“You must learn that the market is a discounting mechanism, and that stocks sell on future and not current fundamentals.” – Stan Weinstein
After a terrible year for investors, January returns were robust across the board. All of the major stock market indexes we follow were up at least 7% (with the Dow Industrials the lone exception, increasing “just” 2.83%). The Aggregate Bond Index, down more than 13% in 2022, posted a January return north of 3%. The losers for the month were commodities and the US dollar.
All data as of 01/31/2023, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
One rather interesting aspect to the markets has to do with the change of the calendar year. On January 1st we are all, essentially, back to even for the year on our returns, regardless of what the previous year looked like.
If you were up 27% (or down 27%) at the close of business on December 31, you were now at 0% on January 1.
We bring this up because the market can take on a completely different mentality at the start of the new year. It is much easier to have a different perspective on the same world when you are back at 0% returns.
Case in point: January 2023.
Did anyone really have the S&P 500 up more than 6%, led by beaten up technology stocks on their bingo card? After a year where the index was down 18.4% and the bond market index was off 13%? We don’t think so.
But that’s the thing about the markets – they will do what many of us least expect.
In part, the start of every year has the advantage of new money flowing into the stock market from a number of sources. There are investors who did tax loss selling in December and have capital to redeploy. Other investors lost interest over the December holiday season and are getting back at it. After a bad year for equities, the cumulative affect of rebalancing can bring flows into the stock market.
Put another way, there are reasons for new money to finds its way into the stock market at the beginning of the year that have nothing to do with the underlying fundamentals.
But that new money only goes so far.
Which brings us back to a new mindset when the calendar page turns.
Think about it – whatever kind of year you are having, come December you are thinking about what that number will be when the ball drops in Times Square at 11:59pm on December 31. You aren’t thinking about the next 10 years or even the next year. The focus is on how will this year end for me.
None of that is there on January 1.
And on January 1, all of a sudden, the big picture can be seen with much clearer eyes.
Coming off an almost unprecedented year with both the stock market and bond markets off substantially, the world didn’t look so bad at the start of 2023:
- The economy ended 2022 much stronger than expected
- The jobs market continues to chug along
- Inflation is higher than desired but continues to move lower
- Company earnings expectations are currently flat to down slightly for 2023, not as big of a break as some were expecting just a few months ago
- Poor markets in 2022 result in better/lower valuations on equities at the start of 2023
- Cash investments – money markets, Treasury Bills and Bank Issued CDs – now pay much higher interest rates than they have for more than a decade
- Bond yields are much higher than they were a year ago
The question this leaves us with is this: Was January an indication of a good year to come or a brief stop higher before more market losses?
Stock Market Cycles and the January Barometer
When thinking about the big picture for the stock market we like to start with the big market cycles. Not a perfect science by any stretch of the imagination, thinking within the structure of a market cycle can help suppress the noise of the day-to-day market action and keep the bigger picture in perspective.
Two of the most important to us are:
- The January Barometer: First mentioned in the 1967 edition of the Stock Trader’s Almanac, it theorizes that the returns in January for the stock market indices predict how the rest of the year will go. Put another way, if January is up, expect a positive year.
- The Presidential Election Cycle Theory: Also developed by Yale Hirsch at Stock Trader’s Almanac, suggests that there are patterns that appear over the four-year and sometimes eight-year cycle. The first and fourth year are the worst while the second year is about recovery and third years are when stock market’s peak.
So, with this as the background, from an historical perspective, 2023 has a better than average chance to be a good year for investors as stock indices across the board posted positive returns.
What About Bonds?
After more than 15 years of historically low interest rates the Federal Reserve Bank (The Fed) aggressively increased short-term rates in 2022. The Fed Funds Rate moved from around zero to above 4% in less than 12 months.
When interest rates increase, the value of bonds decreases. As a result, bond investors had what can only be described as a terrible year.
As crazy as this may sound, we were telling clients that this was exactly what we wanted to see happen!!! Not the terrible year part – that was just a biproduct of the big move up in yields.
What we wanted to see happen was the reset for rates at historically normalized levels, at least on the short end of the yield curve.
Longer-term rates are still below where they should/could be as the yield curve is inverted with 10-year Treasuries paying 0.53% less than 2-year Treasuries (Chart #3).
So, the reset in rates that we were rooting for happened, but not completely. At least for now.
The question is, how do rates resolve themselves in the coming months? With no indication that the Fed will be cutting rates in the 2023, how long can the bond market stay inverted?
At some point short rates need to come down or long rates need to move higher.
What About My Asset Allocation?
This is the million dollar question. How you distribute your investments between different asset classes plays a big part in how you do over the long-term. Hold mostly stock funds and you will have more volatility but higher returns. Increase the levels of bonds and “alternative” asset classes and your returns will be lower but volatility will be lower.
There is no one correct answer to what your asset allocation should be. That is defined by two factors – where you are in life and your risk tolerance. We work with some 30-something year olds who are more risk averse than a number of our 80-year old clients. Balance the asset classes properly for your situation and you have an appropriate risk-reward balance.
One big misnomer about asset allocation, in our opinion, is the idea that the allocation is fixed, not fluid. Take 60/40 stocks to bonds, for example. At Magellan Financial that can be, at times, 64/36 or 55/45. This can happen due to market performance increasing one side of the portfolio, or a calculated shift in how the assets are invested.
During bear markets our goal is to preserve as much capital as possible for our clients. During bull markets it is to increase account values. This should not be taken to mean “cashing out” and “waiting for the markets to feel better” when markets are bad. Nor does it mean going all in on the stock market during boom times. What it is, is something much more nuanced.
In our experience, tactical asset allocation – rebalancing holdings within a range to take advantage of market prices and strengths – is a better method of managing your investment risk and reward.
Are You Sure Timing the Markets Doesn’t Work?
Some investors try and time the markets because the think they are smarter than the markets. Others move to cash in bad times because they don’t understand that time in market more important than timing of the market. Going to cash is not tactical investing.
We get it, the idea of market timing sounds great. Get the upside of the stock market, hide out in cash as the stock market indexes lose value, then get back in when all is clear.
Of course, for things to work out that way you would need to have some pretty good timing over and over again. Jumping in and out of the market increases the number of decisions you have to make. More decisions give more opportunity to make a wrong move. The stock market can be funny like that – what you think SHOULD happen doesn’t mean it WILL happen.
All it takes is one wrong move.
Now, throw in the fact that trading in such a style goes against our natural emotions. Can you really trust yourself to sell when everyone is buying and buy wen everyone else is selling?
No. Seriously. Can you?
But don’t take our word for it, the data proves our point. The average investor underperforms the S&P500 index by more than 3.5%. And according to a DALBAR study, in 2021, a year in which the S&P500 rose 28.71%, the average equity fund investor underperformed by more than 10%.
Bottom Line: Yes, we are sure market timing doesn’t work.
Perspective can be a funny thing. In many cases, Investors are feeling much better about their portfolios at the start of February 2023 than they did just one month ago.
The reason for the change in sentiment? Very positive gains for the month.
This is a good thing, and we are positive on the markets this year. While we do not think it will be smooth sailing all year (which it rarely is), we do believe that 2022 was a normal stock market correction that happened to coincide with a rest in the bond market.
Asset allocation works again. The 60/40 portfolio isn’t dead. Nor is whatever the proper allocation for you and your family.
Paying attention to the markets and the financial world is important, long-term financial success is the result of how much you save and how you allocate your savings.
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On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. Any other referenced entity is a separate entity from WFAFN.
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