concept, any trained eye looking at the chart below can’t help but see what we market technicians call an inverted head and shoulders bottom formation in value stocks, which carries bullish implications historically. I just thought I’d point this out as a rally in value stocks would go a long way towards improving the overall health of the market and boost sentiment among those who have had a dull year.
If you would like to learn more about the forces of El Nino and La Nina, please click on this link https://oceanservice.noaa.gov/facts/ninonina.html and if you have any questions about the markets, your accounts, or our strategy, please feel free to call our office at 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.