February 12, 2023

Fly, Markets, Fly!

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Bottom Line:


Dramatic swings in investor sentiment from pessimism to euphoria drove markets up dramatically in January. This bodes well for returns on the year. Powell may re-evaluate his recession resolve if inflation continues to fall amidst economic resilience as the January Indicator dictates. However, rapid gains in sentiment such as this, require fundamental backfilling for rallies to persist. In the meantime, a rally respite seems in order as February returns usually lag. However, for those with excess cash and seller’s remorse, this provides an opportunity for involvement. Recent economic data shows encouraging strength and disinflation. While the Fed has prescribed recession to battle inflation, the correlation between inflation and unemployment has weakened considerably over the years. Any softening of Powell’s recession stance would certainly harden the market’s recent advance, thereby backfilling optimism with reality as we power on through 2023.


The Full Story:


Welcome to Superbowl weekend! The outcome of the matchup between the Philadelphia Eagles and the Kansas City Chiefs should hold great interest for football fans and investors alike. Historically, a win by the National Football Conference representative (Eagles) yields greater results than a win by the American Football Conference representative (Chiefs). Below are historical returns post-Superbowl:




The good news is that despite the outcome, markets tend to rise into year-end. Therefore, as a fan, root for whomever you prefer. But, for investors seeking higher returns, please root for the Philadelphia Eagles.



Fly, Eagles, Fly!



Rally Respite


January’s 6% return for the S&P 500 marked the strongest first month of the year since 2019, with the S&P 500 returning 8% that January. In 2019, the gains continued, with the S&P 500 closing up 30% by year’s end. While we remain optimistic for 2023, a 30% plus return seems somewhat unlikely. However, based on the often-referenced January Indicator, a strong January does have predictive value:




Over the last 50 years, January gains occurred 27 times. Ninety percent of those years ended positively, with the S&P up 20%, on average. However, when we add in negative performance from the previous year, the numbers become even more compelling:




Gains of more than 5% in January, after a year of negative returns, drive full-year returns to +30%, on average. So, while the January Indicator has an encouraging record, the combination of poor prior-year performance with strong January performance adds even more investor enthusiasm! Herein lies the problem.


As Warren Buffett quipped in 1987, “in the short term, the market is a voting machine, but in the long term, it’s a weighing machine.” Therefore, readings on market sentiment provide more reliable forecasts over shorter periods than fundamental readings. Over longer periods, the fundamental readings matter more. Those who follow our content will recognize that whenever I seek short-term trend guidance, I look to the state of retail investor sentiment. There are many available gauges on offer, but CNN’s Fear & Greed composite offers a good quick read:




At the current moment, January’s strong returns, after last year’s weak returns, have driven investor optimism to its highest level since late 2021. This does not suggest that markets stand poised to repeat 2022’s dismal performance, but it does indicate that a rally respite seems appropriate. Historically, February is the second weakest month of the year, with the second half of February dragging the most. Given the rapid move in sentiment from fear to greed over the past month, and the record volume of short covering pressing indices higher, this market needs to regroup and find fundamental reasons to rally further.


Fundamental Favor


The January jobs report surprised observers with its strength. Unemployment hit 3.4% in the US, its lowest level since 1969. Fortunately, average hourly earnings in January also fell, despite the surge in employment. This led Chairman Powell to recognize the “disinflationary” trend in a recent speech, surprising markets further. The combination of better-than-expected economic data amidst disinflationary trends seemingly defies economic logic. Adherents to the “Phillips Curve” orthodoxy that employment levels drive inflation levels seem incredulous at best and agitated at worst. In their vernacular, lower unemployment should drive higher inflation, and yet, it hasn’t:




Looking back, after the Great Financial Crisis, economic recovery drove inflation higher while the economy regained its productive footing. By mid-2011, inflation ran at 3.6%, even with unemployment of 9%. After a decade of economic recovery, inflation fell to 2.3%, while unemployment fell to 3.5%. Therefore, over the term of the most recent economic recovery cycle, inflation fell alongside unemployment. Post-COVID, the economic results have been greatly amplified due to the rapid collapse and the record policy response. Inflation surged far higher, and unemployment levels fell far faster. However, as the economy now normalizes, the Phillips Curve fallacy has reappeared. Inflation peaked in June at 9%, with unemployment at 3.6%. Since then, inflation has fallen toward 6% while unemployment has fallen even further to 3.4%. While the Phillip Curvians at the Federal Reserve have Powell’s attention, the data trends may have stoked Powell’s skepticism. This would explain the disconnect between the stronger-than-expected jobs report and Powell’s weaker-than-expected policy guidance. Chairman Powell may prove more independently-minded and pragmatic than expected. Removal of the Phillips Curve filter removes the recession requirement to combat inflation. And that’s a fundamental truth worth rallying over.


Enjoy your Sunday!


David S. Waddell  

CEO, Chief Investment Strategist




Sources:  FRED Database, Bloomberg, Bespoke Investment Group, Carson Investment Research, FactSet



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.


David S. Waddell


Chief Investment Strategist

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