Despite a nice gain on Friday, the overall US Market lost over 3% last week, coming off two consecutive weekly gains (Morningstar, Nov. 2022).

  • Growth stocks led the decline last week at -6%, while value stocks lost about 1% (Morningstar, Nov. 2022). Commodities and emerging markets had nice gains of 5% and 4%, respectively (Morningstar, Nov. 2022).
Key events this week include Thursday’s Consumer Price Index (CPI).

Looking at the return tables, there are clearly some interesting stories for trailing performance:

  • Over the last year, Value has outperformed Growth by nearly 40% (using Morningstar total market indices).
    • Over the last 12 months, Value is now down less than 1% (Morningstar, Nov. 2022).
    • The only major asset classes beating Value over the last year are Cash (+1%) and Commodities (+16%) (Morningstar, Nov. 2022).
  • More importantly, because it drives investment flows (even on OPS), Value last week caught Growth on the 3-year number (as of last Friday, it’s now 7%/year for Value vs 6%/year for Growth) (Morningstar, Nov. 2022). If this sticks at month-end, and especially quarter/year-end, it may shape investor interest and flows.
The interest rate markets continue to be a major driver of stock market performance, flows, and economic activity:
  • Last week Ten-year Treasury yields finished at 4.16% (up 15 basis points over the last week); the highest yield last week was 4.22% (Yahoo! Finance, Nov. 2022).
    • The 2-year to 10-year yield curve has inverted to its widest levels in 40 years (meaning 10-year lows are lower than two-year yields) (Yahoo! Finance, Nov. 2022). This is obviously not common and a predictor of economic weakness.
    • More “worst year since…” stats on the bond market. According to BeSpoke: “The Bank of America 10+ Year US Treasury Index declined 6% in October. That marked the third straight monthly decline of 5%+ and the 9th monthly decline in the last ten.  To put these moves in perspective, going back to 1977, the only other time the index even declined 5%+ in back-to-back months was in the first two months of 1980. Similarly, the most number of months that the index was ever down in a ten-month span was in 1994 when it declined in eight out of ten months, so the current period of weakness is unprecedented.” (Nov. 2022)
  • The yield to maturity on the Bloomberg Aggregate Bond Index also rose last week to 5.10%, as of October 28, 2022 (up 15 basis points).
  • The average money market yield rose another 11 basis points last week, finishing at 2.96% as of October 28, 2022 (Crane Data).
  • The average 30-year fixed mortgage rate rose 3 basis points last week to 7.23% (Bankrate, Nov. 2022).
  • Treasury announces new Series I bond rate of 6.89% for the next six months (CNBC, Nov. 2022).
Deeper Dive

Looking for some positive news? How about how the stock market performs after mid-term elections? According to data from RenMac going back to 1950, we haven’t seen a loss in the following 12 months yet (Nov. 2022).

Last week’s losses were partly fueled by the Fed remaining aggressive on rate hikes. While the pace of rate hikes is aggressive, the level of rates really isn’t that crazy. It could be argued that the 0% rates for years WAS the crazy part! You can find this information in a chart from Independent Vanguard Advisor on “Fighting Inflation Agressively” (Jan. 2022).

Some are drawing parallels of this market environment to the environment 20 years ago after the dot.com bust. You can find a good chart from Strategas (published by Blooomberg on October 29, 2022) that shows how the top six largest issues (all tech names in both instances except for Wal-Mart 20 years ago) performed in the years after they peaked. After the dot.com bust, it took six years for the top names to find a bottom in prices (Bloomberg, Oct. 2022). If history repeats itself, this could suggest more absolute (not just relative) price weakness from the FANG stocks in the years ahead.

On that last point, is Apple invincible – or next in line for a price markdown? Apple is now worth more than Google, Facebook (Meta) and Amazon combined (ProfGalloway.com, Nov. 2022)! This tidbit came from Scott Galloway’s latest weekly missive "Elephants in the Room".

Here’s a plus for the economy. According to one of Ben Carlson’s excellent daily “A Wealth of Common Sense” commentaries last week, the consumer remains strong. First, despite the higher interest rates, the household debt service is still near 40-year lows (A Wealth of Common Sense, Nov. 2022). Impressive.

In addition, consumers have a lot of cash – also, near multi-decade levels (Federal Reserve, Nov. 2022).

Flows into ETFs remain hot. The Financial Times has an article about inflows in US ETFs this year vs. outflows of mutual funds. In short, “expect to see the (mutual fund) outflows only worsen as more investors start tax planning and move out of their mutual funds into ETFs to avoid any embedded capital gains they might have to pay” (Financial Times, Nov. 2022).

Fortifying that last bullet on ETF sales, here’s a comment from Strategas: “U.S. equity ETF inflows posted a 7-month high with over +$63 Bn during October.”

All-Star Charts notes that roughly $300 billion has flowed into equity ETFs this year. Meanwhile, investors have put about $150 billion into the bond ETFs.

Isn’t that last bullet on outflows from Commodities fascinating?! Especially on how real assets have outperformed over the last few years (even outperforming US stocks 14%/year vs 8%/year over the last three years) (All-Star Charts, Nov. 2022). On that point, AcreTrader provides more on how various asset classes perform in different economic environments with its “Real Assets Have Performed Well in High Inflation Environments” chart (Nov. 2022).

This is a big week for inflation data, but here’s another storm cloud: diesel fuel shortages (Markets Insider, Oct. 2022). I drive a diesel. I feel that pain. The average price is $5.31/gallon and the situation is "rapidly devolving" (AgWeb, Oct. 2022). This isn’t just inflationary, but diesel shortages could also put a crimp on distributing goods across the country, which would be another factor for slowing the economy.

Why a strong labor market matters to inflation – the close relationship of wages and inflation. Check out the chart in A Wealth of Common Sense article on November 1, 2022: “Why Today’s Inflation is Not a Repeat of the 1970s”.

A couple of key points on Inflation and Fed policy from Capital Group’s economists Darrell Spence and Jared Franz:

  • Most historical tightening cycles have not ended until the real fed funds rate was solidly in positive territory (Capital Group, Nov. 2022). The fed funds rate was 5% to 6% for most of the mid-1990s, with lower inflation than current levels (Capital Group, Nov. 2022).
  • Inflation may remain stubbornly higher than the market and the Fed anticipate (Capital Group, Nov. 2022). Weakness in the housing sector and other areas suggests price pressures should be easing, but inflation reports for the past few months have surprised to the upside (Capital Group, Nov. 2022). There appear to be numerous longer-term drivers of structural inflation that could persevere, including elevated inflation expectations, the lingering impact of household savings accrued during the pandemic, the climate transition, geopolitical risk, and companies bringing supply chains closer to home. It is a realistic scenario that inflation could remain above the Fed's target of 2% for an extended period. In the extreme, inflation could persist at 5% structurally (Capital Group, Nov. 2022).
Here’s a cool tool: FedWatch tool from CME Group. What’s it showing now?
  • Basically 50/50 chance of 50 or 75 basis point hike in December (CME Group, Nov. 2022).
  • Less than 1% chance that rates will be lower a year from now – or more than 200 basis points higher (CME Group, Nov. 2022).
The Hartford Funds on bear market history: “Rather than trying to time the market, here are a few items to consider staying invested for the next bull. Here’s what you need to know.” 
  • This bear may still have a lot of fight left: In the eight bear markets accompanying a recession since 1956, the average drawdown was 37%, and the average length of a drawdown was 16 months (Hartford Funds, Nov. 2022).
  • One sign of a potential bottom for stocks may be bottom-quartile cheapness relative to history (Hartford Funds, Nov. 2022).
  • To prepare for the next bull market, cyclically oriented stocks such as value and small caps historically lead immediately following bear markets (Hartford Funds, Nov. 2022).
Economic data for last week included the Federal Open Market Committee (FOMC) meeting where the benchmark interest rate was raised by another 75 basis points to a range of 3.75%-4.00% (Wall Street Journal, Nov. 2022). As for the economic calendar posted by Calculated Risk this week
  • Thursday, November 10: Consumer Price Index (CPI). Consensus is for a 0.7% increase in CPI for a year-over-year increase of 8.0% (Calculated Risk, Nov. 2022).
  • Veterans Day Holiday: Most banks will be closed in observance of Veterans Day. The stock market will be open.
In the good news department, the Atlanta Fed’s GDPNow‘s estimate for real (“after-inflation”) GDP growth (which uses actual economic data for inputs) for fourth-quarter 2022 is currently at 3.6% as of November 3, 2022.

As for earnings, third-quarter earnings according to I/B/E/S earnings data from Refinitiv:

  • 22Q3 Y/Y earnings are expected to be 4.3% and, excluding the energy sector, the Y/Y earnings estimate is -3.4% (Refinitiv, Nov. 2022).
  • Of the 428 companies in the S&P 500 that have reported earnings to date for 22Q3, 71.3% have reported earnings above analyst estimates (Refinitiv, Nov. 2022). This compares to a long-term average of 66.2% and prior four quarter average of 78.1% (Refinitiv, Nov. 2022).
  • During the week of November 7, 31 S&P 500 companies are expected to report quarterly earnings (Refinitiv, Nov. 2022).
I’ve been arguing that, while the housing sector wouldn’t be a source of growth in the year(s) ahead, it probably wouldn’t crush the economy for a while either. First, prices are still up year-over-year and are definitely up compared to recent years. Second, there was still a supply and demand imbalance that should provide support. I consider these buffers, but only for so long. Well, supply is catching up fast with demand (especially with lower affordability). In short, housing could now be the macro driver for 2023 – even WisdomTree’s Jeremy Siegel now feels that “The Fed needs to look at pending home sales, which are down 30% year over year and down 10% just for the month of September. Home prices had a tremendous stretch of strong gains—that is clearly over. Reverberations from a collapse in housing activity will be felt in 2023” (Nov. 2022).

Crypto Corner – Grant Engelbart, CFA, CAIA, Brinker Capital Sr. Portfolio Manager

  • Crypto prices gained more ground last week, with Bitcoin rising 2.5% to over $21,000 (CoinMarketCap, Nov. 2022). Ethereum added 1% to trade around $1,600. Polygon surged nearly 30% on news about rapid growth in its blockchain’s NFT usage as well as DeFi activity (next bullet) (CoinMarketCap, Nov. 2022).
  • Fidelity is launching crypto trading for retail clients (they already offer on the Institutional side) (Arcane Research, Nov. 2022). Coinbase reported lower trading volumes and revenue than expected but beat estimates on EBITDA and user data (Arcane Research, Nov. 2022). Instagram, Reddit, and Twitter all are pushing further into NFTs (Arcane Research, Nov. 2022). JPMorgan completed its first Decentralized Finance transaction on the Polygon network (Arcane Research, Nov. 2022).
  • No new digital asset ETF news this week (Decrypt, Nov. 2022)
Additional Resources

“Without pain there is no premium.” Portfolio manager, podcaster, quant extraordinaire Corey Hoffstein on investing (GoodReads, Nov. 2022).

Last week’s Orion's The Weighing Machine podcast was with Wellington Investments’ Ken Baumgartner on the infrastructure asset class. Not only is this asset class a potential hedge versus inflation, but it’s an area that has interesting return and diversification benefit potential in the years and decades ahead. On the next podcast (published on Tuesday morning), our guest is Andrew Beer from Dynamic Beta Investments. It’s a thought-provoking interview in several ways, including his view on alternative investment strategies, especially managed futures.

Be on the lookout for the next "Weighing The Risks" podcast that will be published on November 21. Our special guest is Kim Arthur from Main Management, and the topic is: “Geopolitical Turbulence: Prepare For The Future By Stress-Testing Different Scenarios”.

Speaking of podcasts, here’s a good recent one with two popular voices: Peter Attia (on health topics) and Arthur Brooks (author of “The Second Mountain”): "The Science of Happiness" 

Famous investor/trader Marty Zweig’s Investing Rules: 17 classic bullets from 1990 on investing, including managing risks, per Willie Delwiche’s November 2 tweet.

Good Validea article from four years ago that was revisited on November 4: Revisiting the case against value investing. In short, most of the arguments against value investing a few years now seem rebutted or at least checked, expect for the one argument that “Big Data is a Risk to Traditional Value” (Validea, Nov. 2022).

Speaking of risks, ever get questions about why Orion Portfolio Solutions (OPS) investment risk scores are higher than OPS investor scores (0-100)? There’s a good and intuitive reason for that – some investments are a lot riskier than the over-all stock market! Here are some bullet points on the topic – and a video!

  • The most aggressive option for the investor risk score (100) is investing entirely in the global equity market.
  • The global equity market has a risk score of 100.
  • Some investments, however, are riskier than the global equity market and thus have higher risk scores.   
  • If investors are selecting higher risk investments, they should diversify into lower risk investments to bring over-all portfolio risk back to appropriate levels.
  • Thus, the relationship between the investor and investment risk scores is intuitive, consistent with investment theory and fiduciary practice, and completely aligned. 
  • Short OPS Risk Video
Where do millionaires invest? It’s probably less equities than most would have guessed. It’s around 53% equities, which equates into an OPS risk score of approximately 60. That compares to the OPS average dollar invested of around 55% equities and a 62-risk score.

Where are the bulk of the investment dollars going in the decade(s) ahead? It’s the Gen Xers. They’ll be getting the inheritances and they’ll have the highest incomes. To know GenXers, you have to know their music! (Buzzfeed, July 2020).

Speaking of 80s music, how about these awesome 80s music album covers from Classic Pop Magazine article on May 24, 2022: “The best 80s album covers of all time.” I would have bet that #5 would have been #1 though.

Thanks for reading and have a great week! As always, please let us know what we can do better at rusty@orion.com or ben.vaske@orion.com. Invest well and be well.

For financial advisors to get this commentary delivered straight to your inbox, please subscribe at orionportfoliosolutions.com/blog.

 

2150-OPS-11/8/2022

Orion Portfolio Solutions, LLC, a registered investment advisor, is an affiliated company of Brinker Capital Investments, LLC, a registered investment advisor, through their parent company, Orion Advisor Solutions, Inc.

The CFA is a globally respected, graduate-level investment credential established in 1962 and awarded by CFA Institute — the largest global association of investment professionals. To learn more about the CFA charter, visit www.cfainstitute.org.

The CMT Program demonstrates mastery of a core body of knowledge of investment risk in portfolio management. The Chartered Market Technician® (CMT) designation marks the highest education within the discipline and is the preeminent designation for practitioners of technical analysis worldwide. To learn more about the CMT, visit https://cmtassociation.org/.

The CAIA® is the globally-recognized credential for professionals managing, analyzing, distributing, or regulating alternative investments. To learn more about the CAIA, visit https://caia.org/.