Wright Cove Capital: February 2023
February 23, 2023
There’s nothing magical or unique about the number 4,000, yet the market (represented by the S&P 500) appears to have an affinity with this level.
After initially breaking through the 4,000 level for the first time back in April of 2021, the market continued to rally all the way to a record close of 4,796 on Jan 3rd, 2022, only to then drop back below 4,000 to a cycle low of 3,577 in October. The market quickly bounced off these lows and rallied back above 4,000 and ever since early November has spent the last 100+ days within a very narrow range – never breaching more than 5% on either side of 4,000.
As we have talked about in the past:
- In 2021, the playbook was simple, with interest rates near zero and fiscal and monetary policy being supportive, risk assets were the best place to be.
- In 2022, inflation spiked, war broke out in Ukraine, the Fed become more restrictive, and fiscal stimulus ended. Thus, the most defensive strategies were the best places to hide and weather the storm.
2023 is shaping up to be more challenging from an investment and asset allocation standpoint, and opinions vary drastically on which way the market is heading.
On one hand, there is a school of thought that the nearly 10% rally to begin the year was yet another bear-market rally in a broader down trade, and we will soon break through the lower end of the range and potentially below the recent October lows. The thought process being:
- Inflation has cooled some but remains stubbornly above the Fed’s threshold.
- Interest rate hikes are just now beginning to take effect on slowing the economy.
- The Fed will continue to raise interest rates well above 5% and keep them there for longer than the market has priced in – making T-Bills an attractive alternative to stocks.
- Future earnings expectations are still way too high.
- Finally, the market simply isn’t cheap anymore at nearly 19x earnings.
On the other hand, the bulls contend:
- The stock market is typically 6-12 months forward looking and has already priced in many of the above concerns.
- Recent economic data suggest we may avoid a recession (soft-landing) as the consumer and labor markets remain strong and there is plenty of cash on the sideline.
- China’s long-awaited reopening and/or a potential end to the War in Ukraine will spur massive global demand.
- Innovations in technology, clean energy, and AI will be the catalyst for a new bull-market cycle.
- Finally, there is still a camp that believes the Fed will overshoot and be forced to pivot and cut interest rates.
Every day we read and hear strong arguments on both sides of the debate. There is no shortage of smart people and respected institutions who have strong opinions and data that support their theses on which way events will unfold.
Fortunately, we at Wright Cove Capital are actively positioning accounts for success without necessarily betting on one outcome or another.
We still contend that equities offer the best long-term growth prospect and should be owned in a portfolio that seeks capital appreciation and growth over a longer time horizon. However, within the stock market we continue to prefer value and quality growth stocks/sectors that are profitable NOW and NOT reliant on lower interest rates, lower inflation or other future circumstances to change in order to thrive.
We agree with many economists, including those at the Federal Reserve, specifically the comments below from Atlanta Fed President, Raphael Bostic, that the true effects of interest rate increases are just beginning to take hold. Nevertheless, we believe that companies with strong balance sheets and business models not predicated on cheap financing will outperform and better weather the storm. Bostic writes:
…A large body of research tells us it can take 18 months to two years or more, or tighter monetary policy to materially affect inflation. You may be wondering: Why does it take so long?
…it takes businesses and consumers time to recognize, feel, and act on changes in financial conditions. For instance, firms are continually making capital investments that require financing. If a company has already started to build a factory or introduce a new product line, it will often continue to move forward rather than halt the project in midstream, even though financing costs have changed since it launched the venture.
Here is a link to the full story: On Long and Variable Lags in Monetary Policy: Raphael Bostic
As boring as it sounds, our favorite trade from a total risk/reward standpoint remains being overweight short-dated Treasuries and T-Bills. We continue to roll T-Bills as they mature and are now re-investing at a tax-advantaged rate north of 5%. With the current dividend yield of the S&P 500 being ~1.60% and valuations at the higher end of the recent range, we see little reason for conservative to moderate investors to take excessive risks.
With the market stuck in a tight trading range, the little things become increasingly more important to success in investing. Making sure cash is invested, avoiding unnecessary fees, being diversified, and truly understanding what you own and why you own it is more important than ever.
Last year was a great example of what “active asset allocation” can do to improve performance. Not owning certain stocks or bonds or having exposure to specific sectors just because they are in an index, part of a cookie-cutter portfolio, or mentioned repeatedly on cable news can greatly reduce risks and help clients better achieve their investment objectives.
As we embark on our 4th year as an independent advisory firm, we stand steadfast behind our founding premise: that experienced, qualified and independent advisors are best positioned to offer sound investment advice. We continue to define our success by our ability to listen, understand and achieve each of our clients’ unique goals.
We thank all our clients for their continued trust and support. As always, if you have any questions or concerns – or believe someone you know would benefit from working with Wright Cove Capital, please fee to reach out.
Eric and Cass
Eric Leinwand, Principal – Eric@wrightcovecapital.com
Cass Tokarski, Principal – Cass@wrightcovecapital.com
The themes and strategies that we speak about and the positioning we take in portfolios are all customizable to best reflect each of our clients’ own unique goals and should not be interpreted as general investment advice.