“A stumbling block to the pessimist is a stepping stone to the optimist.”
– Elenore Roosevelt
After a fabulous January, the stock market indexes we follow pulled back last month. Overall, the losses were manageable and not unexpected, all things considered. The worst of the damage was in the Emerging Markets and the Dow Industrials. Commodities continued to weaken. The Aggregate Bond Index weekend on modestly higher yields. The Dollar, still down for the year, regained some of its previous losses.
All data as of 02/28/2023, 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.]
February is normally a hard month for the stock market and 2023 didn’t break the pattern. The equity indexes we follow were all down for the month, making sure you didn’t get overconfident after solid gains in January.
The stock market can be like that!!!!
The question as we head into March is a simple one: where do we go from here?
It can be easy to get overly complicated and deep into the weeds when thinking about the direction of the stock market.
Sometimes the best form of analysis is the simplest … and that is what we are going to do.
The Technical Case for Stocks
Chart #1 is a big picture look at the S&P500 over the past two years. From the start of 2022 through about mid-January there is a very clear downtrend that is represented by the straight blue line. The other blue line represents the 200 Day Moving Average (200DMA). In our viewpoint, when the market is above the line it is bullish, below is bearish.
In mid-January the S&P500 rose above both the downtrend line and the 200DMA, which is a positive occurrence.
After almost 5 weeks of strong increases, the index pulled back for most of February. This is also a positive. It is because the index remained above both the downtrend line and the 200DMA.
As we enter the month of March the move lower looks very much like the market is digesting the January gains, not a head fake and a return to lower prices.
Chart #2 takes the same chart and shows us a different perspective. In addition to the downtrend line, we have added the uptrend line off the October 2022 lows. Put the two together and you get a technical pattern referred to as a triangle.
The triangle is important in that this pattern shows a convergence of the two trends. This pattern shows a consolidation of price. It suggests that there will be a break in one direction or the other.
Taken together, we view the technical outlook for the stock market as having an upward bias.
To be clear, this is a strong opinion we hold lightly. While we believe that the odds are in favor of the triangle pattern resolving to higher stock prices, there’s no guarantee.
From a technical perspective, we enter March with a positive setup.
After a dip close to or maybe in a recession in the first half of 2022, the economy perked up in the second half of the year for a strong finish. Early indications are that 2023 has started out on a positive economic note.
This, even as there are continuous calls that a recession is coming.
Is it? Maybe. Maybe not.
What we do know is that companies have been reporting fourth quarter and full year 2022 earnings. Along with reporting what happened in 2022, most CEOs and CFOs will give their outlook for the coming year. Many discuss the trends in their industry as well as any positive or negative catalysts they see on the horizon.
From what we have heard and read from these companies paints a mixed picture:
- Pandemic-driven trends like 5G network buildout and cord-cutting have continued, the pace of growth has slowed down as demand was pulled forward when we were all cooped up at home. Companies have had to adjust. Most noticeable have been the layoff announcements from a number of the large technology companies.
- Retailers were hurt in 2022 by oversized inventory positions as consumer demand moved from buying things to doing things. The corollary to this was price increases at restaurants and all things travel-related (airline tickets, hotels, etc.). As the world continues to rebalance supply and demand we expect to see a promotional environment in the near future.
- Higher interest rates have started to have a negative impact on certain sectors. For those affected by it we are seeing adjustments made to keep profit margins and profitability on target.
- Both the energy and industrial sectors are in the meat of their cycle with a number of positives for the future. Energy is being driven by the war in Europe and the end of lower commodity prices and underdevelopment of new assets. Industrials are flush with orders as projects are moving forward in the United States and overseas.
Overall, some good and some bad, which we think makes sense.
What About Interest Rates?
Interest rates can have a significant on both company fundamentals and how the stock market values company stock.
Higher rates increase the cost of doing business for Corporate America. There have been more than a few companies with good products and services that have been taken down due to mismanagement of the balance sheet and debt structure.
Changes in interest rates also affect how the market values companies.
Generally speaking, the higher rates go, the lower multiple the market is willing to pay.
This is worse for growth companies that are expected to have much higher future earnings than they currently have. Expected earnings 5-10 years down the road are much more valuable when rates are at 2% than they are in a 6% world.
Value companies – those with lower, steady earnings growth – are affected but not as harsh.
The Federal Reserve Bank (The Fed) is not done with its rate tightening. What we don’t know – what we can’t know – is when will they stop increasing rates and how high rates will go.
Putting it All Together
It is very easy to take everything we just laid out for you with a negative connotation. When viewed through the pessimists eyes, the changes taking place daily, combined with the aftereffects from the pandemic, it is easy to view the skies as dark.
We do not agree with that point of view … not even a little.
We tend to think of each year as a standalone event. And if you think about it, every day/week/month/year is part of an ongoing continuum.
The world progresses forward. Eventually setbacks happen, then adjusts.
By taking this more optimistic approach, we believe, it is easier to understand where the stock market is in 2023.
Both 2022 and 2023 are what we consider to be transition years back to a more normal economic environment. An economic environment in which:
- Supply and demand are much closer to evenly balanced
- New technological innovations continue to make life easier and/or better for all of us
- Stable, normalized interest rates (not the high rates of the 1970s, or the unusually low rates of the past 15 years)
- Inflation is present but back at historically average levels
What we cannot give the precise timing of when we will be back to “normal” again.
For sure there won’t be the ringing of a bell to give you the all clear.
Instead, the financial world will just gradually start to feel less stressful and (dare we say it) better. With so many factors involved, it is hard to see it happening any other way.
Last year was a year of resetting the markets. We see 2023 as a stepping stone to the future for the stock and the bond markets. Years where there is little volatility and steady returns are fun times for investors. That is not what you should expect this year.
Fits and starts is the best way to describe it. There will be times you will feel pretty good, others unsure.
The economic numbers will be lumpy, not linear. One month the inflation report will be down, the next higher. Same with economic growth.
This year will be a year in which you need to put your head down and continue to move forward with your investment plan. Markets work in cycles. This is the year to remember that as an asset class equity pay better returns than other asset classes because of the volatility. Because of the cyclicality.
We truly believe it would be a mistake to hide in cash until it “feels better” to be invested. That’s market timing, not investing.
Think of 2023 as a stepping stone and not a stumbling block. Take what the markets are giving you as an opportunity to upgrade your investment portfolio to one built for the future, not the past.
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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.
Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.
Jonathan D. Soden, Partner Jon.Soden@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com