The first 45 days of 2023 have been a welcome reprieve after the incredibly challenging environment in 2022. The much hoped for “Santa Rally” appears as if it was delayed by a few weeks, but better late than never. As normally happens, the positive change in prices has caused a positive change in sentiment among traders. The NDR Daily Trading Sentiment Composite has gone from a cycle low in October of 19 (a level historically associated with extreme pessimism) to a high of 87, a level that hasn’t been reached since late 2019 and is often associated with extreme optimism.
Accompanied by the increase in sentiment has been the participation of some of the most beaten down sectors/styles of 2022. While Value/Defensive names were the big winners (relatively speaking) last year, the beginning of 2023 has seen Growth/Cyclical names as the strongest performing areas. This caught many traders by surprise as recessionary fears, high inflation, and the likelihood of a “higher for longer” interest rate all were seen as headwinds for many Growth sectors.
The chart above shows the year-to-date returns for several different areas of the market. The orange line at the top is Vanguard Growth (VUG) while the blue line at the bottom is Vanguard Value (VTV). The roughly 10% outperformance of VUG over VTV is one of the largest 1-month performance differentials we have seen in years and is in stark contrast to 2022. US (dark purple) and international stocks (light purple) are tracking very closely, while Small Cap (green) has been strong.
Can We Trust This Rally?
As mentioned earlier, the participation of some of the most beaten down sectors/styles from last year, along with an increase in sentiment, has put the current rally on fairly solid footing from a technical standpoint. Many of the breadth thrust indicators that were triggered during some of the “fake out” rallies during 2022 were shorter-term and didn’t include any intermediate-term measures that, in our view, were necessary to support a sustainable advance. As a reminder, breadth thrusts are a way to determine market momentum under the surface.
The intermediate-term thrust triggers that were lacking in 2022 have begun to fire in 2023. While this is no guarantee that a new bull market has begun, it has historically shown favorable forward returns from the time the obversions are made. Simply put, things are looking as favorable from a technical perspective as they have in quite a while.
From an economic standpoint, many mixed signals remain. The labor market remains extremely strong, with the unemployment rate at 3.5% and weekly initial jobless claims maintaining very low levels. Almost every recession over the past 100 years has coincided with a significant increase in both unemployment and job losses. So far, the workforce numbers aren’t indicating imminent danger. This does, however, give the Fed a good reason to keep rates higher for longer which is bad for stocks.
The corporate earnings picture is a little less optimistic. According to Factset Earnings Insight, for Q4 2022 (with 69% of S&P 500 companies reporting as of 2/10/23), the blended earnings decline is -4.9%. If this turns out to be the actual number, it would mark the first year-over-year earnings decline since 2020. For the full year 2023, analysts are expecting earnings growth of 2.5%. While these numbers aren’t great, they aren’t yet dipping into recessionary levels. Earnings associated with recessions typically decline between -15% and -25%, which would likely also cause a downward repricing based on current valuations. The concern remains that the lagged effects of higher interest rates and inflation will continue to pressure margins resulting in earnings continuing to trend much lower than analysts now expect. For now, however, the numbers suggest a slowdown, not a recession.
How HCM Is Responding to Market Conditions
HCM’s base case entering 2023 was for an economic slowdown to take place in the middle to back half of the year as the lagged effects of interest rate hikes begin to show up throughout the economy. Based on that view, we focused more on Value/Defensive equity sectors and shorter duration bond holdings. While we still believe a slowdown later in the year is the highest probable outcome, we are hopeful that the improving technical picture and recent improvement in share prices reflect a better chance for a “soft landing” than previously thought.
In our Tactical Portfolios, we have reduced a portion of our most defensive equity positions and shifted those to a combination of Smaller Stocks, Growth Stocks and Broad Market Index. These adjustments continue to leave an overweight to Value oriented securities but will offer more upside market participation should the current rally continue. Our bond exposure remains unchanged, with a blend of Cash Equivalents, Core Bonds, and Unconstrained strategies to capitalize on higher rates in shorter term bonds as investors digest the Fed’s commitment to remain “higher for longer” against inflation numbers which appear to be ebbing.
Weekly Focus – Think About It
“I prefer tongue-tied knowledge to ignorant loquacity.”
- Marcus Tullius Cicero
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Loss of -1.38%%
- Developed Foreign Markets (EFA) – Loss of -1.05%
- Emerging Markets (EEM) – Loss of -1.69%
- Fixed Income (AGG) – Loss of -1.40%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- The Fed raised interest rates by 0.25%, moving the Fed Funds rate to 4.75% and commented that their fight against inflation isn’t done, despite inflation softening in certain areas.
- Total CPI increased 0.5% month-over-over month and 6.4% year-over-year. While the number remains elevated, this is the smallest 12-month increase since the period ending October 2021.
Eye on the Week Ahead
- Initial Jobless claims are expected to remain below 200,000, which would remain indicative of a very tight labor market.
- PCE and Core PCE are expected to show continued moderation of inflation pressures, although the inflation rates are still likely too high for the Fed’s liking
If you have questions about the recent price volatility please contact a member of HCM’s Wealth Advisory Team:
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- The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in genera
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