21 Dec Where Do We Go From Here? – 2023 Q1 Commentary
Morris & Wells Wealth Management begins 2023 enthusiastically and with eyes on guiding the firm through future decades. As 2022 drew to a close the stock market demonstrated less enthusiasm. Table 1, below, shows that at the time of writing the S&P 500 was on track for its fourth worst performance since 1957. A positive note from Table 1 is that 71% of the time over the last 66 years the S&P 500 has been positive. Relatedly, the most common client question over the last couple of months has been, “What do you expect from the stock market next year.” We do not profess to have a crystal ball or know the precise timing of these things. However, in this newsletter we want to lay out a couple of roadmaps.
The Federal Reserve (Fed) sets the Federal Funds rate, which the market uses to build the yield curve (graph) – a plot of time into the future on the horizontal axis and the corresponding interest rate on the vertical axis. In order to try and tame inflation, the Fed increased the Fed Funds rate. That crimps economic activity and intentionally slows growth. You are forgiven if you have a difficult time understanding an office of the federal government attempting to slow the economy. Nonetheless, that is what is happening. That leaves market pundits expecting a recessionary environment during 2023. That makes sense if the Fed continues to increase rates to the 5%-5.5% range.
Despite the above, when we look at the spectrum of outcomes for 2023, we leave room in our minds for the possibility of a so-called “soft landing” – balancing the taming of inflation without creating a deep recession – by the Fed. The other end of that spectrum includes the Fed “tightening” rates too much and the US slipping into a harsher recession. You have heard us say before that if we knew how much of the bad outcomes the stock market was discounting, we would express more clarity on a pathway forward. Unfortunately, the only thing we know is the market has discounted some percentage of the negative outcomes. Whether that percentage is 90% or 10% will determine the course of the stock market and our portfolio next year. We also know that within this backdrop, there are a lot of companies’ stocks that look like great values. We disagree with the pundits who label the entire market as overvalued.
However, we clearly see that sort of overvaluation fear in the market. Graph 1, above, shows a Bank of America survey of Fund Managers and their cash levels. The surveyed managers shows the highest levels of cash since the tech market implosion in the early 2000’s. Similarly, we see, in Graph 2, above, the highest Put/Call ratio since the early 2000’s. The Put/Call ratio measures the open interest of Chicago Board of Exchange (CBOE) equity puts (an investment betting on a broad stock market decline) versus equity calls (an investment betting on a broad stock market increase). A high reading on either of the above metrics expresses stock market pessimism. Both metrics prior heights appear to precede a move upward in the S&P 500.
The metrics could certainly prove different this time. These levels of extreme pessimism could presage further declines in the S&P 500. However, we note the valuations, discussed above, and the lack of success most investors experience trying to time the market. As a result, we remain more comfortable investing today than we did when we wrote to you this time last year.
The portfolio includes a number of themes as well as one-off company ideas that excite us from both an operational and investment perspective. Those range from cybersecurity to a retailer whose operational excellence did not warrant the valuation the stock market ascribed to it. Supply constraints also seem to exist for one reason or another across several industries – from technology to commodities. We look to take advantage of those too. Currently, we find interesting valuations across all of these potential areas for investment.
As we welcome you to 2023 and a new chapter in our company, we thank you for your continued trust. Your financial health remains our number one objective. As such, if your cash flows have changed or you want to discuss a specific part of your financial plan, please contact us. Similarly, if you have other questions or concerns as we move into the New Year, please let us know. We love to hear from you.