Opportunities Ahead

In ancient Roman mythology, Janus represented the god of time, duality, beginnings, and endings. He was often depicted as a head with two faces: one looking back into the past, the other looking into the future. While investors should always strive to mimic Janus’s ability to see both sides of a situation, it’s no real surprise that recent market activity in both stocks and bonds have made that a very difficult proposition. To quote Schwab’s Chief Global Investment Strategist, Jeffrey Kleintop, “As investors we tend to keep trying to fight the last battle over and over again.” In a year where the S&P 500 is down roughly -20% (as of the morning of 10-4-22), and high-quality bonds are down roughly -14%, it’s no surprise that past experiences are dampening the thoughts of future potential. In fact, sentiment is about as bad as it gets for investors.

Source: AAII Sentiment Survey, 9/29/22The chart above shows the most recent sentiment survey conducted by the American Association of Individual Investors (AAII). The percentage of respondents that are “bearish” (predicting market will fall) over the past two weeks has been over 60%. That number on the surface may not seem high, especially with current market conditions. However, this is the 1st time in the history of the survey (since 1987) that we have had consecutive weekly bearish readings of over 60%!! In addition, there have only been 4 other times during the past 35 years with a single weekly reading over 60%, let alone two in a row.  

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  According to @sentimentrader, the one-year return after those readings was: 22.4%, 31.5%, 7.4%, and 56.9% respectively.

  Why Do We Care? 

  The true challenge right now is to try and interpret the short-term data flying all around the world while not losing sight of the long-term implications of potential outcomes….which happen to be almost exclusively positive.

   Short Term: Good for the Economy, Bad for the Market

   The market recently tested and broke through the previous lows in June on a hotter than expected CPI (Consumer Price Index) reading and an aggressive stance by Jerome Powell at Jackson Hole as he re-iterated the Fed’s commitment to continue the fight to get inflation back down to 2%. This eventually led the market to an extremely oversold position similar to the one we saw back in mid-June. His comments also caused a sharp rise in bond yields, with the 10-year yield briefly touching 4% while the 2-year yield was as high as 4.3%. Both were the highest yields we have seen on those respective bonds since 2007.  

   This sharp move in yields wasn’t contained to the US. The United Kingdom also saw a sharp rise in 30-year Gilts which put several high profile pensions in jeopardy and forced the Bank of England to intervene and begin to aggressively buy 30-year Gilts in order to prevent further damage. This rescue began the conversation about the possibility of other central banks needing to provide similar relief and more importantly for the market, had investors asking if this was the event that would finally force the Fed to reassess their trajectory for rate hikes.

   The hope of a renewed Fed “pivot,” combined with oversold conditions has seen a strong rally over the past two days in both stocks and bonds. The rally will live or die on future readings of inflation, employment, earnings, and the will of the Fed to continue the inflation fight. The paradox of “good for the economy, bad for the market” and vice versa looks like it will continue in the short term.

   Long Term: Risk/Reward Tilts Back in Favor of Long Term Investors

   While most investors become hyper focused on the short term during times of significant market volatlity, it is the long term opportunities that are born from bear markets that are the most crucial to not lose sight of. As we mentioned back in mid-June, conditions are popping up in both the stock and bond markets that have put the risk/reward scale back in favor of investors who have a strong stomach and a sufficient time horizon. And just like in mid-June when we put significant cash back to work in our Advance and Defend models, we are taking similar action for clients to rebalance the equity side of portfolios back to model targets.

  This isn’t a call that THE bottom is in. It is not a call that the volatility that we have seen over the past 9 months is over. It is simply recognition that with the conditions we are currently seeing, both from a sentiment and market internals standpoint, the probability of strong returns looking out 1-year or longer from this point is significant.  

  

  The chart above illustrates one of the many oversold conditions we referenced at the beginning of article. This shows future returns when less than 5% of S&P 500 stocks are trading above their 50-day moving average for two consecutive days. This has happened 85 times since Nov. 1985. Returns have been positive after 6 months 76% of the time, after 9 months 89% of the time, and after 1 year….100% of the time with an average return of 23.6%. You will also notice that every single timeframe had around a -10 % drawdown DURING the period following the signal. Again, this and other signals like it are NOT a sign that the worst is definitely over. It is simply recognition that the odds of a successful outcome are greatly in an investor’s favor at this point.

  Bonds are also seeing opportunities. For the past few years, generating income without taking significant credit risk has been almost impossible. In fact, dividend paying stocks were consistently yielding more than US Treasuries and even more than most Investment Grade Corporate bonds. Now, yields are comparable with most dividend paying stocks.  We still think the opportunity to generate better total returns over the long run favors stocks, but bonds are starting to look more attractive as yields rise. 

  HCM recognizes and understands the returns of the past 9 months have been painful. The losses we have seen in both the stock and bond markets have been historic when taken together. However, we still firmly believe that long-term opportunities are presenting themselves, and we continue to position portfolios to take advantage of those situations when appropriate.

  Ultimately, investors don’t have two faces like Janus, but we do have the ability to set our gaze away from the past and towards the future, despite how difficult the past may make it to do so. 

  Weekly Focus – Think About It 

   “The worse a situation becomes, the less it takes to turn it around, and the greater the upside.”
  -George Soros

  Market Activity

   Performance last week for the four major asset classes were:

  • U.S. Stocks – Russell 3000 (IWV) – Loss of -2.57%
  • Developed Foreign Markets (EFA) – Loss of -1.32%
  • Emerging Markets (EEM) – Loss of -3.06%
  • Fixed Income (AGG) – Loss of -0.88%

   (Note: performance is based on the change in price plus dividends)

   Last Week’s Headlines

  •  Markets remained volatile as investors question the ability of the Fed to generate a “soft-landing” for the economy.
  •  New homes sales came in surprisingly higher at an annual adjusted rate of 685,000
  •  Core PCE (Personal Consumption Expenditures) was slightly higher than estimates at a year-over-year rate of 4.9%, providing the Fed additional room for rate hikes if they view inflation as not coming down fast enough

   Eye on the Week Ahead

  •  Non-Farm Payrolls will give an important update on the health of the labor market.  A weaker than expected report could add fuel to the argument that the Fed is closer to the end of their hiking cycle than forecast. 

If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:

Disclaimer:

 Any tax or other advice contained in this document, including any attachments, is not intended and cannot be used for the purpose of avoiding penalties under Internal Revenue Code. No action should be taken on any information contained in this message without first consulting with your tax/legal advisors regarding the tax/legal consequences for your particular circumstances.

 Additional Notes:

• The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in genera
• Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance
• Past performance does not guarantee future results
• You cannot invest directly in an index
• Consult your financial professional before making any investment decisions

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Doug Johnson CFA Doug is the Senior Investment Strategist in the Investment & Research Department.  He guides the Investment Committee in developing and implementing HCM’s investment strategies. Doug and his wife Cindy live in West Chester with their two sons. In his free time, Doug enjoys family time, golf, playing and watching hockey, and travel.