After the brutal September, the market turned around in October to post robust gains for the month. The S&P 500 advanced 8%, small caps/IWM rallied 11%, and the Dow gained 13% – its best monthly gain since 1976! The NASDAQ advanced only 3%, growth/RPG gained 7.5% and value/RPV matched the Dow’s advance of 13%. Bonds declined 1.5% for the month.
The dramatic difference between the S&P 500’s decline of over 9% in September and its advance of 8% in October is indicative of the heightened level of volatility and uncertainty in the financial markets. For the year, the S&P 500 has seen daily moves greater than +/- 2% over 40 times. The average is 11.
TWG conservative, moderate and growth models returned 2.1%, 3.9% and 3.6% respectively.
What’s moving the market – Searching for a Bottom
The market appears to be getting more comfortable with higher rates and has been acting like it wants to move higher. Perhaps, after 10 months of adjusting to a higher rate environment, the market is beginning to come to terms with a strong economy that may be able to handle higher rates, particularly as earnings are demonstrating resilience in most of the economically sensitive sectors.
Mega cap tech continues to be a source of funding as market participants continue to allocate capital to areas of the market that may be less negatively impacted by an economic slowdown. Healthcare, consumer staples, industrials and financials continue to be bid up at the expense of mega cap tech. Sources of funding these more defensive sectors appear to be coming from those selling off Microsoft, Apple, Amazon, Meta and the like.
We have to respect that we are in a period of reconciliation resulting from more than 10 years of zero interest rates and excessive monetary and fiscal stimulus. To think that the Fed’s job to reign in the highest inflation rate in decades will be swift and easy is unreasonable in our opinion. The Fed has taken decisive and accelerated action over the past six months by raising the Fed Funds rates by a jumbo .75% during each of the past four meetings. These increases are historically large and is causing concern that they are too much and too fast. That inflation is not materially declining, and the labor force remains tight would suggest that the Fed is not close to completing its task of maintaining price stability.
The market was extremely oversold at the end of September and was due for a bounce. It rallied 5% during the first two days in October before declining 5% in the subsequent week to make a new intraday low on the year on October 12th. The S&P just as quickly became overbought as the month of October ended, moving up 8% up in the second half of the month. Making a new intraday and closing low on October 12 suggests to us that the bottom in stocks is not yet in.
Earnings by and large have declined during the 3Q reporting season, though not as sharp as most would have expected. Since borrowing costs, and inflationary input costs are clearly putting a dent in top and bottom-line earnings, as well as margins, many multinational large companies have either revoked guidance due to lack of visibility, or have provided cautionary forward guidance. Many mega cap tech companies announced cost cutting measures as well as job cuts. If you think about the fact that borrowing costs were close to zero at the beginning of the year, and are now north of 4%, such high costs of capital means that companies are trying to cut costs to offset higher lending rates. This, in turn, will likely continue to challenge earnings for the upcoming quarters, which is precisely what the market is wrestling with in order to determine what a fair multiple on the market should be.
Portfolio adjustments
This period of heightened volatility, with 5% moves in either direction, often over the course of several days and even over the course of a single day, makes trading this market on a trend-based process exceedingly challenging. Rolling out of September’s significant drawdown, we further reduced exposure to SPTM and RPV on 10/6 and RSP on 10/11 and again on 10/18. These trims were quite small – a percentage or two of the position, and not placing big bets on continued deterioration. We attempted to capitalize on the market’s oversold conditions by layering in a 5% position in SPHB, the S&P 500 high beta fund. However, as the market rolled over on 10/5 we evacuated SPHB on 10/10 to cut the losses.
On 10/25 we added a little more exposure to RPV and VTV. We then added SPTM and RSP on 10/26 and 10/27, essentially buying a similar amount that we had just sold earlier in the month. With an up and down market we can very well get whipsawed from time to time, and recent trades may very well NOT be sticky until the market has found direction that becomes more durable – either to the upside or the downside. We are prepared to proactively adjust risk exposure as the market searches for stability.
In the month ahead we will be implementing an adjustment of flexibility to our modeling process. Currently, each ticker that we own is checked every 5th trading day to determine whether exposure should be increased or decreased. Our new process will now check daily until a signal is given, then will next be checked five or seven days from that signal. This adjustment will help us be nimbler and move more quickly, which we feel is necessary in the current environment. Thus, we should theoretically be able to evacuate risk sooner and increase risk more rapidly.
Another update is a reconfiguration of the fixed income/bond sleeve or our models. As you know, it has been a tough year for bonds, with the 20-year US treasury bonds collapsing over 30% YTD and the aggregate bond index losing over 15% YTD. We have arranged for our partners at Guggenheim investments to create an investment grade corporate bond portfolio for us. This portfolio will consist of 20-30 individual investment grade bonds, with maturities between 3 to 7 years. The blended yield is in the 4.5% range, and most of the bonds are selling at a discount to par, thus providing some capital appreciation potential on top of the yield. This position will help stabilize our fixed income sleeve and bring a much higher degree of principal preservation attributes with an attractive yield. When the bonds mature, the principal amount will be returned to your account, which we will re-invest in other areas of the fixed income space. Most of our clients who have been with us since 2018 have benefitted from a similar Guggenheim bond unit investment trust and has performed as expected.
Looking Ahead
At the beginning of November, the Fed concluded their second to last rate policy meeting, and, as expected, raised the Fed funds rate by another .75%. Powell’s press conference was short and sweet, and indicated that given the strong labor market, and stubbornly high inflation, the Fed is likely to increase its terminal rate to a level higher than previously signaled. Powell also stated that the Fed is taking the position that it would rather overshoot to the upside than to not tighten economic conditions enough to meaningfully reduce inflation. Thus, even higher for even longer. The market sold off after this press conference as stocks were once again re-rated considering expected higher rates.
With earnings season quickly coming to an end, the 11/10 CPI reading will likely be the next data point move markets, as it has in the past. If inflation does not tick down meaningfully, then the market will likely infer that the Fed will continue its aggressive rate hike plan. If inflation does decline meaningfully, then the market will likely price in a sooner-than-expected Fed pause, which could cause the market to rally.
The Fed will hold their last meeting in December, where it is widely expected they will raise rates again, but likely only a half percent.
We are in a seasonally strong period of market performance, and if the mid term elections result in a split congress, the market has historically taken this as a positive due to gridlock reducing the likelihood that regulation and policy can pass, reducing some of the uncertainty that tends to spook the market.
We are excited about the new trading parameters and anticipate the added flexibility will better help us navigate what we expect to be a continuation of a choppy, up and down market environment.
We hope you are excited for the upcoming Thanksgiving festivities and are grateful for the opportunity to serve as prudent stewards of your wealth.
