October 30, 2022

What a Week

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Bottom Line:

 

Markets extended their robust rally this week, fueled by disappointing economic, earnings, and political developments. Given the broad acceptance of recession, its fears of financial instability stoked by overwrought Fed policy looms largest. Evidence that the Fed’s policy austerity is now working broadly should, in theory, reduce the need for payloads more. With the housing market melting down, consumer savings depleting rapidly, and employer confidence falling fast, the Fed may soon have cover to soften their communication stance, if not their outright policy stance. Meanwhile, Q3 earnings estimates rose from 2.5% to begin the week to 4.1% to close the week, while key short-term interest rates fell–a delicious cocktail alluring enough to tempt longer-term investors once again!    

   

 

The Full Story:

 

Markets gained another 4% this week, now standing 12% above its most recent low, despite a soft GDP report, big tech earnings disappointments, and China’s political retreat from economic reform (I’ll hit each of these topics with more detail below). Because the globe worries most about tight monetary policy in the U.S. leading to financial instability, bad news is seen as good news if it subdues the Fed. And it may. The Bank of Canada raised rates 0.50% this week rather than the 0.75% expected, and the European Central Bank raised rates 0.75%, as expected, but softened their forward guidance. Relying on the 2-year U.S. Treasury bond as a proxy for Fed policy rate expectations, yields fell from 4.5% to begin the week to 4.4% to close the week. The 0.10% change may seem small, but in the current yield game, it’s the direction that matters!

 

Growth-ish

 

The U.S. Government released its preliminary Q3 GDP report this week. Encouragingly, the economy grew 2.6% overall in the second quarter. Discouragingly, energy exports, increased government spending, and smaller inventory builds accounted for the advance. Domestic final private demand, which excludes government spending, trade, and changes to inventories, grew a measly .08% — otherwise known as not at all, accounting for the weakest reading since the pandemic shutdown. Housing activity has collapsed under the weight of 7% mortgage rates, creating a major drag on GDP. Consumption, which accounts for the largest proportion of the economy, has also weakened considerably as COVID consumer savings levels evaporate. Consider these visuals on consumer savings (spending dry powder) along with consumer sentiment (spending enthusiasm):

 

 

A chart showing personal saving in the United States from 2014 - 2022 in billions of dollars

 

 

 

With consumers out of stimulus ammunition, housing investment collapsing, retailer inventories now replenished, and outsized trade contributions unlikely to last, the GDP report depicted an economy slowing, not growing, despite the campaign-able headline number.

 

Market De-Fangs

 

Disappointing earnings results from Google, Meta (formally known as Facebook), Microsoft, and Amazon punished their individual stock prices this week without infecting the stock market overall. Given the outsized influence of the Mega Cap technology names, this is an extremely healthy indicator. To put the scale of these behemoths into context, Microsoft and Apple account for 50% of the S&P 500 information technology sector’s market capitalization; Google, Meta, and Netflix account for 40% of the communication services sector’s market capitalization, while Amazon alone accounts for 31% of the consumer discretionary sector’s market capitalization. As a group, they comprise 20% of the entire S&P 500 market capitalization. For the FAANGs to fall while the market rises suggests a rotation of capital within the market AND more overall buying than selling market-wide. Additionally, the share price comeuppance informs big tech management that the rules of finance apply to them as well. This brutal rebuke will undoubtedly induce less bloated, entitled, conglomerated franchises, improve risk/reward characteristics for shareholders, and rebalance distorted index weightings overall. Having the vaunted FAANGs 4% lower on the week with the broad market 4% higher may be the most encouraging development of the year!

 

China Reddens

 

In an ominous video that broke the internet, former Chinese President Hu Jintao was forcibly ejected from the National Congress as Xi Jinping became “ruler for life.” This grotesque show of autocratic power led to a swift marketplace firesale on all assets Chinese, as Hu’s removal signified the removal of his economic reform and openness agenda. While Xi’s consolidation of power has war vigilantes abuzz about an imminent military invasion of Taiwan, having lived in Hong Kong, I will contend that China has much more subtle ways of reassuming territories, if so desired. More concerning is the abandonment of the Chinese grand bargain. The Communist leadership in China has believed for the last 40 years that enriching the population provided them the safety and security to rule. By consolidating power at the state level while broadcasting a confusing and encroaching array of regulations, the Communist Party seems less compelled to support economic growth and development as a pre-condition to rule and more inclined to direct development for political purposes under the force of rule. In response, the largest China exchange-traded fund (ticker: FXI) fell 10% on the week. For the global economy, this issue of China’s growth has larger implications. China has provided the bulk of worldwide economic growth for decades, and without China as an economic engine, growth rates worldwide will downshift. The middle-income trap that has limited many developing economies as legacy political systems restrict GDP per capita growth may have sprung in China. Let’s hope not… for growth’s sake!

 

Mail Call!

 

Across our models, we made numerous trades this week. Across thousands of accounts, we booked tax losses, rebalanced allocations, and put more capital to work where appropriate. These technical activities align with our year-end strategy outlined in our September 25th email:

 

Here is our year-end playbook:

 

  • Continue harvesting tax losses wherever possible
  • Reinvest proceeds to maintain market exposure
  • Add cash weekly or bi-weekly, and be fully allocated into asset allocations by Halloween
  • Should the market cascade lower between now and then, accelerate purchases

 

This explains the cascade of confirmations in your mailboxes. Remember, we invest our own personal assets within the same investment models we recommend for you. When we trade, it happens in our accounts and your accounts simultaneously. We are truly all in this together!

 

Have a great Sunday!

 

David S. Waddell  CEO, Chief Investment Strategist

 

 

 

Sources:  FRED, Advisor Perspectives

 

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David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.

Author

David S. Waddell

CEO

Chief Investment Strategist

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