November 13, 2022

The FOMO Rally!

Woman with long hair holding a smart phone; the words "FOMO - Fear of Missing Out" on the phone screen.
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Bottom Line:

 

Investors rushed into risk assets this week as inflation took a delightful turn lower. The storyline of “higher for longer” inflation pivoted to “lower faster” for the first time. This led to dramatically lower bond yields and dramatically higher stock prices. Adding additional support, the mid-term election results divided Congress thereby ending Washington’s inflationary spending spree. Lastly, with November underway, we have seasonally entered the strongest six-month period for investment returns. Remember, “risk” applies to being “out” of rising markets just as it applies to being “in” falling ones. For timid investors awash with cash, FOMO may have finally, and justifiably, kicked in.

 

The Full Story:

 

The Dow Jones Industrial Average rallied 1200 points on Thursday for its sixth largest single day point gain in history. A lower-than-expected inflation reading provided the spark, while low investor sentiment levels and high investor cash levels provided the fuel. But this rally has more than one positive inflation report at work. Recent developments have created a high degree of FOMO (Fear of Missing Out) for cash heavy investors. Let’s review just a few of the reasons why.

 

Election Disinflation

 

On Tuesday of this week the Republicans won back the House of Representatives, thereby ending the $5 trillion spending spree since the last election. This resolves the conflict between loose fiscal policy and tight monetary policy, removing a key inflationary rift. This also places singular pressure on the Fed to navigate tightening policy without inciting a credit crisis. In the event of a credit crisis/severe recession, a gridlocked Congress becomes less reliable as a bailout mechanism for the economy. The go it alone Fed must now take this into account as they consider degrees of restraint.

 

‘Tis the Season

 

Markets prefer divided government. Historically the combination of a Democratic White House and a divided Congress results in average annual returns of 13.6%.

 

The third year of a presidential term provides the highest returns of the four-year cycle. On average, the stock market has returned 16.8%. Breaking this down further, average returns for year 2 quarter 4 (where we are now) are 6.6%, year 3 quarter 1 are 7.4% and year 3 quarter 2 are 4.8%.

 

Bar graph showing quarterly returns on the S and P 500 from 1950 to 2020

 

Over the last 18 mid-term election periods, 18 had positive returns with markets 15% higher over the next year, on average.

 

According to the Stock Trader’s Almanac, we have just entered the strongest 6-month period for equity returns. Between November and April, stock markets have returned 7% on average and vault higher 80% of the time.

 

Investors who focus on probabilities rather than possibilities will recognize that the above data array constructs the strongest seasonal case possible for owning equities now.

 

The Inflation “Pivot”

 

Thursday’s cooler CPI data surprised investors. Within the report, goods prices dis-inflated faster than expected. Used car prices, for instance, fell 2.4% last month. Apparel prices fell as well, indicating that we may have finally entered the downslope from stimulus. An increase in rents offset these declines, but rents lag housing prices by months and housing prices began falling in August. Added together this introduces the “risk” that inflation may decelerate faster than expected. Not only is this possible, but it’s historically probable. Consider the rapid down slopes following peak CPI readings going back to 1948:

 

Chart showing the consumer price index for all urban consumers as US city averages from 1970 to 2020

 

The reason I say “risk” that inflation may decelerate faster than expected is because up until Thursday’s inflation report the “risk” was that inflation would be higher than expected for longer than expected. Yes, I know one number does not make a trend, but the mere introduction of a counterpoint led to massive repositioning as the stock market surged, treasury yields plummeted, and the dollar collapsed. Attention paid to the Fed policy pivot always seemed backwards to me, as it’s the inflation pivot that matters more, since the Fed clearly operates with a lag.

 

A More Patient Fed

 

At the last FOMC meeting, Chairman Powell laid out a three-dimensional framework for future rate decisions. The first dimension was speed which he signaled could slow from .75% in November to .50% in December. The second dimension was height, which he signaled could rise above 5% by March of 2023. The third dimension was length where he suggested holding rates higher for longer. The Dow fell over 800 points in response. But wait. The Fed said it will slow the pace of rate increases. That’s suddenly positive. If inflation falls faster than expected from here, it’s likely that they will not have to raise rates as much as projected nor for as long as projected. A slowing pace of rate hikes means more opportunity for inflation to surprise positively between hikes, as it did on Thursday.

 

Fallings Dollars = Softer Landings

 

The U.S. dollar index peaked at 114 on September 28th. It closed on Friday at (106). A 7% decline may not sound like much, but this change in direction after a relentless run removes significant financial stress worldwide. A lower dollar means a lower chance of an international credit event. A mild recession (already priced in) poses little threat to investors. But a recession and a credit event (not priced in) could inflict significant 2008 like damage. As the dollar declines, so does the risk of a “hard” landing.

 

Laws of Valuation Attraction

 

The S&P 500 trades for 16 times earnings. 100 companies within the S&P 500 trade for less than 10 times earnings. The S&P 400 mid-cap index trades at 12.5 times earnings. The S&P 600 small cap index trades for 11.7 times earnings. The international markets collectively trade for 11.4 times earnings. The emerging markets trade for 10 times earnings. Simply put, outside of U.S. technology names, stocks are cheap. History rewards investors “brave” enough to buy stocks at low valuations rather than high ones.

 

Taken together, favorable mid-term results, strong seasonality, lower inflation, dollar declines, Fed policy patience, and low valuations activated massive investor FOMO on Thursday. Will it persist? Unclear. But the odds of October 14th marking a meaningful bottom grow greater every trading day.

 

Have a great Sunday!

 

David S. Waddell  CEO, Chief Investment Strategist

 

 

 

Sources:  LPL Research, FactSet, FRED
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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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