“I would also say it’s premature to discuss pausing and it’s not something that we’re thinking about. That’s really not a conversation to be had now. We have a ways to go. And the last thing I’ll say is that I would want people to understand our commitment to getting this (quelling inflation) done, and to not making the mistake of not doing enough or the mistake of withdrawing our strong policy and doing that too soon. So those—I control those messages and that’s my job.”
- Jerome Powell, Federal Reserve Chairman, November Federal Open Market Committee (FOMC)
Investors have been on the lookout for the Fed “pivot”, which would be a dovish signal indicating a more tempered pace of hiking interest rates to get inflation under control. During the November FOMC meeting investors got a pivot; just not the one they had been hoping to see. Powell pivoted from hawkish, to even MORE hawkish and raised the bar further on how aggressive the Fed plans to hike rates. This hawkish messaging from the Fed may have just effectively stopped the year-end stock market rally in its tracks. The ramifications for higher rates for a longer period increase the odds of a hard landing (recession) for the economy next year and may cause risk assets to struggle until inflation and jobs data turn decisively lower. We’ve taken portfolio risk back down and are comfortable waiting and watching for the time being.
On our Fourth Quarter update webinar back in early October, we made the case for a fourth quarter rally based largely on the Behavioral component of our investment process. Here is a view of our Dashboard at the time of the update. At the time, the setup was bullish for a tradeable rally as sentiment was depressed and institutional positioning was offsides. We also mentioned that the Macro and the Fundamental picture was not conducive to making a run at new highs. The economy remains late cycle, our models forecast consecutive QUAD 4s, (economic growth and inflation slowing), the Fed remains aggressive and a neutral valuation and earning picture need to resolve before a structural bull market can begin anew.
As we anticipated, October was a strong month for equity markets, as the S&P 500 rallied over 12% from the low on October 13, (Which happened to be the date of our last webinar!) before reversing lower during the Fed press conference. Here is what the dashboard looks like in early November. As you can see the extreme fear and light institutional positioning has somewhat normalized, while the macro and fundamental picture has not improved.
We also anticipated that while the Fed was far from a “pivot” or “pause”, the likelihood was that their next move would be incrementally dovish, in line with their global counterparts. After the November 2nd FOMC meeting, it is clear that this dovish view does not hold water. John Maynard Keynes, one of the great all-time economists is attributed this famous quote: “When the facts change, I change my mind. What do you do, sir?”
As a result of the developments at the FOMC meeting and given that the bullish extremes in the Behavioral pillar of our process are no longer present, we have taken the opportunity to lower risk in many of our portfolios and are comfortable holding higher levels of cash temporarily as we wait and watch for what is to come. In the short-term there is heightened risk around data releases for Nonfarm Payrolls and Consumer Price Index (CPI – inflation), which are likely to produce a binary yet impossible-to-predict outcome. We invest on behalf of our clients for the long-term, and the core of our portfolios will remain invested, however there are times when our process compels us to reduce risk tactically. This does not mean we go completely to cash, nor does it mean that our portfolios will be completely insulated from the gyrations of the market. In environments such as these the aim is to protect capital where we can, blunting the full downside of the market, so that when the setup is more conducive to taking risk, we can compound returns from relatively higher levels in order to help our clients achieve their longer term goals with a smoother ride than what a passive index may provide.
Thanks for reading my notes.
Cliff Hodge, CFA
Chief Investment Officer, Cornerstone Wealth
The S&P 500 Index, or the Standard & Poor's 500 Index, is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market capitalization because there are other criteria to be included in the index. The index is widely regarded as the best gauge of large-cap U.S. equities. Market indices are unmanaged and are not available for direct investment
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