For the month of November, the broad market indices were up for a second month in a row. The DOW, NASDAQ and S&P500 all gained around 5.5%, with the S&P equal weight (RSP) up 6.5%, and small caps (IWM) lagging with a 1.8% gain.  Bonds advanced 4% as rates declined.

Even after rising 10-15% off the lows, the YTD results for major indices are:

  • S&P 500 is down 14.5%,
  • QQQ’s are down 26%,
  • S&P equal weight/RSP is down 8.5%, and
  • Value/RPV up 2.25%,
  • Bonds are down 13%

What’s Moving the Market

The big market moving events of the month were, of course, Fed and inflation related.  On November 9th the all-important inflation readings for October came in softer than expected, and softer than the prior month, indicating that inflationary forces are starting to ease.  The market rallied 5% in a single day, providing the bulk of the gains for the month.  We will also add at this time that the November inflation data arrived on 12/1 and indicated a continued decline in the year-over-year inflation rate, supportive of a trend forming and likely peak inflation in the rearview mirror.

The market then traded sideways until November 29th when we received our next market moving event – Fed Chief Powell’s speech at the Brookings Institute.  After this speech the market rallied 3% on the belief of a more dovish position taken by Powell when he acknowledged the declining inflation data and indicated it may be appropriate to moderate the pace of future rate increases, perhaps as early as the December meeting.  The market took this as a sign that the Fed is closer to the end than the beginning, but more importantly that future rate hikes will probably not be additional huge.75% increases.

While this is calming, given how rapidly rates have risen thus far in the cycle, our thought is that his comments do not suggest that the Fed is about to “pivot” – meaning starting to reduce rates, or even pause raising rates.  But we will take the relief rally that ensued and believe that the Fed will likely take some time to observe the economic impact of the prior rate increases. During this time they will obtain additional inflation data– and hopefully lower the perceived risk of going too far, making a policy mistake and increasing the likelihood of a soft landing.

Portfolio Adjustments

As the market continued to move higher, we continued to systematically increase our exposure to all our equity positions. We added:

  • RPV, our largest position, on 11/1, 11/8, 11/10, 11/14 and on 11/30 ending the month about 95% of target.
  • RSP, our second largest position, on 11/1, 11/15, and 11/29, taking us to 95% of target.
  • Vanguard Value/VTV on 11/1, and 11/22, taking us to 100% of target.
  • Total Stock Market index/SPTM on 11/14, taking us to 90% of target when including the 12/1 increase.

For those accounts valued at least $100,000 the Guggenheim Bond UIT has been secured and is now a core position in your bond sleeve.

Busy month for sure!

We are also very excited to share some technological enhancements we have implemented at the end of the month.  Our modeling process “checks” each fund and recommends either hold, add, or trim on a five-trading day cycle.  This was a control put in the technology to mitigate excessive trading and minimize whipsaws.  However, most funds were on the same five-day cycle, meaning a lot of changes were recommended on the same day.  With the market action this year being as volatile as it is, five days has often been a long time to respond, and big moves have and can occur over that short time frame.

The new modeling technology will check each fund every trading day, and when the price stream breaches the model’s threshold to trigger a trim or add, the system will immediately provide us the recommendation.  When there is a trim or add, then the model will not check again for either three or five trading days, depending on the sensitivity of the model.

What this means is that upon the fund breaching the threshold of a trigger, the trade will be executed the very next day, instead of perhaps having to wait five days to execute the recommendation.  This will help us be nimbler, more flexible and respond more quickly to a quickly changing market.  Our back tested results indicate a significant improvement in YTD as well as other time periods of market stress (2020, 2018 for example).  Essentially, we hope to now be able to trim/move into cash a bit quicker, as well as re-enter the market sooner than the prior iteration of the model.  Very exciting stuff, and this should help us over the course of ongoing challenging market cycles.

Looking ahead

We believe that the new year will usher in the second phase of this period of market reconciliation.  We feel that in the months ahead the environment will likely transition from a period of the “market” reacting to the Fed’s rate hikes and towards a period where the “economy” will now be reacting to the rate hikes.  As we’ve explained before, rate hikes take around six months to fully work their way into the economy.  Now that we have seen a total of 3.75% in hikes, the effects should start spooling up fully into economic activity in the months ahead, which are likely to show cooling demand and softening economic activity.

Thus far, the market was shoot first and ask questions later, as the full impact of a rising rate regime were unknown – no one knew how far rates would rise, how long it would take, the duration of elevated rates, and when inflation may start to soften.  The market knew that higher rates would likely require a hit on valuations, so the selling was somewhat indiscriminate, although the higher valuation growth stocks got clobbered the most.

We should now begin to observe the economic impact of the series of rate hikes, which are quickly working their way through the economy.  We will likely better understand the risks and impact of higher rates such as unemployment, earnings, profit margins, personal savings, consumer spending behavior, revolving credit utilization, housing prices and rental costs – those things that impact the consumer and businesses alike all of which impact the price that investors are willing to pay for any given stock.

While the two months of declining inflation are a welcome trend, we are mindful that the current 6-7% inflation level is still a long way from the Fed’s target of 2%.  Also, the Fed is still in a tightening mode, and additional rate hikes are very likely.  The overall trend is down, and we are still in a bear market, evident from a series of lower lows and lower highs.  One bright spot that occurred on 11/29 was the S&P 500 moving above its 200-day moving average for the first time since March.  The market staying above this trend line would suggest that it can continue to move higher.

However, the 200-day moving average is still in a declining slope, warranting ongoing caution. 4Q22 and 1Q23 earnings season should fully reflect the year’s rate hikes and its impact on corporate earnings, which are the mother’s milk of investing.  So far, earnings have he up so-so.  In the aggregate they have not declined year over year, but the pace of growth has slowed considerably.  If companies continue to report deteriorating earnings, particularly where valuations are currently due to the rally off the October lows, then stocks will likely get re-rated again, which should force another leg lower in the markets.  While this scenario is not guaranteed, in our opinion it is likely, barring a considerable reduction in inflation in the months ahead.  As inflation moves closer to the Fed’s 2% target, the Fed will likely then be closer to the end of raising rates.  When rates stop rising, it’s hard to imagine things getting much worse from there.

Again, we are not as concerned about the economy’s ability to handle higher rates as we are about the economy’s ability to handle such a swift increase in rates from zero to 4% in 8 months.

Should earnings decline but then start to grow again, such earnings “troughs” historically coincide with the end of a recession and the start of the next expansionary cycle.

These are some of the important data points that we regularly monitor to help navigate this challenging market environment.

With seasonality on our side (December being one of the strongest average months), as well as the recent positive inflation data points, we are hopeful that we can end the year higher than where we ended November.  Next year things are likely to get a little tricker before things get better, but we are very well prepared to respond to whatever “that” may be.

We wish you a happy, healthy, safe and fun holiday season.