FAIR WARNING!
Looking Forward Into 2023

December 11, 2022

Weekly Market Outlook

By Keith Schneider and Donn Goodman


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Gaugers, it was another choppy week in the stock and bond markets with negative returns for all of the major indices.

Small caps, which can be most negatively affected by rising interest rates, had the worst performance of the major equity indexes, with a decline of 5% for the week.

Most of the other indices were down from 2.7% (Dow) to -3.7% (QQQ) for the week.  Bonds were also down on the week fueled by Thursday’s PPI (Producer Price Index) report that came in hotter than expected and led interest rates to rise in expectation of a more hawkish Fed.

Looking back at 2022

It certainly has been a difficult and choppy year in BOTH the stock and bond markets.  As we have shown repeatedly, this has been the worst year for a balanced portfolio approach with most balanced funds (60% equites and 40% fixed income) down in the mid-teens.  I noticed yesterday that Vanguard’s $43 billion dollar Balanced Mutual Fund is down over 19% year-to-date.  I feel bad for all the 401k investors that have just closed their eyes and kept their investments in this and other Balanced funds.

If you were a passive investor during 2022, the Dow was the best place to be invested and is down in single digits (as opposed to the S&P 500, the NASDAQ and Small Caps which are all down mid-teens to almost 30% for QQQ).  WOW.

The Dow (mostly large cap value plays) has vastly outperformed the other indices because of its high concentration of industrial stocks, health care, energy, and less weighting on technology.  See charts below:

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This has been the largest outperformance of the Dow over the S&P since its modern version origination in 1957.

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There have been 4 sectors that have been the bright spots during 2022.  XLE – Energy, XLV-Health Care, XLP-Consumer Staples, and XLU-Utilities.  As expected, these are commodity related sectors (Energy) or Defensive areas of investments (Staples, Health Care & Utilities).  See chart below (adjusted for dividends):

XLE-Energy (light blue): +51%
XLU-Utilities (purple): +1.97%
XLP-Staples (orange): +0.50%
XLV-Health Care (yellow): +0.47%
S&P 500 (dark blue): -16.75%

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What Bias Do You Have?

Below is a chart showing two different historical perspectives overlaid on the S&P 500.  Which one do you relate to more?  The negative or positive scenario?  Let us know.

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Will there be a long-awaited Fed Pivot?

The Fed will meet again this Tuesday & Wednesday December 12/13.  They are expected to raise rates yet again to curb elevated and ongoing persistent inflation.  However, Chairman Powell and other Fed Governors have recently been implying that it may be time to slow down the rate of the raises.  Given this more dovish rhetoric coming out of them, here is how the stock and bond market has acted since the last raise in early November:

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However, to keep this in perspective, the Fed has raised rates faster and higher, breaking historical precedents.

Additionally, with last week’s hotter than expected PPI, the Fed is likely to continue increasing rates and 0.75% which everyone thought was OFF the table, may be back on.  While the Fed may slow down their raise from the previous 0.75% to 0.50%, most analysts are expecting several additional increases as we head into 2023.  Expectations remain that we will get to 5% (or possibly even higher) on the Fed overnight lending rates before they are finished.

Economics 101

I was fortunate to attend a University (Ohio University) which was one of the first in the US to offer courses on economics.  John Galbraith, a successful American businessman and economist, graduated from there in 1922.  As an economist, Galbraith urged economists to look at the real world and not made-up financial calculations.

In 1977 I attended a course whose guest speaker was Milton Friedman. Friedman, a professor at University of Chicago (today considered the best economics university in the US) received the Nobel Prize for Economics in 1976.  He authored many books about monetarism.  He was an economic advisor to Presidents Nixon and Reagan.  It was Friedman who convinced Reagan to reduce income tax rates to spur economic growth.

Don’t Fight the Fed

Part of Friedman’s teachings were that if economic policy had been different and more accommodative, we might have avoided the Great Depression.

I bring this up because all one really needs to do is watch current monetary policy to see the most probable trajectory for interest rates and the stock and bond markets.

An interesting chart came out this week showing exactly what Milton Friedman wrote and spoke about in the 50s, 60s and 70’s.  Monetary policy rules everything.  Check out the following chart showing the effect of the Fed’s quantitative tapering (selling their bond holdings and draining liquidity from the system) and then having to infuse liquidity to prop up a falling market.   See below:

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People keep sending me all kinds of articles and commentary on why we may be in a new “bull market.”  I hope they are all spot on, but I don’t buy it.  Inflation and economic policy do not add up.  We may instead be on the precipice of another leg down.

Maintaining a Positive Bias

As most frequent readers will attest to, we try and provide a fair and balanced view of any future perspective.  Recently, we have pointed out positive seasonality trends, positive behavior from the decline in longer-term interest rates and the US Dollar.  All these factors and the above Fed supported liquidity chart above shows a recent positive stock AND bond performance bias.

Recession Clouds Persist

The original thoughts on this week’s article was to refrain from a negative bias. Then a series of articles dropped overnight indicating Blackrock (the world’s largest asset manager) has recently joined Morgan Stanley, Banc of America, and Deutsche Bank (to name a few) in warning of what they believe is likely to come.

All their collective beliefs (and our own Guru Mish) is that we will see elevated inflation far into the future and this will lead to more of an economic downturn.  This would be no surprise given the heavily inverted yield curve that has existed for the past few months.  Historically this inversion has accurately predicted a recession with over 90% certainty.

These large investment firms believe that the Fed is willing to allow the economy to slide into a deep recession if that is necessary to bring down inflation to its target of even 3%-4%, which some say is the new (secret) target.

These analysts are also pointing to a possible decline of another 20% or more in the stock market before a bottom is reached.

Blackrock produced the following charts to drive home their negative market thesis:

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Unlike other recessions that were affected by rising unemployment and a large number of corporate layoffs, this one could be different.  We have a shortage of workers and that will compound STAGLFATION and keep corporate America from downsizing enough to offset persistently high labor costs. See chart below:

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This is why you see major robotic innovation developing in just about every industry in the US today.  It is also why many analysts believe we will see a shallow downturn and NOT the severe recession many of these analysts are calling for.

On top of the potential economic downturn Blackrock is suggesting, they are also concerned with ongoing Geopolitical risks.  They believe we are at a heightened risks that cause additional disruption to our economy and put a lid on economic growth in 2023:

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The conclusion that the Blackrock team stated (like Morgan Stanley and others) is that equities are not yet pricing in a recession and the potential of an earnings growth decline.  See chart below:

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At MarketGauge we would rather be Early than Late

As many of you know I joined MarketGauge late in 2021 after a long career in asset management for a large money manager that replicated the S&P 500.  I was concerned that we would be entering a much more difficult market and MarketGauge aligned with my investment goals because they were active and became defensive earlier than later.

Growing up with two amazing parents, they instilled in my brother and I to be EARLY.  My father was a stickler for getting to a restaurant earlier than his reservations or making sure he was at the airport gate at least an hour before the flight left.  (He would have laughed if he watched many of my near misses getting on flights).

His message was engrained in me.  Better to be early than late.

This works even better in an effective investment construct.

In its 25-year history, MarketGauge has exemplified in its various investment strategies, investment techniques, tools and especially Mish’s discretionary service, that it is far better to be OUT of the market before the s**t hits the fan.  Our goal and highest aspiration is to help you achieve above average risk adjusted performance.  One of the best ways to achieve this is not to lose as much as the market when times are difficult, as they are now.

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More importantly if you look at many of the themes our quant investment strategies invest in, we have been very early this year alone in Energy, Alternative Energy, Rising Interest Rates, Natural Gas, Biotechnology, and a host of other profitable investment themes.  In last week’s Market Outlook, we listed many of our best trades during 2022.  Click here to review last week’s outlook.

The Blends Are Best

We have spent an inordinate amount of time and effort (thank you James, Holden & Mike) fine tuning and putting together optimal combinations of investment blends.  One of our favorites, LGT and LGTA are easily tradeable whether you are receiving signals from us or allowing us to manage the blend through Auto Trading with our partners; Interactive Brokers and Tactive Wealth.  LGT is positive on the year and both LGT and LGTA have produced returns in excess of 15% annualized over the past 3 years (before fees).

Reach out to Rob Quinn, Keith Schneider (keith@mgamllc.com), or me (Donn Goodman)(dgoodman@mgamllc.com) if you would like information on these Blends and several others with similar performance (or better) that you could utilize.

 

Here are the additional observations from BIG VIEW:

Risk On

  • Despite the negative performance overall in the equity markets, Copper (COPX) has continued to hold up well. (+)

Neutral

  • Longer-term rates (TLT) appear to be in overbought territory and now look to be mean reverting. (=)
  • Oil (USO) has broken down and closed below its key 200-week moving average for the first time since February. However, it is quite oversold on a daily timeframe and could reverse this week’s move next week and recover its 200-WMA. (=)
  • The US Dollar (UUP) still hasn’t closed below long-term support at the 200-day moving average, which has not been below since the early Summer of 2021. (=)

Risk Off

  • Two key US indices out of the four failed to stay above their 200-day moving averages (SPY & IWM) after brief spikes above that resistance level in the previous two weeks. (-)
  • Although all of the key US indices are still holding  above their 50-day moving averages, on a weekly timeframe, indices are showing bearish crosses in Real Motion, indicating a breakdown in the longer-term momentum of the market. (-)
  • Volume Patterns have completely flipped to negative across the market, with 3 of the four major indices (excluding IWM) now showing significantly more distribution days than accumulation days over the past two weeks, and all four indices ended this week with a distribution day on Friday. (-)
  • All major sectors were red on the week, with safety plays such as Utilities (XLU) ending the week nearly flat and outperforming the S&P 500 by a wide margin. (-)
  • One of the most notable trend changes this week was the uptick in long-term volatility (VXX). Meanwhile, the entire Energy sector, including Clean Energy (PBW), got rocked. (-)
  • Market Internals continue to deteriorate across the indices, with the McClellan Oscillator confirming a deeper breakdown in price. (-)
  • The New 52-week  High / New Low ratio has also flipped negative on both a short and long-term basis for the S&P 500 and Nasdaq Composite. (-)
  • Risk Gauges have deteriorated to completely Risk-Off across the board. (-)
  • Volatility increased this week, and the ratio of 1-month to 3-month volatility has moved to bearish territory in the short term. (-)
  • Utilities continue to outperform the SPY (-).
  • The number of stocks above key moving averages has broken down across the board, and most notable is that the number of stocks above their 200-day moving average has sold off significantly from recent highs. (-)
  • The inversion of the Yield Curve has intensified further. (-)
  • Value Stocks (VTV) continue to outperform Growth (VUG), with Growth needing to maintain its 50-DMA to maintain positive footing. (-)
  • Four of the six members of Mish’s Modern Family (excluding SMH and IBB) are underperforming relative to the key S&P 500 benchmark, a risk-off indication for the market. (-)
  • Foreign Equities (EEM & EFA) continue to outperform the US. (-)
  • Gold (GLD) looks poised to take out both the 50-week and 200-day moving averages, which is not shocking given the weakness in equities and persistent geopolitical stress. (-)


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