For a PDF version of the below commentary please click here Weekly Letter 1-30-2023

Callahan Capital Management

Weekly Commentary | January 30th, 2023

 

Major Theme of the Markets Last Week: Growth Rotation Continued

Throughout much of 2022, there was a pronounced move by investors out of growth-focused companies and into more value-oriented companies. This was seen at a general index level during 2022 with the NASDAQ being down more than 30 percent for the year while the more value-oriented indexes such as the S&P 500 and Dow were down 20 and 10 percent, respectively. These cycles of growth or value outperforming the other tend to be lengthy with some of the cycles lasting more than five or six years. However, the trend of value beating growth, which largely started during 2022, is being tested at this point. 2023 started out with investors piling back into large cap technology after having shunned it for many months. So far for 2023, the growth-related indexes have outperformed the more value-oriented indexes by a factor of four, with average growth indexes up nearly eight percent while value indexes are up only two percent. While there are a number of theories as to why this is the case, the Federal Reserve is certainly playing a role.

 

During the fourth quarter of 2022, investors were fearful about how high the Fed would have to raise rates. The raising of rates increased the cost of capital for companies that depend heavily on debt to finance their operations. This is something that technology companies tend to utilize more so than value-focused companies. Research and development, as well as costs to stay on the cutting edge of technology while potentially not having a significant customer base, force many technology companies to the debt and private equity markets. When investors thought that rates would need to go much higher to stop inflation, they drove down the values for technology stocks. Now that we have gotten into 2023 and we see that the Fed’s previous actions have resulted in inflation slowing down in many cases and in some instances actually reversing course and moving lower, the expectations for the cost of debt for technology companies has come down. This thought process in turn means that many technology companies were overly sold during 2022 and set up nicely for the bounce that we have seen so far in 2023. “Will this trend continue?” is the question that everyone is asking. For growth to continue outperforming value in a meaningful way, we would need the Fed to quickly slow down the pace of its rate hikes and, by the end of 2023, actually begin cutting the Fed funds rate. While this scenario is not impossible, it is a difficult one to navigate as there would need to be many pieces falling exactly into place. With the first FOMC meeting of 2023 taking place this week, we should get a good idea of how Fed Chair Powell thinks about what has happened with the economic data and the economy since the Fed’s last meeting back in 2022 and he could provide some insight into what the Fed is considering going forward. Until this meeting, there has been no official talk by the Chairman about the possibility of cutting rates at some point in 2023. Chair Powell’s line has been that the Fed will need rates to stay high for a long period of time to combat inflation; just how long is what everyone is theorizing about.

 

Financial News Impacting the Markets

 

One of the factors in the continued rotation out of value and into growth last week was earnings, as investors had to contend with the busiest week of the Q4 2022 earnings season so far. Below is a table of some of the better-known companies that reported earnings last week with companies that beat expectations by more than 10 percent highlighted in green while companies that missed expectations are highlighted in red:

 

3M

-3%

General Electric

12%

Progressive

1%

Abbott Laboratories

14%

IBM

0%

Raytheon

2%

AT&T

3%

Intel

-50%

SAP

-27%

Automatic Data Processing

1%

Intuitive Surgical

-2%

ServiceNow

13%

Blackstone

11%

Johnson & Johnson

6%

SherwinWilliams

3%

Boeing

-3600%

Lockheed Martin

5%

Tesla

9%

Canadian National Railway

-1%

Marsh & McLennan

5%

Texas Instruments

9%

Comcast

5%

Mastercard

4%

U.S. Bancorp

8%

CSX

4%

Microsoft

2%

Union Pacific

-3%

Danaher

17%

NextEra Energy

2%

Valero Energy

13%

Freeport McMorran

30%

Norfolk Southern

0%

Verizon

-1%

General Dynamics

1%

Northrop Grumman

14%

Visa

8%

 

The earnings figure that drew my eye first in the above table was Boeing as a -3,600 percent is certainly eye catching. Boeing was expected to post a small gain of $0.05 when looking a earnings per shares. The company posted a loss of $1.75. While one may reasonably expect that such a miss would cause the stock to tank, Boeing actually traded higher for the day when it announced earnings. This is largely because investors have gotten used to wild movements in earnings from Boeing due to vast amounts of uncertainty surrounding regulatory issues as well as COVID-19. The big positive for Boeing during the fourth quarter of 2022 was that China allowed the resumption of Boeing MAX planes to fly in China. This is something that was seen as very positive for the company and something that investors have been waiting for years to occur. 

 

Looking at other data points in the above table, large cap technology saw very mixed results. Microsoft beat expectations slightly while Intel badly missed. IBM posted results that were very close to expectations while Tesla handedly beat expectations. Large defense contractors, General Dynamics, Raytheon and Lockheed Martin, all turned in better than expected quarters as demand for their products have increased around the world with the war in Ukraine. One negative theme last week was seen in the railroad companies as less product being moved around the U.S. during the fourth quarter led to lower earnings across the industry.

 

According to FactSet Research, we have seen 29 percent of the S&P 500 component companies report their results for the fourth quarter of 2022. Of the 29 percent that have reported, 69 percent have reported earnings that beat expectations while 31 percent met or missed expectations. The percentage of companies beating earnings remains below the one-, three- and five-year averages. When looking at revenues, 60 percent of companies that have reported have beaten expectations while 40 percent have fallen short. The blending earnings growth rate so far for the S&P 500 currently stands at -5 percent, a decline of 0.4 percent from this time the prior week. This week, earnings season remains in high gear with more than 500 companies reporting their results. Below is a table of some of the better-known companies that are set to report with companies highlighted in green having the largest potential market impact:

 

Advanced Micro Devices

Exxon Mobil

Moody’s

Air Products and Chemicals

Ford Motor

Novartis

Alphabet

General Motors

Pfizer

Altria Group

Gilead Sciences

Phillips 66

Amazon.com

Honeywell

Qualcomm

Amgen

Humana

Shell

Apple

Illinois Tool Works

Starbucks

Becton, Dickinson

Marathon Petroleum

Stryker

Boston Scientific

McDonald’s

Estee Lauder

Bristol Myers Squibb

McKesson

Thermo Fisher Scientific

Caterpillar

Merck & Co.

T-Mobile

Chubb Limited

Meta Platforms

UBS

ConocoPhillips

MetLife

United Parcel Service

Eli Lilly

Mondelez International

Waste Management


We will see if large cap technology companies can deliver on their earnings this week as the biggest of the big are set to report. Apple, Alphabet, Amazon and Meta could change the overall tone of their earnings season this week. Many of the high-tech companies have recently announced hiring freezes or layoffs and it will be very interesting to see how they describe such actions if 2023 is going to be a strong year. After the strong results from Tesla last week, investors will be looking for how EV sales were at both Ford and GM during the fourth quarter as both companies ramped up their shipments of EVs.

 

Aside from earnings last week, investors had to contend with a large amount of economic data being released, related to inflation, the U.S. economy and consumer spending. The big release of the week was the Personal Consumption Expenditure (PCE) index as it is one of the favorites of the Federal Reserve when evaluating inflation levels. Expectations for the December reading were that the inflation rate would remain at the 5.5 percent annualized rate we saw in the November data. However, last week the December data came in better that expected at 5 percent. This release solidified the idea that the Fed will only be raising rates by 25 basis points at the FOMC meeting this week.  Durable goods orders came in better than expected last week, as did the University of Michigan’s consumer sentiment index, adding to the positive feeling about the current state of the U.S. economy. The final significant positive economic release last week came in the form of the preliminary GDP print for the fourth quarter of 2022, which posted a 2.9 percent reading, ahead of the expected 2.6 percent but below the 3.2 percent we saw in Q3 2022. On the negative side last week in the economic data, personal spending was shown to have declined more than expected during December and the U.S. PMI manufacturing data remained in contraction mode for the month of January.

 

The final focus of the U.S. markets last week was the Federal Reserve. Fed officials were in a quiet period so all talk about the Fed was purely speculation. Could we see the continuation of the Fed pivot this week at the FOMC meeting? Markets expect only a 25 basis point hike at this meeting and another 25 basis points at the following meeting followed by a period of no movements in rates until closer to the end of 2023 when the Fed will cut rates. Following four rate hikes of 0.75 percent during the middle of 2022 (June through November), the Fed stepped down to a hike of only 50 basis points at the December 2022 meeting. If the market is correct and the Fed decreases the size of the hike to only 25 basis points, it would probably add to the idea that the Fed is very close to being done raising rates and we could see the equity markets move higher. As is usually the case, the initial move in the markets based on the rate decision can be tested during the press conference that Chair Powell holds following each meeting. The markets are waiting to hear anything about the potential for a rate cut later this year and while Chair Powell is unlikely to say much more than the Fed is data dependent and will evaluate the situation as more data is received, he could tease the markets a bit about future movements with how exactly he addresses the topic of a potential rate cut.

 

Market Statistics

 

  • Equities: The equity markets received a boost last week from economic data showing inflation continuing to slow and an earnings season which, while not great, has not been as bad as some feared. The rotation out of value and back into technology was apparent when looking at the index performance last week as the NASDAQ led the way higher on higher-than-average volume. The S&P 500 came in second while the small cap Russell 2000 took the third spot in the ranking of performance. The Dow came in last as the index was held back by industrials giants IBM and 3M, both of which declined by more than 4.5 percent last week following earnings.

 

  • NASDAQ (4.32%) – Above Average volume
  • S&P 500 (2.47%) – Average volume
  • Russell 2000 (2.36%) – Above Average volume
  • Dow (1.81%) – Above Average volume

 

  • Sector Performance: The rotation out of value and into technology companies with earnings reports was the primary driver of sector performance last week when looking at the best performing sectors. Semiconductors led the sector performance higher last week despite the poor earnings reported by Intel. Consumer Discretionary came in second place as Visa and MasterCard both turned in solid quarterly numbers, numbers that continued to show consumer resilience among middle and upper end consumers. Technology in general took third with Tesla playing a big role as the stock was up more than 33 percent last week following its quarter earnings release. Software made the top five sectors last week, largely due to IoT companies turning in strong earnings numbers. Rounding out the top performing sectors last week was the Aerospace and Defense sector which saw both positive and negative earnings last week, but ultimately the positive earnings outweighed the negative.

 

When looking at the bottom five performing sectors of the markets last week there were two significant themes: sectors that are value-oriented and sectors that performed well on a relative basis at the end of last year. Consumer Goods, Utilities and Consumer Staples are three defensive sectors of the markets and sectors that investors were selling last week to fund purchases of large cap technology companies. Medical Devices as well as Healthcare overall were two sectors of the markets that investors had moved into late last year, figuring they would be the hot sectors of the market for 2023. This, so far, has not been the case.

 

  • Top Sectors: Semiconductors, Consumer Discretionary, Technology, Software, Aerospace & Defense
  • Bottom Sectors: Consumer Goods, Utilities, Consumer Staples, Medical Devices, Healthcare

 

  • Commodities: Commodities were mixed last week as Oil broke its streak of two weeks of gains by posting a modest decline. The Goldman Sachs Commodity Index (a production weighted index) decreased 1.35 percent for the week as Oil declined 2.87 percent as future demand remains uncertain and big oil companies started to report earnings. Metals were negative last week as Gold, Silver and Copper declined 0.04, 1.54 and 0.97 percent, respectively, in an environment of low trading volume. Metals trading was more subdued last week than most as activity from China was very limited due to the lunar new year holiday. Soft commodities were positive last week with Livestock posting a gain of 0.59 percent while Grains advanced 1.09 percent. Agriculture overall posted a gain of 2.37 percent last week.

 

  • GS Commodity Index (-1.35%)
  • Oil (-2.87%)
  • Livestock (0.59%)
  • Grains (1.09%)
  • Agriculture (2.37%)
  • Gold (-0.04%)
  • Silver (-1.54%)
  • Copper (-0.97%)

 

  • International Performance: Last week was a largely positive week when looking at global market performance as we saw 75 percent of the global markets posting gains while 25 percent declined. The average return of the global indexes last week was 0.71 percent. When looking at the global index performances for the previous week, the strongest regions of the globe focused on Asia, excluding China (China was closed all week for the new year celebrations) and the USA. When looking at regions of the world that underperformed last week, the Middle East and the Mediterranean were at the bottom of the list.

 

  • Best performance: Laos’s Laos Composite Index (7.87%)
  • Worst performance: Turkey’s BIST 100 Index (-5.44%)
  • Average: (0.71%)

 

  • Volatility: Last week, the VIX continued to meander lower on each consecutive day as the markets’ “Fear Gauge” remains near the bottom of the trading range that we have seen over the past 12 months. As the VIX moves lower, it appears the direction of the movements is correct on a daily basis. However, the magnitude of the moves in the VIX seem to be smaller. While this phenomenon isn’t unusual, it does tend to set up more wild movements in the future when there is an event that causes fear to rise for investors. The VIX closed last week at 18.51 after declining by 6.75 percent. A reading of 18.51 implies a move of 5.34 percent over the course of the next 30 days for the S&P 500. As always, the direction of the movement is unknown.

Model Performance and Update

 

For the trading week ending on 1/27/2023, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2023

Since 6/30/2015

(Annualized)

Aggressive Model

0.27%

1.48%

3.98%

Aggressive Benchmark

1.93%

6.63%

5.43%

Growth Model

0.13%

0.88%

3.52%

Growth Benchmark

1.51%

5.19%

4.57%

Moderate Model

0.00%

0.18%

3.05%

Moderate Benchmark

1.09%

3.75%

3.62%

Income Model

-0.10%

-0.23%

2.89%

Income Benchmark

0.57%

1.98%

2.30%

Quant Model

1.07%

4.47%

S&P 500

2.47%

6.02%

9.39%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week but there were a number of core equity positions that reported their latest results. The companies reporting results included Johnson and Johnson (JNJ), McCormick (MKC), Arthur Gallagher (AJG), and Canadian National Railway (CNI). It was a mixed bag for earnings results among these four companies, with two beating expectations for earnings and two beating expectations for revenues. Starting with the easy one, AJG beat on both the top and bottom lines as the company continues to perform very well and is growing its business through acquisitions and strong policy renewals. CNI saw earnings slightly miss expectations while revenues beat expectations, but the company is well set for 2023 as it modernizes and works toward being a more efficient railroad company. JNJ posted strong earnings for the fourth quarter, but revenues slightly missed expectations as its COVID-19 vaccine saw less demand than had been anticipated. MKC missed on both the top and bottom lines, in what the executives on the analyst call called a very difficult quarter. The company is not used to posting results that miss expectations. However, inflation of raw materials combined with continued global logistical issues and price increases hit the company during the quarter. According to management, peak inflation for the company should have happened either late last year or early this year. Price increases have already been put in place late last year and the company doesn’t foresee needing more increases any time soon. Management also thinks that with the current mix of products and pricing, the company should be able to make back all of the lost revenues to inflation and then some over the remainder of 2023. With such a negative quarterly surprise, the stock is automatically put on my concerned watch list where it will be watched for signs of either positive or negative developments.

 

This week is another busy week for earnings being reported of core equity holdings in the hybrid models as there are five companies reporting: McDonalds (MCD), Church & Dwight (CHD), Otis Elevators (OTIS), Quest Diagnostics (DGX) and Zimmer Biomet (ZBH).

 

Looking to the Future

 

  • FOMC meeting: This week is the first FOMC meeting of 2023
  • Earnings: Large cap technology is on deck to report this week
  • ECB: Meeting, with an increase in rates expected
  • Bank of Japan: Rate setting meeting

 

Interesting Fact: Where has the snow gone?

New Yorkers know that every year won’t bring a white Christmas, but by late January, the city has usually seen enough powder for sleds and snowball fights to make an appearance.

That is not the case this winter. It has been 50 years since the city has waited this long for the first measurable snowfall of the season. It’s a record-tying absence that has made many residents at turns grateful, wistful and worried.

 

Source: New York Times, Kimiko de Freytas-Tamura

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

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For a PDF version of the below commentary please click here Weekly Letter 1-23-2023

Callahan Capital Management

Weekly Commentary | January 23rd, 2023

 

Major Theme of the Markets Last Week: What Will the Fed Do Next?

Last week was a holiday shortened trading week due to the markets being closed on Monday, but that didn’t stop Federal Reserve officials from taking advantage of the four regular business days to get out in front of the week and a half long quiet period leading up to the February 1st FOMC meeting. The U.S. financial markets have been keenly listening to all of the speeches that Fed officials have been giving over the past few months and last week was packed with eight different speeches given by seven different members of the Fed. In almost all of the speeches last week, there seemed to be consensus building that Fed officials are getting comfortable with the idea that they need to slow down on the pace of rate hikes and allow for the hikes that have already been made to work their way through the U.S. economy. On Friday, Fed Governor Christopher Waller said the “central bank’s rate increases are aimed at slowing inflation by reducing demand, and there is ample evidence that this is exactly what is going on in the business sector.” This is a pretty big change from one of the most hawkish members of the Fed. At this time last year he, along with James Bullard, were banging the table about needing to aggressively raise rates to combat the coming inflation. St. Louis Fed President James Bullard last week was the only Fed official to keep with the hawkish tone saying that the Fed needs to get the Fed funds rate up to 5 to 5.25 percent as fast as possible and urged Fed members to keep with the quick rising rates policy until those numbers are achieved. While President Bullard is certainly interesting to listen to, this year he is not a voting member of the FOMC as there are several seats that rotate among regional Bank Presidents and Saint Louis is not a voting member for 2023. So, while President Bullard may be very verbose in his talking about what the Fed should do, he has no actual vote when it comes time to vote.

 

Federal Reserve Vice Chair Lael Brainard last week endorsed a quarter point hike at the upcoming meeting, citing the time it takes for the full effects of a rate hike to take place. She also said that raising rates by a smaller increment “gives us [the Fed] the ability to absorb more data…and probably better land at a sufficiently restrictive level.” With a little over one week to go before the FOMC meeting, we have rarely seen such a consensus in the CME Group FedWatch tool as to what will occur at the upcoming meeting. Currently, there are odds of 99.8 percent that the Fed will increase rates by 0.25 percent and the 0.2 percent chance isn’t that the Fed will raise rates by 0.5 percent but rather that it will leave rates unchanged at the meeting. This is a tremendous change from a month ago when the Fed had a higher than 35 percent chance that it would raise rates 0.5 percent and no chance that it would leave rates unchanged. Looking out one more meeting, the Fed is expected to raise rates an additional 0.25 percent at the March meeting, bringing the Fed Funds rate up to 4.75-5 percent, at which time the FedWatch tool predicts that the Fed will hold rates at those levels for several meetings. This is what Chair Powell has been saying in speeches as well as his after-meeting press conferences for the past few meetings and it looks like it will be coming to fruition baring some unforeseen event causing him to veer off course. One aspect of the Fed’s thinking that could change this course is dramatic changes in the economic data, as the Fed remains largely data dependent.

 

Financial News Impacting the Markets

 

The Fed received a lot of new data points last week to help guide its thinking about what it should do next with both positive and negative data being released. On Tuesday last week, the New York Empire Manufacturing Index posted a reading of -32.9 for the month of January after posting a -11.2 in December. This reading was much worse than anticipated and is the worst reading that we have seen on the greater New York Manufacturing index since the height of the COVID-19 pandemic back in early 2020. Also in the New York report was the factors that brought the number down so much with weakness in activity and new orders being the primary culprits. The Philadelphia manufacturing numbers were not much better when they were released on Thursday although they are not down to levels seen back in early 2020. Both of these manufacturing reports confirm what we saw in the ISM Manufacturing numbers two weeks ago when it showed a general decline in manufacturing in the U.S. with falling manufacturing employment numbers as well as falling demand for U.S. manufactured goods.

 

The manufacturing data wasn’t the only data that caused concern last week as the retail sales figures for the month of December, released on Wednesday, badly missed their mark. After posting a decline of one percent for the month of November, expectations were for a slower decline in December with retail sales falling only 0.8 percent. However, retail sales for the month of December posted a decline of 1.1 percent. Core retail sales also posted the same decline of 1.1 percent during the month of December. This is a concerning figure as December is typically one of the strongest months of the year for retail sales as it makes up the bulk of the holiday shopping season. We thought consumers appeared to be pulling back a little based on retailer comments when compared to previous years for holiday shopping but having the figures confirm the suspicions caused the markets to sell off on Wednesday. The Housing data released on Thursday and Friday last week also continued to show weakness with both building permits as well as housing starts both lower in December than they were in November. Existing homes sales came in slightly above expectations but still showed a decline when compared to the prior month. The news wasn’t all bad on the economic front last week, however, as the Core Producer Price Index (PPI) came in as expected at 0.1 percent while the overall PPI posted a decline of 0.5 percent, a larger drop than expected. Both of these figures add to the idea that inflation has rolled over and is moving in a downward direction, likely giving the Fed enough room to slow the rate hikes and wait to see how far down inflation will go given all of their actions thus far.

 

Recession fears were stoked last week as investors watched the inverted yield curve. Last week, all eyes were on the 10-year Treasury and the 3-month T-bill as the inversion spread to a width of 1.18 percent. With the 3-month T-bill paying an annualized rate of 4.66 percent and the 10-year Treasury paying only 3.48 percent at the same time, we saw the widest gap (inversion) that we have ever seen looking back through the Fed’s data going back to 1982. The yield curve inversion signals have now been occurring for almost a year in one form or another and we have yet to officially see a recession. It is this fear of a coming recession—soft landing, softish or hard landing—that is constantly being wrestled with by investors. Equity markets are pricing in a soft landing at this point though the probability of such as event is pretty small. In fact, it has never been accomplished when the Fed is in a rate hiking cycle. More typically, the Fed overdoes the rate hikes, pushing the U.S. economy into a recession, during which the Fed has to cut rates to stabilize things once again. Maybe with all of the data and smart minds at the Fed this time will be different and the Fed will successfully pull off the feat of squashing inflation while keeping the labor market steady and not causing a recession.

 

Another risk to the financial markets came into focus last week in Washington D.C., where there is always the potential for fireworks. On Thursday, Treasury Secretary Yellen sent a letter to Congress to let them know that the U.S. debt ceiling had been officially hit and that the Treasury was beginning to take “extraordinary measures” to keep paying bills on time. While these measures can certainly last for many months, there is a very real risk that the government could default on its debt as there appears to be no consensus in Washington D.C. to move legislation forward to increase the debt ceiling, suspend the debt ceiling or do away with the debt ceiling all together. Currently, the political leadership in both parties are very far apart on many fiscal topics and with the very weak Speaker of the House and the fractured Republican party, it is uncertain whether these groups will come together to stop a default. The positive in all of this is that the Treasury will not run out of money quickly. Treasury Secretary Yellen will also go before Congress several times between now and when the Treasury runs out of funds asking for bipartisan support in keeping the government paying its bills. There are also some untested theories and tactics that could be attempted by the administration that could circumvent Congress’s inaction should a default be imminent.

 

While everything else was occurring last week, earnings season kicked up a little. Below is a table of some of the better-known companies that reported earnings last week with companies that beat expectations by more than 10 percent highlighted in green (there were none) while companies that missed expectations are highlighted in red:

 

Charles Schwab

-3%

Netflix

-74%

Prologis

2%

Goldman Sachs

-37%

PNC Financial

-12%

Schlumberger

3%

Morgan Stanley

5%

Procter & Gamble

1%

Truist Financial

2%

 

The above table is pretty ugly. Very few weeks do we see a table that only has red an no green. Financials were mixed in their results last week, much like the results of other members of the sector two weeks ago. Goldman Sachs was particularly hard hit as it experienced very high expenses and a drought in investment banking revenues during the quarter. An announcement from Goldman that it will be “significantly” reducing its asset management arm of alternative investments over the coming years could help provide some more stability to the company’s earnings in the future. Netflix missed earnings expectations by a wide margin, but the miss was largely due to a loss in some of its Euro denominated debt that it took during the quarter. Subscriber growth during the fourth quarter beat expectations as the new ad support tier of programming was added to their platform during the quarter. The bigger news last week out of Netflix than earnings was that 25-year CEO Reed Hastings will be stepping down and the CEO position will be split between two executives whom have been working together with Hastings for the past 15 years. The last major media company to have the CEO step down was Disney when then CEO Iger handed the reigns to Bob Chapek, a move that was reversed late last year when Bob Chapek was fired. Hopefully, Netflix can have a more successful handoff.

 

According to FactSet Research, we have seen 11 percent of the S&P 500 component companies report their results for the fourth quarter of 2022. Of the 11 percent that have reported, 67 percent have reported earnings that beat expectations while 33 percent either met or missed expectations. The percentage of companies beating earnings is currently below the one-, three- and five-year averages. When looking at revenues, 64 percent of companies that have reported have beaten expectations while 36 percent have fallen short. The blended earnings growth rate so far for the S&P 500 currently stands at -4.6 percent. This week, earnings kicks into high gear with more than 500 companies on deck to report their earnings for the fourth quarter of 2022. Below is a table of some of the better-known companies that are set to report with companies highlighted in green having the largest potential market impact:

 

3M

Danaher

Norfolk Southern

Abbott Laboratories

Freeport-McMoRan

Northrop Grumman

American Express

General Dynamics

Progressive

AT&T

General Electric

Raytheon Technologies

Automatic Data Processing

Intel

SherwinWilliams

Boeing

IBM

Tesla

Canadian National Railway

Intuitive Surgical

Texas Instruments

Charter Communications

Johnson & Johnson

Blackstone Group

Chevron

Lam Research

U.S. Bancorp

Colgate Palmolive

Lockheed Martin

Union Pacific

Comcast

Mastercard

Valero Energy

Crown Castle

Microsoft

Verizon Communications

CSX

NextEra Energy

Visa

 

Many bellwether stocks will report this week and it could set the tone for the rest of earnings season for many sectors. Microsoft will be closely watched as the company announced a large round of layoffs last week, following suit with many other high technology companies over the past few weeks. Visa, American Express and MasterCard will be closely listened to by analysts and investors alike to see if they have any up-to-date information about consumer spending trends as they typically have some of the best spending trend data available as they process so many transactions each and every day.

 

Outside of the U.S. last week, all eyes were on Davos, Switzerland, as the World Economic Forum held its annual meeting of business and political leaders from around the world. The overwhelming theme in the media reports from Davos this year was caution by the elite that attended the meeting. They are cautious about the situation with the Fed in the U.S., about the war in Ukraine, about China reopening and about a potential global recession occurring during 2023. One big test will be China reopening as China begins the weeklong celebration of the Lunar New Year this week and we could see a fallout spread of COVID-19 as a result of so many people traveling in China this year.

Market Statistics

 

  • Equities:S. equity markets were mixed last week as investors dealt with a large amount of Fed speak as well as mixed signals in the economic data. Large cap technology continued to push higher last week as the NASDAQ was the only index that managed a positive return for the week. The S&P 500 came in second, Russell 2000 third and the Dow last. The Dow struggled last week as a decline of more than 8 percent by Goldman Sachs and 6 percent for 3M proved too much for other component companies to overcome.

 

  • NASDAQ (0.55%) – Average volume
  • S&P 500 (-0.66%) – Average volume
  • Russell 2000 (-1.04%) – Average volume
  • Dow (-2.70%) – Below Average volume

 

  • Sector Performance: The continued rotation into large cap technology drove some of the sector performance for the week last week. Telecommunications led the way higher thanks in large part to a gain of more than 9 percent by Match.com and Alphabet (Google) posting a gain of more than 6 percent. These moves, combined with other large cap technology companies, helped drive Technology overall into the second-best performing sector and Software into third for the week. Oil & Gas Exploration benefitted from earnings reports last week that increased expectations for the sector overall during the remainder of earnings season. Rounding out the top five performing sectors last week was the Mortgage Real Estate sector which benefitted from the expectation that the Fed is close to being done with raising rates.

 

When looking at sectors of the markets that underperformed last week, many of them were low risk sectors of the markets that investors had been hiding out in at the end of last year when technology was selling off. These sectors included Utilities, Insurance and Consumer Goods which took three of the bottom five spots last week. Broker Dealers made the bottom performing list last week thanks in large part to Goldman Sachs, as mentioned above in the earnings section of this commentary. Multimedia Networking rounded out the bottom five sectors last week as Inseego posted a weekly decline of nearly 15 percent while Calix dropped by more than 11 percent.

 

  • Top Sectors: Telecommunications, Technology, Software, Oil & Gas Exploration, Mortgage Real Estate
  • Bottom Sectors: Consumer Goods, Utilities, Multimedia Networking, Broker Dealers, Insurance

 

  • Commodities: Commodities were mixed last week as Oil made it two weeks in a row of gains. The Goldman Sachs Commodity Index (a production weighted index) advanced 1.61 percent for the week as Oil gained 2.14 percent almost entirely due to increasing demand coming from China. Metals were mixed last week as Gold and Copper gained 0.30 and 2.07 percent respectively while Silver decreased by 1.39 percent. Much of the movement in metals last week was due to Chinese demand ahead of the Chinese New Year. Soft commodities were negative last week with Livestock posting a loss of 0.59 percent while Grains declined 0.51 percent. Agriculture overall posted a loss of 0.61 percent last week.

 

  • GS Commodity Index (1.61%)
  • Oil (2.14%)
  • Livestock (-0.59%)
  • Grains (-0.51%)
  • Agriculture (-0.61%)
  • Gold (0.30%)
  • Silver (-1.39%)
  • Copper (2.07%)

 

  • International Performance: Last week was a mixed week when looking at global market performance as we saw 51 percent of the global markets posting gains while 49 percent declined. The average return of the global indexes last week was 0.22 percent. When looking at the global index performances for the previous week, the strongest regions of the globe focused on China, Asia Central and South Eastern Asia. When looking at regions of the world that underperformed last week, the USA and Europe were at the bottom of the list.

 

  • Best performance: Turkey’s BIST 100 Index (10.14%)
  • Worst performance: Pakistan’s Karachi 100 Index (-4.75%)
  • Average: (0.22%)

 

  • Volatility: Despite the near certainty of the Fed’s next actions at the upcoming FOMC meeting, the VIX advanced last week by more than 8 percent up to 19.85. The gain in the VIX was largely seen on Wednesday after the poor retail sales figures were released. A reading of 19.85 implies a move in the S&P 500 over the next 30 days of 5.73 percent. As always, the direction of the movement is unknown and should be seen as a more general gauge of volatility. If we do venture close to the possibility of a U.S. government default, we could see the VIX spike significantly higher as fear will take over many investors’ decisions.

Model Performance and Update

 

For the shortened trading week ending on 1/20/2023, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2023

Since 6/30/2015

(Annualized)

Aggressive Model

-0.41%

1.21%

3.96%

Aggressive Benchmark

-0.23%

4.62%

5.18%

Growth Model

-0.50%

0.71%

3.51%

Growth Benchmark

-0.17%

3.61%

4.38%

Moderate Model

-0.62%

0.18%

3.06%

Moderate Benchmark

-0.10%

2.63%

3.48%

Income Model

-0.73%

-0.13%

2.91%

Income Benchmark

-0.02%

1.40%

2.23%

Quant Model

-0.10%

3.36%

S&P 500

-0.66%

3.47%

9.06%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week. We did see earnings season kick off for the core equity positions as Proctor and Gamble (PG) released its results. PG beat on both the top and bottom lines for the fourth quarter but saw a decline in profits and sales volume. Much of the decline in sales volume was due to a price hike of 10 percent on many of the company’s product lines during the fourth quarter as the company attempts to balance out passing along price hikes from its suppliers and taking a hit on its profits and margins in the short-term, hoping that things work out over the longer term. During the analyst call, CEO Jon Moeller pointed out that demand remains high for higher-end products but that higher-end shoppers are looking for more deals. The company has seen increasing demand for both smaller packages of products as well as bulk items such as those sold in warehouse and club stores. This week is a busy week for earnings in the core equity positions in the hybrid models. The companies reporting results include: Johnson and Johnson (JNJ), McCormick (MKC), Arthur Gallagher (AJG), Church and Dwight (CHD), and Canadian National Railway (CNI).

 

Looking to the Future

 

  • Politics: The debt ceiling debate could start this week in Washington D.C.
  • Q4 GDP: The U.S. releases the preliminary Q4 GDP print on Thursday, expected to be 2.6 percent growth.
  • Inflation Data: PCE data is released on Friday and is the last inflation reading prior to the Fed’s FOMC meeting the following week

 

Interesting Fact: Letters in Numbers

Letters A, B, C and D do not appear anywhere in the spellings from 1 to 99 (one, two, …, ninety-nine), while letter D comes for the first time in 100 (hundred).

Letters A, B and C do not appear anywhere in the spellings from 1 to 999, while letter A comes for the first time in 1000 (thousand).

Letters B and C do not appear anywhere in the spellings from 1 to 999,999,999, while letter B comes for the first time in 1,000,000,000 (billion).

Letter C does not appear anywhere in the spellings from 1 (one, two, … , ten, twenty, … , hundred, … , thousand, … , million, … , billion, … , trillion, … ) until (octillion).

Source: Cityu.edu.hk

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

 

 

 

 

For a PDF version of the below commentary please click here Weekly Letter 1-17-2023

Callahan Capital Management

Weekly Commentary | January 17th, 2023

 

Major Theme of the Markets Last Week: Up and Away

U.S. equity markets last week moved higher for the second trading week of 2023, driven by inflation figures that came in as expected, Fed officials speaking and the resumption of the idea that the U.S. economy really could pull off a “softish” economic landing during 2023. Last week saw a continuation of what we saw two weeks ago with stock prices increasing while bond yields declined, the U.S. dollar weakened, and the risk of a recession came down.

 

The week started out with Chair Powell speaking in Sweden early Tuesday morning to a forum on Central Bank independence, but his prepared remarks held no information about the U.S. economy or monetary policy. His speech was all about the role of the Fed needing to be independent of politics and not be tied to goals such as climate change. He did veer slightly into current policy when he said, “Restoring price stability when inflation is high can require measures that are not popular in the short term as we raise interest rates to slow the economy. The absence of direct political control over our decisions allows us to take these necessary measures without considering short-term political factors.” U.S. equity markets quickly read this as negative, pushing prices lower as markets opened for trading on Tuesday, but they quickly turned around and moved higher for the rest of the day.

U.S. equity markets rallied the rest of the week, notching four consecutive days of gains on each of the major indexes. The inflation data released on Thursday was one of the main driving forces behind the movement late in the week as the numbers all came in almost exactly as expected. This is somewhat rare as there are normally misses here and there in the trove of government releases as there are many different indexes and ways of measuring inflation related to Consumer Price Index (CPI). Last week, however, almost every single data point was as expected; inflation slowed down from December when compared to November, and it was the third month in a row showing such a decline. When we first saw a slight decline in the monthly Core CPI data back in October, investors thought that, while nice, it was only a single data point. The November data point moving lower made it a second point, but two points don’t make a trend. Now, however, we have three data points in a row on the Core CPI data that show a slowing each month and that is certainly a trend. Overall CPI on an annualized basis has been declining for an even longer time as it peaked with the June 2022 reading at 9.1 percent and has now, in December, come all of the way down to 6.5 percent. These declines have been substantial and a very welcome sight for the Federal Reserve which is seeing the results of its actions and falling commodity prices (specifically gasoline and oil) greatly reduce inflation rates here in the U.S. While some areas of the inflation data are moving in the correct direction, food inflation is still a significant problem for many Americans who are dealing with prices that just keep moving higher. Recently, it has been the price of eggs, in part due to sickness causing the removal of a large portion of the egg laying population in certain regions of the U.S., that has caused many Americans concerns. Even taking into account food inflation, however, it is clear that inflation is coming down. Now the question remains as to whether the Fed will overdo it with rate hikes and kill the U.S. economy.

 

The Fed has recently been very clear that it will be raising rates at the next FOMC meeting, being held in about two weeks. From recent statements and the CME FedWatch tool, it looks like the Fed will raise rates 25 basis points at the February 1st meeting. The question that investors are wrestling with is what happens after that meeting. The fixed income market is currently pricing in that the Fed will pause raising rates after that meeting and by the end of the year will begin to cut rates. This, however nice it sounds, just isn’t what the Fed has been telegraphing for months. Rates will stay higher for longer until the Fed is sure that inflation is dead. So far this cycle, the Fed has been clear and has done what it has said it will do, so why would the Fed begin to deviate from what it is saying at this point in the cycle?

 

Financial News Impacting the Markets

 

Oil prices rose last week, gaining a little more than eight percent and pushing back up to near $80 per barrel on WTI crude. This move was interesting because it was attributed to the inflation data, with the thinking being that if inflation slows down and prices start to decline on some items, that leaves more money for buying gasoline and potentially stronger demand for gas as a result. This, combined with rising demand for fuels in China as the country continues to forge ahead with reopening, could put upward pressure on future U.S. inflation data readings, causing a bit of a catch 22 situation. OPEC+ and Russia have been largely quiet recently when it comes to the price of oil on the global markets and the price cap that has been put in place on exported Russian oil so we will have to wait and see what develops.  

 

Earnings season officially kicked off last week with several of the big banks getting things rolling. Results of the big banks were mixed with JP Morgan and Bank of America beating expectations on both the top and bottom lines while Wells Fargo beat on earnings and missed on revenues. Citigroup missed on earnings expectations and posted inline revenue figures for the fourth quarter of 2022. The earnings numbers were not what drove headlines for the group, however. It was the fact that during the fourth quarter, the big four banks added $2.8 billion to their potential loan loss reserves. Loan loss reserves are typically raised ahead of what the banks think will be more difficult economic times. When JP Morgan CEO Jaime Diamond was asked about this, he said that the bank was getting ready for a recession and that “It may be a mild recession. It may not be.” Obviously wanting to err on the side of being too cautious, this tone set by the big banks seemed to dampen the already lowered expectations for the quarter. According to FactSet Research, the current expected growth rate for the S&P 500 is -3.9 percent for the fourth quarter of 2022. This is a huge decline in expectations as of September 30th, 2022, for the fourth quarter earnings when they were expected to be +3.5 percent. The decline in earnings expectations isn’t due to just one sector really having a difficult quarter as it is all ten of the major sectors of the S&P 500 having been revised significantly downward.

China made headlines last week as the country continues to reopen despite a wave of COVID-19 continuing to sweep through the country. Over the past weekend, China released its 2022 GDP figure which came in at 3 percent, the lowest growth rate for the country since the COVID-19 year of 2020 when China posted a 2.2 percent growth rate. We are about a week away from the Chinese New Year celebrations (2023 is the year of the Rabbit), which officially lasts 16 days this year, but only during the first seven days do most Chinese workers have time off. The world is watching to see what happens to the spread and mutations of COVID-19 during the holiday week in China, as it is typically a time for many people to travel and see relatives. These activities and gatherings have been something that most people in China have not been able to do for the past few years due to COVID-19. Historically, the year of the rabbit has been good for stock markets around the world. The last five years of the Rabbit have seen the S&P 500 here in the U.S. average a 17.67 percent gain. This year, that figure seems very lofty.

 

Last week, the World Bank announced its economic projections for 2023 and they were not positive. However, they were overlooked by investors. The World Bank lowered the overall global GDP rate to 1.7 percent from its June 2022 projection of 3 percent for 2023 GDP. The U.S. specifically was hard hit in the projections with the World Bank now seeing U.S. GDP growth of only 0.5 percent for 2023. The numbers that the World Bank project is the third weakest growth rate for the global economy in the last 30 years behind only 2020 (COVID-19) and 2009 (Great Recession). The World Bank is just the latest of the global financial institutions calling out higher risks for the global economy during 2023. One wild card that has been pointed out in many of the projections for 2023 is the situation in Ukraine. If the war in Ukraine comes to an end quickly and peace is returned to the region, this could be a positive catalyst for the region and have far reaching impacts on agriculture markets around the world. The likelihood of this is pretty low, however, as Russia seems determined to continue its mission in Ukraine despite a multitude of battlefield setbacks over the past few months.

 

Market Statistics

 

  • Equities: Equity markets moved higher for the first full trading week of 2023 as investors were buying areas of the markets that were the hardest hit during 2022, including large cap technology and smaller growth-oriented stocks. Volume picked up on three of the four major indexes with only the Dow seeing volume not in the “above average” range for the week. Last week was also the second week in a row for gains on the four major U.S. indexes, the first time that we have seen this since early December.

 

  • Russell 2000 (5.26%) – Above Average volume
  • NASDAQ (4.82%) – Above Average volume
  • S&P 500 (2.67%) – Above Average volume
  • Dow (2.00%) – Average volume

 

  • Sector Performance: Sector performance was all driven last week by a risk-on and risk-off trade that permeated throughout the markets. The risk-on sectors of the markets all rallied throughout the week with Semiconductors, Technology in general and Software making up three of the top five performing sectors. Mortgage Real Estate came in second as bond yields continued to fall last week. Basic Materials made the top five list as increasing demand coming from foreign buyers, especially China, have recently been pushing up all of the basic material prices and expectations of strong future demand post-COVID continues to be the best-case scenario playing out.

 

When looking at sectors that underperformed last week, the classic defensive sectors, Healthcare and Consumer Goods, took two of the bottom five performing spots. Pharmaceuticals made the list as well as Pfizer fell more than 6 percent ahead of news about a potential safety issue with the new, updated COVID-19 vaccine and an increased risk of stroke. Insurance made the bottom five performing sectors last week as the sector was negatively impacted early in the week as bond yields fell and didn’t really stage much of a recovery when yields came back a little on Friday. Rounding out the bottom performing sectors last week was the Aerospace and Defense sector which was hurt on Friday by a Goldman Sachs research note that pushed Lockheed Martin from a hold to a sell rating as the investment firm thinks the bloated defense spending of the past few years will be reigned in by the current composition of Congress.

 

  • Top Sectors: Semiconductors, Mortgage Real Estate, Technology, Basic Materials, Software
  • Bottom Sectors: Pharmaceuticals, Healthcare, Insurance, Aerospace & Defense, Consumer Goods

 

  • Commodities: Commodities were mixed last week as Oil made a comeback. The Goldman Sachs Commodity Index (a production weighted index) advanced 5.91 percent for the week as Oil gained 8.05 percent. The gain in Oil was almost exactly the amount that the liquid gold declined two weeks ago. The primary drivers behind the gain last week were the opposite of what caused Oil to decline two weeks ago; a falling fear of a recession and increasing demand due to falling inflation. Metals were positive last week as Gold, Silver and Copper increased by 2.91, 1.87 and 6.84 percent, respectively. Much of the movement in metals last week was due to Chinese demand ahead of the Chinese New Year. Soft commodities were mixed last week with Livestock posting a loss of 0.92 percent while Grains advanced 2.42 percent, once again on increasing Chinese demand. Agriculture overall posted a small loss of 0.15 percent last week.

 

  • GS Commodity Index (5.91%)
  • Oil (8.05%)
  • Livestock (-0.92%)
  • Grains (2.42%)
  • Agriculture (-0.15%)
  • Gold (2.91%)
  • Silver (1.87%)
  • Copper (6.84%)

 

  • International Performance: Last week was a strong week when looking at global market performance as we saw 82 percent of the global markets posting gains while 18 percent declined. The average return of the global indexes last week was 1.60 percent. When looking at the global index performances for the previous week, the strongest regions of the globe focused on the USA, Europe and North Africa. There were no specific regions of the world that underperformed last week as the underperformance was concentrated in underdeveloped Third World countries around the world.

 

  • Best performance: Laos’s Laos Composite Index (10.46%)
  • Worst performance: Turkey’s BIST 100 Index (-6.68%)
  • Average: (1.60%)

 

  • Volatility: Last week, the VIX broke down below 19 for the first time in several weeks. In looking back at the historical chart of the VIX, last week the VIX also broke down through the area of support for the previous five spikes downward that we have seen in the markets’ “fear gauge.” We are now at a level on the VIX that has not been seen in the past 12 months and there is very little technical support levels around these prices. While it is nice that the VIX is so low on a relative basis, it is normally when investors get complacent with risk in the markets that we see a spike higher. For the week, the VIX declined by a little more than 13 percent ending the week at 18.35. A reading of 18.35 implies a move of 5.3 percent for the S&P 500 over the next 30 days. As always, the direction of the movement is unknown.

 

Model Performance and Update

 

For the trading week ending on 1/13/2023, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2023

Since 6/30/2015

(Annualized)

Aggressive Model

0.01%

1.62%

4.02%

Aggressive Benchmark

3.02%

4.87%

5.22%

Growth Model

-0.14%

1.22%

3.59%

Growth Benchmark

2.36%

3.80%

4.41%

Moderate Model

-0.29%

0.80%

3.15%

Moderate Benchmark

1.70%

2.73%

3.50%

Income Model

-0.43%

0.60%

3.01%

Income Benchmark

0.88%

1.42%

2.24%

Quant Model

0.93%

3.46%

S&P 500

2.67%

4.16%

9.18%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were two changes to the hybrid models over the course of the previous week, both adding to the overall risk being taken in the models. The first change was to take a second step into the Franklin Templeton International Low Volatility High Dividend ETF (ticker LVHI). International stocks have been benefitting from the weakness that we have seen in the U.S. dollar recently as well as significantly better valuations on many of the publicly listed companies. LVHI currently has a distribution yield of 7.7 percent, and has been just over half as volatile as the S&P 500. LVHI also posted strong performance last year, gaining nearly 4 percent while the S&P 500 was down almost 20 percent. The second change last week to the hybrid models was the addition of an initial position into the WisdomTree European Small Cap dividend ETF (ticker DFE). European stocks last year were hit hard with small caps being harder hit than many of the larger companies. Despite the pressure, there were many small cap companies that maintained their dividends and some that increased them. These companies are currently trading at very low multiples of earnings, in some cases less than half of their U.S. counterparts. The fund has been on the watchlist for several months and last week the fund broke out above a level of resistance that it has been unable to breach in the past. The fund currently has a distribution yield of about 5.8 percent. If the fund continues to perform well, there will be two subsequent steps that will be taken in order to make a full position in the fund. This week, earnings season for core equity positions within the hybrid models kicks off with Procter & Gamble. Expectations have been set pretty low for the company and analysts will be closely watching their margins and price increases during the quarter to see how it is impacting their overall sales.

 

Looking to the Future

 

  • Davos World Economic Forum: Davos starts this week, and the gathering of business and political leaders is closely watched by investors around the world
  • Economic Data: PPI and retail sales are set to be released this week; both could meaningfully move the markets
  • Fed Speak: There are nine scheduled speeches by Fed officials this week, including Fed Hawk James Bullard, who is no longer a voting member of the Fed

 

Interesting Fact: Cows Moo in Regional Accents

Language experts have suggested that cows have regional accents just like humans. According to the BBC, this phenomenon was first detected by dairy farmers who noticed that their cows had different moos, depending on what herd they came from. Very moooo-ving indeed.

 

Source BBC.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

 

 

 

For a PDF version of the below commentary please click here Weekly Letter 1-9-2023

Callahan Capital Management

Weekly Commentary | January 9th, 2023

 

Major Theme of the Markets Last Week: Sort-of Santa

Last week was the last chance for the Santa rally that many investors had been hoping for as we start 2023. Technically, the definition of the Santa rally, which has been correct about 75 percent of the time in predicting the direction of the markets for the year ahead, is the final five trading days of the year and the first two trading days of the new year. There are some varying definitions in terms of exactly the number of days to count due to markets being closed on normal trading days during that time, but the final five and first two is generally accepted. For the time period this year, three of the four indexes posted gains while the NASDAQ was the sole laggard of the group. The Russell 2000 posted the strongest gain, advancing a little more than one percent while both the S&P 500 and the Dow were near a three quarters of a percent gain. The NASDAQ declined by seventeen basis points. Coming out of a bear market, which almost all investments and indexes experienced during 2022, the lack of a strong conviction move in the markets made it feel that, yes, Santa showed up so that is positive, but it didn’t change many people’s thinking that 2023 will be a bit of a rollercoaster.

 

The next big saying that investors will be watching for is, “As goes January, so goes the year.” According to S&P Dow Jones indexes, the saying has been correct 71 percent of the time going back to 1929. We have a lot of uncertainty coming in January, everything from politics to a weak earnings reporting season kicking off and potential signals from the Fed about its future actions. The jobs report on Friday gave the markets a bit of a bad-news-is-good-news situation but no one knows if the Fed will read the data the same way, so we will have to wait and see what unfolds over the next three weeks and then we will have a second stock market adage in the books for 2023.

 

Financial News Impacting the Markets

With last week being a slow week in terms of meaningful news flow historically, investors focused on Washington DC more so than usual and boy was it a show of dysfunction than anything else. It has long been said that running a democracy can be messy. While there was almost an outright fist fight on the floor of the House last week, there ended up being no violence and a new Speaker of the House was elected, eventually. Kevin McCarthy is a Republican member of the House of Representatives from California who has been in the House since 2007. During his tenure in the House, he has held many high-ranking roles including, most recently, House Minority Leader (the highest-ranking Republican in the House). He was supposed to be a shoe in for the new Speakership position after Republicans took control of the House in the November election, but the process of electing his as the Speaker was messy. Democrats collectively opposed his Speakership, as the minority party always does. However, the Republican party saw an unexpected fracture with 20 members of the party coming out against McCarthy. In a House that is so thinly controlled, McCarthy could only afford to lose four Republican votes in order to hit the magic majority number he needed. What ensued was 15 rounds of voting held over four days and a significant amount of behind-the-scenes horse trading within the Republican party. The outcome is that Kevin McCarthy is the Speaker of the House, the new session of the House and members of the House have been seated and they can finally get down to trying to govern. The negative outcome from the debacle is that the Speaker is very weak, potentially the weakest Speaker that has ever presided over the House. McCarthy had to give into far-right Republican demands that make it easier depose himself as speaker, drive their legislation to the floor and be assigned to powerful subcommittees within the House. More important for investors is the fact that the fight showed the fractures within the Republican party. This is important because of the debt ceiling debate that will be upcoming later this year. In December of 2021, the debt ceiling was lifted by $2.5 trillion. However, this cash extension will likely be used up at some point this year. While the exact date is unknown, some Washington think tanks put it at early summer 2023 and The Committee for a Responsible Federal Budget says third quarter of 2023. Whatever the date, clearly the debt ceiling will need to be raised and there will be no agreement among the Republican party as to how to raise it, if there is any desire to raise it at all. This could lead to market uncertainty over a potential U.S. government default on debts, which could only be a negative for the U.S. and global economy.

 

The Fed was a topic that investors paid close attention to last week as the Fed minutes for the December meeting were released as well as economic data that could impact the Fed’s upcoming decisions. The Fed minutes showed that officials were united in their commitment to keep interest rates high to reduce the impact of inflation and keep inflation from being entrenched. The minutes also pointed out that an early easing of the interest rates by the Fed could complicate the economic situation. In total, the meeting minutes remained hawkish and made it seem like the Fed is willing to risk a recession, even if it is of their own doing, in order to squash inflation. The economic data released last week was mixed at best. The labor market data released on Friday was strong with many new jobs being added to the economy during the month of December. The wage growth figures for the month of December increased at a slightly slower pace than expected, a good sign that inflationary pressures may be starting to loosen. On the negative side last week, the ISM manufacturing PMI broke down below 50 (contraction level) while the services side of the ISM Non-manufacturing index also moved into contraction and the overall employment level in the index was also shown to have declined during December. This is a little concerning as the services sector typically sees an uptick in the month of December as seasonal workers tend to push up this figure.

The fixed income markets were very busy last week with bond yields falling as bond prices moved higher. While bond yields are still very high compared to where we started 2022, they have come down a meaningful amount in the past few months and are now at levels that we have not seen since the middle of September, prior to several of the large rate hikes by the Fed. The fixed income markets are signaling that the Fed has done enough (with bond yields declining) and that rates will come down before they go any higher and yet the yield curve remains inverted. Either the movement in rates will end up being correct or the curve inversion will be proven correct, but either way the signals are mixed. Currently, the FedWatch data from the CME group has the Fed raising rates at the February 1st meeting by 0.25 percent, with a 75 percent chance of the move. There are still 25 percent odds that the Fed will hike rates by 50 basis points. The March meeting has another rate hike forecasted, although it is expected to only be 25 basis points. May is expected to have the Fed hold on moving rates, and the remainder of the year calls for one rate cut of 25 basis points by the Fed. There are many differing expectations out there, but it is normally best to listen to the Fed and believe what it is saying. The Fed will keep rates higher for longer and investors who invest for a different outcome do so at their own risk.

 

The oil markets last week took a bit of a nosedive as investors were concerned about a coming recession in the U.S. Last week, WTI Crude oil declined from near $80 to below $73 before making back some of the lost ground on Friday. For the week, oil declined by more than 7 percent, in a welcome relief for motorists who have been paying high rates at the pumps for gasoline. The decline in the price of oil will likely be temporary due to the U.S. government. In October of last year, President Biden signed an order instructing the Strategic Petroleum Reserve (SPR) to be refilled when oil prices got to between $67 and $72 per barrel. With the U.S. being such a large buyer of oil on the open market, it is unlikely that oil prices could move meaningfully below this level until the SPR is refilled. China also played a role in the falling oil prices last week as the disorder caused by the current outbreak of COVID-19 is calling into question the overall growth rate for China in 2023. The government in China is continuing to allow the relaxed rules for COVID-19. However, all of the infections are starting to have an adverse impact on the economy as people are still fearful of getting the disease.

 

Market Statistics

 

  • Equities: Markets moved higher for the first trading week of 2023, the first weekly gain for all four of the major U.S. indexes in the past five weeks. Volume for the week was actually pretty strong, although it was only average when looking on a weekly basis, but last week made it to average volume with only four trading days.

 

  • Russell 2000 (1.79%) – Average volume
  • Dow (1.46%) – Average volume
  • S&P 500 (1.45%) – Average volume
  • NASDAQ (0.98%) – Average volume

 

  • Sector Performance: Sector performance last week was a combination of a few factors. The first being a continued decline in bond yields, pushing Home Construction and Mortgage Real Estate into two of the top five performing sectors. The decline in rates also positively impacted both Semiconductors and Telecommunications which both made it into the top five sectors after both sectors had been under a significant amount of pressure during the rising rate environment late last year. Rounding out the top five performing sectors last week was the Consumer Discretionary sector, which moved higher following the labor market data that was released on Friday.

 

When looking at the underperforming sectors last week, four of the five sectors had been the winners of 2022, including Energy, Oil & Gas Exploration, Healthcare and Healthcare Providers. The trading in these sectors looked more like investors rebalancing than anything else last week. The odd ball sector was the Software sector making it into the bottom five as the sector was led lower by declines in pandemic darlings PagerDuty, Cloudflare and Datadog, all of which declined by more than 10 percent last week.

 

  • Top Sectors: Home Construction, Telecommunications, Mortgage Real Estate, Consumer Discretionary, Semiconductors
  • Bottom Sectors: Healthcare, Energy, Software, Oil & Gas Exploration, Healthcare Providers

 

  • Commodities: Commodities were largely negative last week with only two metals turning in positive returns for the week. The Goldman Sachs Commodity Index (a production weighted index) declined 5.93 percent for the week as Oil dropped 7.53 percent. The decline in the price of Oil was one of the largest declines during the first week of a year that we have seen in a long time and was largely due to increasing concerns about a recession here in the U.S. later during 2023. Metals were mixed last week as Gold and Copper increased by 2.40 and 2.58 percent, respectively. Silver was the odd metal out last week as it declined by 0.45 percent, in what looked like thin trading volumes. Soft commodities were negative last week with Livestock posting a loss of 2.73 percent while Grains dropped 3.84 percent. Agriculture overall posted a loss of 2.93 percent last week.

 

  • GS Commodity Index (-5.93%)
  • Oil (-7.53%)
  • Livestock (-2.73%)
  • Grains (-3.84%)
  • Agriculture (-2.93%)
  • Gold (2.40%)
  • Silver (-0.45%)
  • Copper (2.58%)

 

  • International Performance: Last week was a strong week when looking at global market performance as we saw 69 percent of the global markets posting gains while 31 percent declined. The average return of the global indexes last week was 1.53 percent. When looking at the global index performances for the previous week, the strongest regions of the globe focused on Europe with both eastern and western Europe seeing strong performance. The regions of the world that saw the weakest performance last week included Africa and South America.

 

  • Best performance: Laos’s Laos Composite Index (8.11%)
  • Worst performance: Morocco’s MASI Free Float Index (-9.35%)
  • Average: (1.53%)

 

  • Volatility: The markets “fear gauge,” the VIX, had an unremarkable week last week staying within a very tight trading range on both the movements higher and lower for the S&P 500. The VIX last year had many times that it did not appear to act as it historically has, so investors are still taking the movements with a grain of salt until we see if it starts to act more “normally” during 2023. For the week, the VIX declined by about 2.5 percent at 21.13. 21.13 implies a move in the S&P 500 over the next 30 days of 6.1 percent. As always, the direction of the movement is unknown.

Model Performance and Update

 

For the shortened trading week ending on 1/6/2023, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2023

Since 6/30/2015

(Annualized)

Aggressive Model

1.61%

1.61%

4.03%

Aggressive Benchmark

1.79%

1.79%

4.82%

Growth Model

1.36%

1.36%

3.62%

Growth Benchmark

1.41%

1.41%

4.10%

Moderate Model

1.09%

1.09%

3.20%

Moderate Benchmark

1.02%

1.02%

3.28%

Income Model

1.04%

1.04%

3.08%

Income Benchmark

0.53%

0.53%

2.12%

Quant Model

2.51%

2.51%

S&P 500

1.45%

1.45%

8.82%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There was one change in the hybrid models over the course of the past week, the addition of a new holding. The new position that was purchased last week was the JP Morgan Equity premium income ETF (ticker JEPI). The fund is a bottom up fundamental research driven fund that focused on good risk adjusted returns. The fund also employs an options writing overlay to help mitigate risk in the portfolio as well as generate income. The fund has a very high dividend yield, currently more than 11 percent, as the income is a combination of the underlying stocks paying dividends as well as their call writing premiums that are collected. The purchase last week was the first in what will likely be three steps into the position over time. In other news about the hybrid models last week, core holding McDonald’s announced that it is actively looking at its headcount in the corporate office as the company seems to be setting up for a round of layoffs as many companies have been doing recently. I do expect that they, as well as several other core equity companies, will undergo a bit of a right sizing after the companies grew bloated during the pandemic. We should hear more about these plans during the upcoming earnings reporting season which kicks off over the next two weeks for some of the core positions in the models. Overall earnings expectations for the core positions have been coming down with the analysts looking like they are doing the standard lowering of the bar so that companies can look better when they do release their results.

 

Looking to the Future

 

  • Chair Powell: Tuesday morning discussion about the state of the U.S. economy
  • China: COVID-19 outcome from current spike is very uncertain
  • Earnings: Q4 earnings season is about to kick off
  • CPI: December CPI reading is released on Wednesday

Interesting Fact: Bright Green Comet

A comet known as C/2022 E3, marked by its bright green nucleus and long faint ion tail, will be on display in the Earth sky later this month — possibly for the first time ever or at least for thousands of years. “If C/2022 E3 has ever passed through the solar system before, it would have last been seen in the sky more than 10,000 years ago,” says Jon Giorgini, a senior analyst at NASA’s Jet Propulsion Laboratory.

Spectators in the Northern Hemisphere can begin to spot the comet’s faint glow in the morning sky this month as it journeys toward the northwest. The comet will likely be visible to those in the Southern Hemisphere starting early February.

 

Source: NPR.org

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

 

 

For a PDF version of the below commentary please click here Full Year 2022 in Review

Full Year 2022 in Review

January 3rd, 2023

 

2022 Wrap Up

Following the strong performance in 2021, as the world emerged from COVID-19, investors knew that 2022 would be different. During 2021, interest rates were held artificially low by the Federal Reserve, an action that would ultimately have to be unwound at a future time. That time turned out to be 2022 and the beginning of the unwinding process took many investors by surprise. The largest impacts for the year on the U.S. markets came not from forces outside of the U.S. but from within, as the Federal Reserve and Chair Jerome Powell attempted to adjust monetary policies that had been in place since the onset of the COVID-19 crisis, policies that arguably worked very well given the uncertain situation the world was facing at the time. All good things must come to an end, however, as was the case with the ultralow interest rate policy that began turning around during 2022.

 

We started 2022 with the market expecting three rate hikes during 2022, all 25 basis points in size according to the CME Group FedWatch tool, which is calculated as a transaction-volume weighted average of the previous day’s Fed funds rates on trades arranged by major brokers in the market for overnight unsecured loans between depository institutions. Three rate hikes of 25 basis points would have taken the Fed funds rate from 0.00-0.25 percent up to 0.75-1 percent, which would have been a large move but one that the financial markets could have easily dealt with. Starting at the January FOMC meeting, however, the odds of hikes larger than 25 basis points started to be priced into the markets and the equity and fixed income markets started to move lower. The only rate hike to occur during the first quarter was 25 basis points at the March FOMC meeting, with Chair Powell saying the Fed would be data dependent in its fight against inflation. As we moved into the second quarter, inflation was shown to be continuing to increase at a faster pace than the Fed and investors anticipated. It became a bit of a guessing game for investors as they attempted to read between the lines as to what the Fed would do next. The May FOMC meeting held a rate hike of 50 basis points and Chair Powell, in his press conference, said that he was not considering a rate hike of 75 basis points at the June meeting. Following a few more hot inflation numbers, the market began pricing in a rate hike of 75-basis points, something the Fed had not done since Paul Volker was the chairman back in 1994. About this time was when the fixed income market really began to move as well, moving quickly down at the same time as the equity markets, something that rarely occurs, historically. The June meeting came and the FOMC voted for a 75-basis point hike, which surprisingly caused a bit of a bounce in the equity and fixed income markets as there was hope that the Fed would be able to slow down future rate hikes and the 75-basis points would be enough to catch up to inflation. This turned out not to be the case and the fixed income market was correct; the Fed was woefully behind the curve and the curve was accelerating. Being behind the curve didn’t stop Chair Powell from floating the idea of a “softish” landing toward the end of the second quarter. This was the idea that while the Fed needed to keep raising rates to combat inflation, it wouldn’t do it so much to cause a hard recession (landing) in the economy. Rather, the rate hikes would cause the economy to essentially stall in terms of unemployment while at the same time bringing down inflation.

In July, the Fed was forced to go with another 75-basis point hike, taking rates up to 2.25-2.5 percent, more than double the beginning of the year forecasts. Inflation was still increasing by all economic measures and the labor market remained strong with three to four open jobs per unemployed person in the U.S. as companies struggled to hire qualified workers in nearly all sectors. At the end of August, the Fed held its annual Jackson Hole Symposium and Fed Chair Powell outdid himself with his less than 10-minute speech this year. Chair Powell was very hawkish in his short speech, indicating that he is holding the course of “resort price stability” but that it will take longer than first thought and the Fed will get inflation under control even if it comes at the expense of a recession. He even went so far as to say getting inflation back to the target rate of 2% is the Fed’s “overarching focus” currently and the Fed will get there, even though consumers and businesses will “feel economic pain” in the process. Chair Powell even quoted former Fed Chair Paul Volcker several times during his speech, the last Fed Chairman who had to fight inflation on a level that was even higher than it is currently, back in the late 70s and early 80s. The equity and fixed income markets latched onto Chair Powell’s statement about feeling pain and swiftly moved down, posting some of the steepest losses of the year over the weeks following the Jackson Hole comments. In fact, the comments provided a large part of the push toward the lows on the year for many investments with the equity markets down 20 to 40 percent while many bond indexes were down 20 percent or more.

 

Chair Powell followed through, as expected, with a hike of 75 basis points at the September FOMC meeting and an additional 75 basis points at the early November FOMC meeting. He capped off his year of hiking rates to combat inflation at the December meeting with a hike of only 50 basis points, taking the Fed Funds rate up to 4.25 to 4.5 percent after having hiked rates seven times during 2022. Interestingly, this is the same number of hikes as Paul Volker did back in 1994. However, his hikes only increased the Fed funds rate by 2.75 percent. We ended 2022 with the CME FedWatch tool expecting three more rate hikes during 2023. However, they are expected to be small hikes of only 0.25 percent as the Fed now takes a more wait-and-see approach after many members expressed concern about going too far and pushing the economy into a recession. This idea of a looming recession became almost an obsession for investors during 2022 as the warning signs began to flash early in the year.

The fixed income yield curve first inverted to a meaningful extent late in the first quarter of 2022 as the shorter end of the yield curve started to have higher yields than the longer end of the curve. When this occurs, it is commonly seen as a leading indicator of a recession in the next 6 to 18 months. As we progressed through the year, the yield curve inverted even further with pairs inverting that rarely do so, like the NOB pair (10-year and 30-year bond). Despite the repeated action by the Fed, the yield curve remained inverted at the end of the year and, in some cases, inverted to the largest amount in the last 40 years. While the equity market and the Fed are certainly not pricing in a recession, the fixed income market is. Only time will tell who ends up being correct. The 10-year bond saw the largest percentage move in rates since 1953 during 2022 as the yield went from 1.61 percent at the start of 2022 up to 3.88 percent at the end of the year. The higher bond rates had a significant impact on the mortgage and housing market during the third and fourth quarter of 2022 as mortgage rates more than doubled from 3.11 percent at the start of the year to 6.42 percent by the end of the year after briefly topping out over 7.1 percent. While many homeowners have equity in their homes and can afford to have prices come down a little after the crazy move higher over the past three years, it can still be unsettling to the consumer base to see their largest asset falling in value.

The U.S. consumer base was behind much of the economic expansion seen during 2022 with many consumers flush with cash at the start of the year coming off of government stimulus and excessive saving during the pandemic and recovery. Experiences and travel were at the top of many Americans’ lists despite sky high airline ticket prices and inflated hotel costs, even as services at many hotels were constrained. As we moved through 2022, inflation started to bite into consumer spending as the cost of food and fuel jumped higher, causing many Americans to have to cut back on spending in other areas. This was especially seen during the holiday shopping season which ended up being on the lighter side as consumer confidence declined as they fretted over inflated prices and the potential for an upcoming recession and job layoffs in 2023. Washington DC became involved in the inflation fight a few times during 2022, the first with the release of oil from the Strategic Petroleum Reserve as President Biden delivered one million barrels per day for 180 days in an effort to bring down the prices at pumps across the country. The second attempt was the passage of the U.S. Inflation Reduction Act of 2022, which, despite its name, did very little to actually bring down inflation in any manner according to non-partisan economic think tanks that poured through the legislation. The legislation was comprised more of Congress members’ pet projects with unrealistic forecasts that made them look like they were lowering costs many years down the road.

Outside of the U.S., 2022 was a very eventful year with the biggest black sawn event of the year being the Russian invasion of its neighbor, Ukraine, on February 24th. Russia initially said it was just retaking the Russian portions of Ukraine, but quickly made it clear that it intended to try to take all of Ukraine. The international community came together in support of Ukraine, donating billions of dollars’ worth of military hardware and other gear to the county. By the end of the year, Ukraine had beaten back many of the Russian advances. The biggest impact on the global markets with the war in Ukraine was on the energy market as Europe attempted to pull away from Russian supplied oil and natural gas. The international community followed with sanctions against many components of the energy sector in Russia, including an oil price cap, which was agreed to by many countries around the world. The global grain and fertilizer markets were also impacted by the war in Ukraine as a significant percentage of the global supply of potash, fertilizer and grain comes from the area of Ukraine what was in the heart of the conflict. Prices moved higher during the middle of 2022 but by the end of the year, many prices had started to come back down as it because clear that neither side was going to win quickly and suppliers did what they could to move some of the commodities out of the region. As we ended 2022, Ukraine was receiving more and more advanced weaponry and, with the help of foreign aid, appeared to be able to hold off any Russian advances during the winter months, but this conflict is a long way from being over.

 

China was the other wildcard during 2022 as the country dealt with its own internal problems, COVID-19 and an ever-widening gap in the relationship between the U.S. and China. China started 2022 looking pretty good in terms of its zero COVID-19 policy working, at least according to the government. However, the country still saw very restricted movements for many people. What’s more, as the cases began to rise China, the government became more and more heavy handed in how it dealt with the lock downs. At some points during the quarter, more than 65 million people were in “hard lock-downs,” essentially locked into their homes from the outside. This came back to haunt China as a fire in a western province in the country saw many residents unable to escape their building due to the doors being welded shut. This sparked protests that were the largest since Tiananmen Square back in 1989. President Xi started to have his government roll back COVID-19 restrictions following the protests and the country began to reopen. However, as the year came to a close, China was experiencing a surge in COVID-19 cases and countries around the world were implementing new travel restrictions for people coming from China as the world does not want new variants of COVID-19 being exported by China. China’s President was elected for a third 5-year term at the People’s Congress and he has his work cut out for him turning around the Chinese economy which is growing painfully slowly as the country deals with supply chain disruptions and uncertain future demand for its goods.

High technology items were a hot button issue during 2022 here in the U.S. and around the world with China being one area of contention. At several points during the year, the U.S. government warned about specific apps that China was too controlling of, and China retaliated with the same rhetoric. Large cap technology companies were often stuck in the middle and in some cases were used as political pawns in the debate. This didn’t help the large cap technology companies which were dealing with many other problems during the year as well. The poster child of 2022 technology trouble was Tesla, which started the year with a market cap over $1 trillion. Despite the company delivering 1.31 million vehicles during 2022, an increase of 40 percent over 2021, it was the precipitous fall in the stock price that caught most people’s attention. Tesla stock declined by 65 percent during the year, and, with that, the market cap of the company fell to less than $400 billion after being one of the most valuable companies in the world less than 12 months earlier. Much of the decline occurred in the fourth quarter when Elon Musk got involved with Twitter and ended up purchasing and running the company, diverting both his attention and billions of dollars away from Tesla. Increasing competition for the company also played a role in the company’s decline as new vehicles from other companies are starting to show up and offer more competition for Tesla than ever before. The problems for technology were not all Tesla’s as other companies also had a difficult year.

 

The old guard technology stalwarts—Google, Microsoft, Meta (formerly Facebook), Netflix, Intel and Nvidia—all posted their worst year for market returns since 2008. In total, the big 10 technology companies in the U.S. lost a combined $4.6 trillion in market cap during the year. That is almost three times the value of the U.S. budget for 2023 that was passed in December. The companies were seen as being bloated with employees and spending money very quickly to acquire new customers or continue servicing the customers they have. As the cost of financing rose with interest rates, so too did the cost to operate for the high-tech companies and many ended the year announcing layoffs or hiring freezes. Big technology does not look like it will easily rebound from the current situation, so it will be up to some other part of the markets to lead the way in 2023.

 

2023 Outlook

Looking to the future, 2023 looks to be a very interesting year. This time of year, many financial pundits and economists like to put out forecasts for what could happen in the coming year. I normally do the same in this commentary, but last year, all predictions were so utterly wrong on every aspect of the markets that looking back at them they were all completely useless.

 

2023 will probably be a lot like the back half of 2022. We will continue to see the Fed hiking rates, although it should be at a slower rate than we saw during 2022. These rate hikes will invariably go “too far” and we will probably see the U.S. economy dip into a recession, and the problems are not just here in the U.S. Over the past weekend, the IMF said it predicts that a full 30 percent of the world’s countries will have a recession during 2023. The recession in 2023 will probably be unlike most recessions. There will probably not be a crash in any specific area of the economy. Home values here in the U.S. are elevated and the average mortgage rate on an existing mortgage is low so a housing crisis is unlikely in the recession. Corporate America has had more than a year to get ready for a potential recession and with the ultralow rates from earlier in the year, has been stock piling cash to make it through a lean period. The labor market remains strong for employees that are laid off as a result of the recession; there are many open jobs that should be available to them. The Fed and Central Banks around the world also have tools available to help a faltering economy as they are no longer stuck on the lower bound in terms of monetary policy.

 

COVID-19 remains a wild card for 2023. With so much circulation in China currently, mutations are bound to occur, and should a mutation be made that is more lethal and transmissible than past variants, that could be a game changer for the global economy as we would certainly have to go back toward COVID-19 lockdowns. China itself is yet another wildcard as the country continues to try to build alliances with other countries to become less dependent on the U.S., and there is always the question of whether China tries to take back Taiwan, which would significantly impact the markets.

 

On a positive note, we have never had back-to-back years as bad as 2022 when looking at both the equity and fixed income markets. The losses in the fixed income markets during 2022 were very possibly a once in a generation loss. So, these markets are probably ripe for investment in early 2022. Equity valuations came down a lot in 2022 and look much more reasonable at these levels. While there are certainly very few “bargains” out there currently, it would not take much to turn around some of the more beaten down areas of the markets as investors jump on opportunities.

 

Have a great 2023!

 

Peter Johnson

Callahan Capital Management

 

 

Full Year 2022 in Numbers

 

The following is a numerical representation of 2022 performance for the major U.S. indexes and VIX:

Index 2022
Dow -8.78%
S&P 500 -19.44%
Russell 2000 -21.56%
NASDAQ -33.10%
VIX 25.84%

 

2022 was the most difficult year for U.S. equity investors since the Great Recession in 2008, as all of the major U.S. indexes posted losses for the year. The sharp increase in inflation and the subsequent increases in bond yields created a turbulent year for investors. The Dow turned in the best performance of the major U.S. indexes as it has the lowest weighting toward high technology companies and was led higher by the likes of Chevron (+58%), Merck (+49%) and Travelers (+22%). The more diversified S&P 500 came in second place, declining just less than 20 percent for the year as the technology companies in the index weighted it down. The Russell 2000 came in close behind the S&P with a decline of 21 percent as higher borrowing costs adversely impacted small cap stocks throughout the year. The technology-heavy NASDAQ brought up the rear for 2022, declining by more than 33 percent, having the second worst year for the index in the past 20 years. The VIX during 2022 had four spikes during the year, during which the fear gauge increased by about 80 percent each time, with each spike ultimately being very short lived. For the year, the VIX increased about 26 percent as we moved through some market uncertainties during the fourth quarter.

 

Overall, 2022 was a difficult year for many of the global indexes with 74 percent of the indexes posting losses for the year, while only 26 percent posted gains. The average return for the global indexes was a decline of 3.89 percent, but this was heavily skewed by the near 200 percent gain in Turkey. If this is removed from the data, the average return goes down to a loss of 5.91 percent. Looking globally, the developing world saw stronger performance than much of the developed world. When looking regionally, the Middle East, Eastern Europe and South America stand out as areas of strong performance during 2022, while the USA, China and Western Europe were the weakest regions. Globally, the top three performing indexes for 2022 were:

 

Country Index 2022
Turkey BIST 100 Index 196.6%
Montenegro MONEX Index 43.3%
Lebanon BLOM Stock Index 37.0%

 

The strong performance of the Turkish stock markets is a bit misleading. In reality, it was the only asset in the country that did not plummet during 2022 with local people using the stock markets as a store of value. Inflation at times during 2022 was running over 100 percent and the value of the Turkish lira decline by nearly 30 percent for the year. Combine that with political turmoil as well as complete economic and fiscal uncertainty and you have a recipe for the stock market to do very well. The same dynamics were at play for both Montenegro and Lebanon as well, albeit to a lesser extent, landing each of the countries’ local stock markets on the top performing list as well.

 

Globally, the bottom three performing indexes for 2022 were:

 

Country Index 2022
Vietnam HO CHI MINH Stock Index -32.8%
USA NASDAQ Index -33.1%
Russia RTS Index -39.2%

 

With Russia invading its neighbor, Ukraine, early in the year, it was not surprising to see that the RTS Russian stock market index took the bottom spot when looking at full year performance. Russia has been largely cut off from foreign investments and blocked out of many economic partnerships that it once belonged to. With Europe actively trying to move away from Russian oil and natural gas, the biggest exports for Russia, it was no surprise that the Russian stock market suffered. The NASDAQ here in the U.S. posted the second worst performance of any stock market during 2022, thanks to the dismal performance of some very large key technology companies. Vietnam came in third from the bottom during 2022 as the country struggled early on with COVID-19 and then with the uncertainty over the Chinese economy as China is a very important trading partner for the country.

 

The U.S. dollar remained the safest currency globally during 2022 with banks around the world using the US Federal Reserve’s reverse repo facility to park trillions of dollars during the first three quarters of the year. During the fourth quarter, as countries started to normalize their interest rate policy, there was some flow out of the U.S. dollar and back into local currencies. The Uruguay peso had a very strong year, thanks to the country’s agribusiness exports that benefitted from the higher global prices due to the war in the Ukraine. The Sri Lankan rupee posted the worst loss of any of the global currencies during 2022 as the political unrest caused several political leaders to be ousted. The country also defaulted on its foreign debt obligations and was left at the mercy of the IMF coming in with bailout funds that were ultimately held up because they didn’t trust the collateral that was being put up by the new government.

 

Currency Change
US dollar 9.5%
Uruguay peso 11.9%
Sri Lanka rupee -44.8%

 

For those of you who follow and are interested in the style box performance of various investments throughout the year, below is the standard style box performance for 2022 using the Russell family of indexes:

 

Style / Market Cap Value Blend Growth
Large Cap -7.74% -19.19% -29.31%
Mid Cap -12.28% -17.47% -26.90%
Small Cap -14.75% -20.48% -26.26%

 

This year’s style box showed a pretty normal dispersion of returns, as value outperformed blend and growth across all three market caps and the larger companies did better in general than the small and mid-sized companies. Looking at specific boxes, as stated several times in this commentary, large cap technology was not the place to be during 2022 and the corresponding style box is large cap growth which is highlighted in red as the worst style box. The opposite of growth is value focused companies with the large cap version taking the top spot in style box performance for the year.

 

The following table gives the performances for the top-performing sectors for 2022:

 

Sector Change
Energy 60.26%
Oil & Gas Exploration 57.87%
Insurance 11.35%
Aerospace & Defense 9.97%
Consumer Goods 3.58%

 

With the price of oil up nearly 30 percent for the year and the various restrictions that were put on Russian oil and gas during the year, it was not surprising to see that Energy overall and Oil & Gas Exploration took the top two spots when looking at sector performance. Insurance came in third, but the returns were only about a fifth of energy for the year. Insurance benefitted from a relatively quiet year in terms of natural disasters here in the U.S. as well as higher interest rates during the back half of the year. Aerospace and Defense came in fourth for the year as military spending increased greatly around the world as the fighting between Ukraine and Russia broke out with many countries sending supplies into Ukraine. The sector was also helped late in the year by the passage of the U.S. government’s budget for 2023 which boosted military spending by more than eight percent. Rounding out the top five sectors for 2022 was the Consumer Goods sector as Americans went on a shopping spree early during the year after having saved a signficant amount of money during COVID-19 and were eager to get out and spend.

 

The following table shows the bottom-performing sectors for 2022. They were as follows:

 

Sector Change
Consumer Service -31.78%
Telecommunications -32.94%
Semiconductors -35.09%
Software -35.65%
Technology -35.91%

 

The overall Technology sector posted the worst performance of any sectors during 2022 as the sector was hit on many fronts. High interest rates, political targeting, poor acquisitions, uncertain spending and falling demand were just some of the factors that took down the mighty Technology sector. Software came in second from the bottom and was the main culprit of the tech wreck of 2022 as companies pulled back on spending with other technology companies for subscription software. Semiconductors came in third from the bottom after having a difficult supply chain year as the sector was still trying to recover from the supply chain problems caused by COVID-19 back in 2021. By the end of 2022, the problem for the sector was cancellations of orders and falling demand for chips that had at one point been backlogged. Telecommunications came in fourth from the bottom during 2022 as Netflix declined by 50 percent and Google fell nearly 40 percent, two of the largest weighted stocks in the sector. General decline in old media and cable networks didn’t help the sector either during 2022, as the streaming wars continued. Consumer Service took the fifth and final spot in the bottom performing list as inflation hit the services sector hard during the year as many consumers had to forgo services they would have otherwise utilized to buy gas and food at significantly higher prices.

 

2022 was a good year for most commodities as Chinese demand picked up with the reemergence from the COVID-19 lockdowns:

 

Commodity Change
Goldman Commodity 24.08%
Gold -0.77%
Silver 2.37%
Copper -13.25%
Commodity Change
Oil 28.97%
Livestock 7.14%
Grains 17.21%
Agriculture 2.53%

 

Overall, the Goldman Sachs Commodity index (a production weighted index) advanced by 24.08 percent during 2022, largely the result of a gain in excess of 28 percent on Oil, as mentioned above. Metals were mixed during 2022 with the inflation protection aspects of Gold not working out during 2022; it declined by 0.77 percent. This was the second year in a row that Gold failed to be an inflation hedge. Silver saw an uptick in demand toward the end of the year and managed to post a small gain of 2.4 percent during the year. Despite a bit of a comeback during the fourth quarter, Copper had dug too big of a hole earlier in the year to get to positive territory during 2022, finishing with a loss of more than 13 percent for the year. Agriculture overall posted a solid gain of 7.14 percent, as grains enjoyed a gain of 17.21 percent thanks to the massive dislocation in the global grain and fertilizer market due to the war in Ukraine. Livestock saw a solid gain during 2022 as consumer demand around the world continued to pick up and supply was constrained by the rising cost of feed due to the war in Ukraine.

 

The performance of U.S. government bonds for the year was as follows:

 

Fixed Income Change
Long (20+ years) -31.24%
Middle (7-10 years) -15.16%
Short (less than 1 year) 0.94%
TIPS -12.24%

 

The bond market blew up in 2022, leaving many bond investors with losses that have never been seen before on such a widespread scale. It was the worst year on record for nearly all of the types of bonds that are traded and there were almost no hiding spots. We started the year with bond yields very low and ended the year with bond yields having increased two to three hundred percent and more in some cases. The yield curve was not inverted at the start of 2022 and by the end of the year every maturity of the curve was inverted and the most inverted in the past forty years. Even the inflation protected bonds (TIPS) had a difficult year as the inflation kicker, as large as it was, wasn’t enough to help offset the losses due to falling bonds prices. By the end of 2022, some bonds were catching bids as the prices had fallen enough that the yields were on par with what was being seen in the equity markets. At least going into 2023 the silver lining for the bond market is that we have never seen back-to-back years as bad as last year for the fixed income markets.

For a PDF version of the below commentary please click here Fourth Quarter 2022 in Review

Fourth Quarter 2022 in Review

In many ways, the fourth quarter of 2022 was a lot like the third quarter, in that investors were hanging onto Federal Reserve officials’ every word, watching every economic data point and attempting to guess what the Fed will do next. The quarter started with the Fed having undertaken 75 basis points rate hikes at the previous two FOMC meetings and with the bulls in control of the equity markets with the strongest start to the month of October since 1930. The early month rally faded, and the S&P 500 soon found itself knocking on the 3,500 level, a decline of nearly 25 percent from the start of the year and a key psychological level for the markets. The S&P 500 bounced off the 3,500 level on October 14th after experiencing a very sharp decline the day before, following a hotter than expected Consumer Price Index (CPI) release from the Fed. One of the main factors in the bounce was the big banks, of which several reported earnings before the market opened on the 14th, reporting strong profitability and margins in the higher rate environment of the third quarter. The bounce in the equity markets was almost 10 percent and lasted through the end of October and the first day of November, which happened to also be the first day of the November FOMC meeting, which held some interesting surprises for the markets.

The early November FOMC meeting, producing the expected 75 basis point rate hike, was closely watched by investors because there had not been an FOMC meeting since the middle of September, during which many economic data points had been released. The meeting statement was the first thing released by the Fed at the conclusion of the meeting and it was released, as usual, 30 minutes before Fed Chair Powell’s press conference. The statement was very dovish and sent the equity markets rocketing higher by more than 500 points on the Dow. Specifically, investors liked the following lines of the statement: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” This sounded like the pivot in policy that investors had been hoping for, but the exuberance from investors was short lived. Chair Powell took questions during his press conference, as he always does, but it was his answer about whether the Fed was considering pausing raising rates that shook the markets’ initial optimism. He said, “It is very premature to be thinking about pausing, we think we have a ways to go—we have some ground to cover with interest rates.” Chair Powell also added that the “peak” Federal funds rate may be higher than initially expected by the Fed officials. The market reaction to the now seemingly hawkish comments from the Fed was to whipsaw from the highs following the statement releases to new low levels for the day, an intraday swing of nearly 1,000 points on the Dow and, in percentage terms, even wider swings on the Russell 2000 Small Cap index and the NASDAQ. During the ensuring days the week of the November FOMC meeting, several Fed officials made comments and gave interviews but, much like the statement and press conference, it was clear that there was no uniform consensus among Fed officials. The hawkish Fed officials seemed just as hawkish as ever and the same can be said for the dovish members of the Fed. The key between all of the officials was that they were all watching for “economic and financial developments” in the U.S. economy.

One of those such developments was the release of the Consumer Price Index (CPI) data for the month of October. The CPI index was released with overall CPI posting a gain of 7.7 percent on a year-over-year basis through October. This reading was better than the 8.2 percent that was seen in September and better than the expected reading of 8.0 percent. It also represented the fourth sequential decline in the CPI reading which certainly makes a trend that the Fed is seeing when evaluating the size and timing of the next rate hike. Core CPI (CPI that removes the volatile food and energy prices) also beat expectations, coming in at 6.3 percent lower than the previous month’s 6.6 percent and below the 6.5 percent expectation. Expectations jumped that the Fed would immediately slow its pace of rate hikes and some more extreme pundits even called for the Fed to stop the rate hikes immediately. The equity markets rallied an amazing amount on Thursday, seeing the single largest daily gains on all four of the major averages since early 2020, in the height of the COVID-19 market volatility. Over the following weeks, the Personal Consumption Expenditures Price Index (PCE) showed similar declines for the month of October, as did various other economic data points. The declines were not observed as a single point in time as all posted further declines in the November data that was released in December and look set to continue declining in the December data that will be released in January.

The positive developments in the data were the primary driver of the Fed slowing the rate of its hikes at the December FOMC meeting, at which the Fed went with a 50-basis point rate hike rather than the 75 basis points at the previous three meetings. With this hike, the Federal Funds rate ended 2022 at a range of 4.25 to 4.5 percent. However, it looks set to go a bit higher as the Summary of Economic Projections (SEP) that were released had yet another surprise for the markets. The SEP projection for the 2023 Federal Funds rate is 5.1 percent, up from the September SEP of 4.6 percent. The figure was well above market expectations and yet still on the lower bound of the Fed’s Central Tendency projection of the rate, which printed 5.1 to 5.4 percent. The SEP also held projections for both the U.S. GDP and unemployment rate. For 2023, the Fed took down its estimate of GDP for 2023 from 1.2 percent growth back in September to only 0.5 percent growth. On the unemployment side, the unemployment rate in the U.S. was raised from 4.4 percent for 2023 up to 4.6 percent, significantly higher than the current 3.7 percent unemployment rate. Equity markets took hold of the line from Chair Powell’s press conference in December in which he said that he was willing to risk a recession in order to stop inflation and that there would be pain felt by consumers and businesses alike in the process. It was this statement that seemed to set the tone for the month of December, which saw all of the U.S. equity markets post declines as they slid into the end of the year.

The fixed income market here in the U.S. was very active during the fourth quarter as it finished out one of the worst years ever for investors. The 10-year Treasury started the fourth quarter at a yield of 3.83 percent and ended the quarter at a yield of 3.88 percent which would imply that very little happened during the quarter but that was not the case. We saw wild swings in bond yields in reaction to the Fed as well as inflation data with some days’ volatility in the bond market being the same as what would take place over months only a few years ago. Maybe it is the proliferation of easy to trade fixed income investments or maybe just the fact that small moves at very low yields have a larger magnitude than when yields are high but, whatever the reason, it was a volatile quarter. The yield curve remained inverted throughout the quarter with many of the inversions being wider than any time in the last 40 years.

Inverted yield curves and higher borrowing costs were just two of the problems for large cap technology companies during the quarter which posted some of the worst quarterly returns since the dotcom bubble. Earnings at big technology companies that were released during the quarter showed most of the companies were burning through cash and having very little to show for it. Meta (formerly Facebook) was particularly concerning as the company said it would spend whatever it takes to realize its vision of the Metaverse. Tesla was a disaster throughout the fourth quarter as the company lost more than 50 percent of its value as Elon Musk became fully focused on the Twitter debacle unfolding since he purchased the company. Google, Apple and Amazon also had their share of issues during the quarter which saw more than a trillion dollars of market cap wiped out from the large cap technology companies. Earnings overall for the quarter that were reported during the fourth quarter were not very strong.

Ahead of the fourth quarter, earnings expectations for the third quarter had been steadily declining and, by the end of September, the expectation was for 2.8 percent growth on the S&P 500. During the fourth quarter, the numbers reported came in a little soft with a growth rate of 2.2 percent. Energy and Financials were two of the strongest sectors of the markets during the reporting season. According to FactSet, earnings expectations for the fourth quarter of 2022 now stand at -2.8 percent, which means that during the first quarter it is unlikely that we will see many positive gains in the markets due to earnings being reported.

On the political front during the fourth quarter, the financial markets seemed just as relieved as most Americans that the midterm elections were over as the amount of money spent on media advertising by candidates was the highest ever for a midterm election. Republicans managed to win a majority in the House of Representatives but their victory in the midterms was smaller than expected. The Democrats held on to and actually expanded their advantage in the Senate, so starting in January of 2023 we will see a split Congress in terms of control, the best scenario for the stock market looking back in history. The big achievement for Congress during the quarter was that they were finally able to pass an omnibus spending bill at the very end of December. The bill spends about $1.7 trillion during fiscal 2023 with large portions of the funding going to military and nonmilitary spending, encompassing many pork amendments put into the bill by both political parties. The Aerospace and Defense sector benefited from the increase in military spending late in the quarter.

Outside of the U.S., the financial media focused on China as the country had some significant developments during the quarter. COVID-19 continued to be a problem in China leading up to the People’s Congress at which President Xi was elected for an unprecedented third five-year term effectively making him President for life. Tensions between China and Taiwan increased during the quarter, adversely impacting stock markets both in China and Taiwan at different times. Of most concern to the U.S. was the technology sector in Taiwan potentially becoming an issue, should China make a move at taking over Taiwan. Semiconductor chips in particular were seen as an area of need for U.S. involvement and several chip fabrication sites in the U.S. were being built as quickly as possible. For the time being, however, China doesn’t have time to think about anything other than COVID-19. Following several days of intense protests in China during the middle of the fourth quarter, the government capitulated and started to roll back its COVID-19 restrictions. However, at the end of the quarter, these roll backs were causing massive amounts of COVID-19 infections in China. Some estimates were that more than one million people per day were contracting the virus. Throughout the quarter, China made headlines in the markets with commodities seeing some of the most extreme movements on the hopes of China demand coming back online as the country continues to reopen.

Central bankers around the world during the quarter took the cue from the U.S. Fed and raised their rates, except for the People’s Bank of China, which needed to maintain its loose fiscal policy to try to keep the Chinese economy growing. In Europe, countries continued to deal with an energy crisis of Russia’s making as the war in Ukraine raged on. Natural Gas prices remained elevated throughout the quarter with expectations of higher prices to come in the winter months. The other common theme in the international markets was the political upheaval of government officials being overthrown and new governments installed, causing confusion for many investors.

Looking to the Future

The future for the U.S. and global financial markets remains uncertain. On the one hand, we have the economies of almost all of the developed countries around the world growing, albeit at a slower rate compared to where they would like to be. Most central banks around the world have focused their attention on inflation, which continues to run higher than most central bankers are comfortable with, and the longer it does so, the more entrenched it could become. The persistence of inflation presents a tough balancing act for the Federal Reserve as well as central bankers around the world because if they do too little, inflation will continue, and if they push too hard to stop inflation, it could push their economies into a recession.

The fixed income yield curve that was inverted for all of the fourth quarter here in the U.S. has been flashing the recession warning light now for several months. Many economists see the U.S. economy slowing down during the first quarter of 2023, as seen in the lowering of earnings expectations, the pull back in consumer spending and the increase in job layoffs that are being seen around the country. The Fed is willing to withstand a recession if it gets inflation back on the correct track, but the equity markets are not currently pricing in very high odds of this occurring. In looking at the CME Groups FedWatch tool, currently there are high odds of rate hikes at each of the first three FOMC meetings of 2023: February, March and May; after which the figures put the odds-on rates remaining steady. Any deviation from these expectations could cause wild movements in the markets just like we saw during the fourth quarter. Large swings in interest rate expectations happen quickly and cause outsized moves in both the equity and fixed income markets; these looks set to persist.

COVID-19 isn’t done yet. Right now, it is spreading rapidly in China and while we think the main variants that are circulating in China are close to what many people around the world have been inoculated to in the past, things could change. Variants are popping up every day in China and if one becomes more deadly and more transmissible than past variants, it could cause another round of global lockdowns, especially in countries that are not as prepared for another health crisis as the U.S. More importantly for the global economy, the world is still very dependent on China, and while we have been quickly trying to lessen our dependence on China, we just aren’t very far along in the process yet.

 

Peter Johnson

Callahan Capital Management

 

Fourth Quarter 2022 Numbers

 

The following is a numerical representation of the fourth quarter of 2022, along with commentary. Performance for the four major U.S. indexes and the VIX were as follows:

 

Index 4th Quarter 2022
Dow 15.39%
S&P 500 7.08%
Russell 2000 5.80%
NASDAQ -1.03%
VIX -31.47%

 

The Dow took the top spot for the quarter out of the four major U.S. equity indexes, driven higher by a nearly 60 percent gain in the price of Boeing. During the quarter, Boeing got the 737 Max plane cleared for operation in nearly all countries around the world, with the exception of China, and saw strong demand for new orders of the plane. Caterpillar and Nike both gaining more than 40 percent also helped push the Dow to the top spot for the quarter. Coming in second was the S&P 500 as the index is a well-diversified index that does not have an overweight to Technology which was the under performer for the quarter. The small cap Russell 2000 came in close behind the S&P 500 as investors saw value opportunities in some of the small cap stocks that maintained strong balance sheets through the pandemic. The technology-heavy NASDAQ was the sole decliner for the quarter as large cap technology once again struggled during the quarter. The primary stocks driving the NASDAQ to negative performance during the quarter were Tesla (-53%), Amazon (-25%), Meta (-11%) and Google (-8%). Despite there being many positive performing stocks in the NASDAQ, it is a cap weighted index so when the large companies fall, they take down the whole index. The VIX for the quarter declined by almost one third as there was a significant amount of risk easing during the quarter, on everything from the Fed to consumer confidence and stabilization of bond yields.

 

Looking globally, performance was mostly positive during the fourth quarter of 2022. In total, 73 percent of the world’s stock market indexes posted gains for the quarter, with the average return of the global indexes being a gain of 6.4 percent. When looking at the top performing regions for the quarter, South America and Europe posted the best performance. When looking at underperforming regions of the world for the quarter, we find Southeastern Asia, Russia and the Middle East at the bottom of the list. The top three performing indexes for the fourth quarter of 2022 were:

 

Country Index 4th Quarter 2022
Turkey BIST 100 Index 73.2%
Argentina MERVAL Index 45.3%
Poland WSE WIG Index 25.0%

 

Turkey is a very interesting country from an investment standpoint and, as we have seen in past quarters, the returns for the country are either very good or very bad. During the fourth quarter they happened to be very good. Much of the reason for the strong gain in the stock market is that local people in Turkey are using the market to try to hedge against inflation and a weakening Turkish Lira. For the 12 months ending November, the inflation rate in Turkey was 84% while the Lira had declined by nearly 50 percent over the same time period. The same situation can be said for Argentina, which saw political turmoil and unrest combined with sky high inflation during the fourth quarter as well. Poland saw a gain of 25 percent during the quarter as the country has become a sort of staging ground for NATO and other allies for sending supplies into Ukraine and, with all of the activity and foreign money in the country, the stock market benefitted.

 

Globally, the bottom three performing indexes for the fourth quarter of 2022 were:

 

Country Index 4th Quarter 2022
Laos Laos Composite Index -12.5%
Sri Lanka COLOMBO All Share -14.5%
Qatar QE Index -15.9%

 

Despite hosting the World Cup in Qatar during the quarter, the country saw the worst performance globally for the stock market. Much of the decline was due to the shutting down of many companies within the country during the world cup and the volatility of the price of oil during the quarter. Sri Lanka came in second from the bottom as the country is still waiting for the bailout funds from the IMF to be delivered following the country’s default on its foreign debt back in May. It has also been a very unsettling time politically for the small country as the people continue to have distrust for the government. Laos came in third from the bottom last quarter as the country continues to deal with political uncertainty at the same time as China is trying to make inroads in the form of partnerships with the country.

 

The U.S. dollar had been moving only higher during the first three quarters of 2022, but in the fourth, the reserve currency of the world took a little bit of a breather at is posted a decline of nearly 7 percent. Much of the decline seemed to be due to central banks around the world catching up to the actions of the U.S. Fed and due to the stability of global economies following COVID-19. During COVID-19 everyone wanted to own the U.S. dollar as it is the safest and most liquid currency in the world. Now that COVID-19 has largely ended in much of the world, investors are venturing back to own local currencies. The Hungarian Forint was the top performing currency in the world during the fourth quarter, thanks in large part to the EU approving the country’s pandemic recovery plan and the disbursement of about 7.5 billion euros from the EU, two actions that helped clear away some economic uncertainty for the country. The Egyptian pound declined by more than 21 percent during the fourth quarter after Egypt agreed to a flexible exchange rate in order to get financial support from the International Monetary Fund (IMF).

 

Currency Change
US Dollar -6.95%
Hungary forint 15.59%
Egypt pound -21.09%

 

For those who follow and are interested in the style box performance of various investments throughout the quarter, below is the standard style box performance for the fourth quarter of 2022:

 

Style / Market Cap Value Blend Growth
Large Cap 12.21% 7.13% 2.08%
Mid Cap 10.26% 9.04% 6.88%
Small Cap 8.26% 6.21% 4.07%

 

The style box performance for the fourth quarter was almost an exact flip of what we saw during the third quarter of 2022. Value outperformed growth across all of the different market cap sizes and the larger companies outperformed both the mid and small cap companies. All of the returns in the style box grid were also positive when during the third quarter they were all negative except for one. During the fourth quarter, investors seemed to grasp that value stocks that paid dividends were the best investment in these uncertain times as holders of these stocks were essentially paid to wait out the market volatility. Large cap growth companies encompass many of the large cap technology companies that struggled during the quarter as interest rates rose and political scrutiny came upon the group.

 

The following table gives the performances of the best sectors for the fourth quarter of 2022:

 

Sector Change
Aerospace & Defense 22.93%
Energy 19.33%
Industrials 19.03%
Materials 18.09%
Home Construction 16.68%

 

Aerospace and Defense is a relatively small sector of the markets in terms of the number of companies in the sector and with the ongoing war in Ukraine, Boeing taking off and Maxar being purchased, it easily drove the sector to the top spot for the quarter. Energy came in second as the price of oil remained relatively high as well as U.S. production of both oil and natural gas during the quarter. Industrials came in third with much of the gain being driven by Caterpillar and Boeing. Materials came in fourth as there was a steady uptick in demand for most materials during the quarter on the hope of China reopening and increasing global demand. Home Construction came in fifth for the quarter, thanks in part to positive earnings reported during the quarter and because the higher mortgage rates didn’t start to bite until the back half of the quarter.

 

The bottom-performing sectors for the fourth quarter of 2022 were as follows:

 

Sector Change
Software 2.29%
Technology 1.53%
Regional Banks 0.74%
Consumer Discretionary -1.98%
Residential Real Estate -3.84%

 

Residential Real Estate was the bottom performing sector for the markets during the fourth quarter as we saw home prices start to roll over in many areas of the country as potential buyers were facing higher mortgage rates and sky-high home prices. Consumer Discretionary came in second from the bottom during the quarter as there were several times during the quarter that consumer spending and sentiment were being called into question. With fear of a looming recession coming in 2023, many consumers toward the end of the quarter pulled back on the discretionary items in favor of more necessary items or saving money for the future. Regional Banks came in third from the bottom as they are not as diversified as larger financial institutions and depend more on local home mortgage lending, something that became very scarce by the end of the quarter. Technology in general came in fourth from the bottom for the quarter as large cap technology companies struggled during the quarter. While there are many subsectors of technology, Software in particular had a rough quarter, earning it the fifth and final spot on the bottom performing sectors as companies such as Meta and some of the cyber defense companies struggled with companies and consumers pulling back on spending.

Commodities were all higher with the exception of Grains during the fourth quarter of 2022, with Oil increasing by more than seven percent. Returns were as follows:

 

Commodity Change Commodity Change
Goldman Commodity 3.16% Oil 7.40%
Gold 9.68% Livestock 8.09%
Silver 25.83% Grains -0.42%
Copper 14.13% Agriculture 1.14%

 

Overall, the Goldman Sachs Commodity Index (a production weighted index) advanced 3.16 percent during the quarter, most of the gain coming from the increase in Oil prices. For the quarter, Oil prices increased by 7.40 percent as global demand increased with the demand increases from China. The war in Ukraine, the price cap on Russian oil and the production moves by OPEC also contributed to the gains seen in oil during the quarter. All of the metals traded higher for the quarter with silver jumping the most, gaining more than 25 percent while the more industrially used Copper gained 14 percent. Gold was the laggard of the group gaining just under 10 percent. It was interesting to watch Gold trade during the fourth quarter as it was not trading as a hedge against inflation as it has sometimes done in the past, but rather trading at times in lock step with inflation. Agriculture overall advanced by 1.14 percent during the quarter, while Grains saw a slight decrease of 0.42 and Livestock jumped 8.09 percent for the quarter. Food inflation in the US was a hot topic during the fourth quarter as everything from eggs to milk and bread increased in costs. One item that didn’t increase was chicken breast, which plummeted more than 60 percent during the quarter on a massive over supply of birds in the U.S. system.

 

Unlike the horrible first three quarters of the year for bonds, the fourth quarter was not as bad, but it was still far from good. The fixed income market stabilized more than anything else during the fourth quarter with small gains being seen in the short and middle parts of the curve while losses continued to be experienced at the longer end of the curve. With yields having risen as much as they did during the fourth quarter, toward the end of the quarter many investors were starting to see opportunity in some of the bonds as yields were getting close to that of equity positions. TIPS during the quarter actually worked as the inflation kicker on the underlying bonds did help pull them upward into some of the best performing bonds in the markets. Though bonds have a long way to go to come back up, they appear to have turned the corner during the fourth quarter of 2022.

 

Fixed Income Change
Long (20+ years) -1.89%
Middle (7-10 years) 0.58%
Short (less than 1 year) 0.88%
TIPS 1.92%

 

For a PDF version of the below commentary please click here Weekly Letter 1-3-2023

Callahan Capital Management

Weekly Commentary | January 3rd, 2023

 

Major Theme of the Markets Last Week: Waiting on Santa

Heading into last week, many investors were waiting on the elusive Santa rally as the major U.S. equity indexes were down between four and nine percent for the month of December. With the markets being closed on Monday in observance of Christmas, there were only four trading days left in the year. Tuesday and Wednesday were both down days for three of the four indexes as only the Dow managed a small gain on one of those two days. Thursday saw a solid gain for the equity markets as large cap technology once again took the lead and led the markets higher. The gains were short lived as Friday’s very low volume trading day ended with all four of the major U.S. indexes in the red for the day. For the month of December, the major U.S. indexes declined between four and nine percent, as a Santa rally tried a few times to get going but ultimately failed to materialize.

Financial News Impacting the Markets

Aside from waiting for a Santa rally last week, many Americans were waiting around airports to get to where they wanted to go or return home. The U.S. air travel industry was a mess following flight cancellations around Christmas due to the large winter storm impacting much of the U.S. While all of the airlines had many cancelations, Southwest Airlines stood a full head above all others in terms of problems. Southwest Airlines was forced to cancel approximately 15,750 flights between December 22nd and December 29th. Elaine Chao, who served as the Secretary of Transportation during the Trump administration, described the Southwest Airlines breakdown as “a failure of unbelievable proportions.” She also said that it was a perfect storm of all the things that have been going on with the company. It’s going to take them a very long time” to rebuild trust with consumers. The primary problem for Southwest appears to be the use of antiquated systems for assigning flight crews and moving airplanes around. Thus, when there was a problem with the system, rather than being able to use the system to fix and work around the issues, Southwest had to revert to manual labor to try to fix things. Manual labor, of course, was short this time of year and the problems began to snowball for the company. The Department of Transportation (DOT) formally warned Southwest Airlines on Thursday that the company would face heavy consequences if it failed to reimburse all passengers affected by the issues not only for their airline tickets but also for alternative transportation costs, meals, hotels and other costs incurred by passengers due to the company’s problems. This presents a bit of an issue for investors in Southwest Airlines (ticker LUV) as the airline industry in general was already having a difficult time coming back from COVID-19. Now, add in the fact that Southwest could face tens of thousands of dollars in potential fines per violation and per passenger from the DOT and it is hard to see how Southwest makes it out of this predicament unscathed. At least we found out why Santa didn’t show up for his rally; he must have been booked on Southwest flights!

With Congress officially in recess and the term closed until the new Congress is seated in early January, there wasn’t much in the financial media coming out of Washington DC last week. China, however, made many headlines as the country deals with several very aggressive strains of COVID-19 that appear to be working their way through the population, especially Omicron BF7. While the exact numbers are unclear, some outside estimates are that more than one million people per day are being infected with COVID-19 within China. This explosion of cases has led some countries, including the U.S. and many European countries, to announce that they will begin requiring negative COVID tests for passengers to fly into their countries. Here in the U.S., there is talk of the airlines having the sewage from the flights tested as well so that the CDC can figure out what strands of the virus are currently circulating most widely within China. The need to do this is because there is much speculation by the international community that China may not be telling the truth as it relates to what is actually happening inside its borders with COVID-19. So far, there has not been any further disruptions to the global economy from the current outbreak of COVID-19, but the government has also chosen not to lock down people like it has in the past. With the Chinese New Year celebration coming up in about a month, it will be interesting to see if President Xi once again starts to lock down different cities and regions as he attempts to navigate the pandemic once again. Some of the technology stocks in China that performed well during COVID-19 the first time around started to perform well again last week, with companies like the local Netflix and gaming platforms outperforming other areas of the markets.

 

Market Statistics

 

  • Equities: Equity markets were mixed last week with the Small Cap Russell 2000 managing to eek out a small gain for the week while the other three major indexes declined by small amounts. The movements of the markets during those last four trading days of the year were rather unremarkable and looked very systematic as investors and financial institutions were moving investments around to get ready for the start of 2023. Overall markets’ volume, as expected, was very low but not the lowest volume week that we saw during 2022. That honor went to the four-day trading week of Labor Day.

 

  • Russell 2000 (0.02%) – Below Average volume
  • S&P 500 (-0.14%) – Below Average volume
  • Dow (-0.17%) – Below Average volume
  • NASDAQ (-0.30%) – Below Average volume

 

  • Sector Performance: Sector performance last week was a combination of a few different things happening. When looking at sectors that did well last week, three of the top five sectors—Multimedia Networking, Software and Telecommunications—were all sectors of the markets that experienced some of the worst performance of the year. Essentially, investors were buying the beaten down sectors. Regional Banking and Financial Services don’t fall into this group of beaten down sectors and appeared to be purchased on the hope of a better rate environment to operate in during 2023.

 

When looking at the sectors that underperformed last week that were under selling pressure, three of the five sectors were some of the best performing sectors for 2022, including Oil & Gas Exploration, Basic Materials and Infrastructure. Transportation made it into the bottom five list primarily because of the lunacy of Southwest Airlines’ travel problems and other airlines having a rough time around Christmas due to the massive winter storm that hit much of the U.S. Mortgage Real Estate rounded out the bottom five sectors last week as the sector was in the media a lot with many experts predicting what 2023 will bring for the U.S. housing market. Most of what was said was not very positive.

 

  • Top Sectors: Regional Banks, Multimedia Networking, Software, Telecommunications, Financial Services
  • Bottom Sectors: Oil & Gas Exploration, Basic Materials, Infrastructure, Transportation, Mortgage Real Estate

 

  • Commodities: Commodities were mixed last week. The Goldman Sachs Commodity Index (a production weighted index) advanced 0.66 percent for the week as Oil gained 1.14 percent. While the move was relatively small, it could in part be attributed to China continuing to reopen despite a rapid rise in COVID-19 cases. Metals were positive last week as Gold, Silver and Copper increased by 1.42, 0.78 and 0.52 percent, respectively. Soft commodities were mixed last week with Livestock posting a loss of 0.05 percent while Grains advanced 2.45 percent. Agriculture overall posted a loss of 0.25 percent last week.

 

  • GS Commodity Index (0.66%)
  • Oil (1.14%)
  • Livestock (-0.05%)
  • Grains (2.45%)
  • Agriculture (-0.25%)
  • Gold (1.42%)
  • Silver (0.78%)
  • Copper (0.52%)

 

  • International Performance: Last week was a nearly split week when looking at global market performance as we saw 54 percent of the global markets posting gains while 46 percent declined. The average return of the global indexes last week was 0.05 percent. When looking at the global index performances for the previous week, the strongest regions of the globe included China, India and the Middle East. There were no clear clusters, trends or patterns in the regions of the world that posted the lowest returns last week.

 

  • Best performance: Jamaica’s JSE Market Index (3.17%)
  • Worst performance: Mexico’s BMV IPC Index (-4.09%)
  • Average: (0.05%)

 

  • Volatility: The VIX, much like the overall markets, took a bit of a lazy week last week as there was very little movement in the index on a weekly or daily basis. For the week, the VIX advanced by 3.83 percent and closed out the week at 21.67. A reading of 21.67 implies a move of 6.26 percent for the S&P 500 over the course of the next 30 days. As always, the direction of the movement is unknown.

 

Model Performance and Update

 

For the shortened trading week ending on 12/30/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2022

Since 6/30/2015

(Annualized)

Aggressive Model

-0.30%

-12.23%

3.81%

Aggressive Benchmark

-0.05%

-17.72%

4.58%

Growth Model

-0.32%

-9.27%

3.43%

Growth Benchmark

-0.03%

-13.51%

3.92%

Moderate Model

-0.34%

-6.03%

3.06%

Moderate Benchmark

-0.01%

-9.23%

3.15%

Income Model

-0.41%

-4.67%

2.94%

Income Benchmark

0.02%

-3.77%

2.06%

Quant Model

1.50%

-23.25%

S&P 500

-0.14%

-19.44%

8.63%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes to the hybrid models over the course of the previous week. The hybrid models continued to perform very well on risk-off days for the markets and lagged on days when the markets were in a more bullish mood. None of the items on either the watch list for potential selling positions or for potential new purchases hit any trigger points requiring action during the low volume trading week. We enter 2023 with the hybrid models still overweight on short-term cash-like investments, such as short-term T-bills, floating rate bonds and senior loan bonds. With the beginning of 2023 likely to be a lot like the end of 2022 in terms of market volatility, as everyone guesses as to the potential for a recession and what the Fed will do next, keeping dry powder for future investments seem the most prudent approach.

 

Looking to the Future

 

  • Start of 2023: Will we start 2023 with a surge of buying?
  • China: Travel restrictions imposed for travelers coming from China as the country continues to try to reopen

 

Interesting Fact: $120,000 to Tie His Shoes

Last week, football’s greatest player, Pelé, passed away at the age of 82 after battling cancer. During the late ‘60s, competition between sportswear brands Adidas and Puma had become so fierce they actually signed somewhat of a peace treaty, an unspoken deal known now as the “Pelé Pact,” where both companies agreed not to sponsor him because they figured they would spend so much in a bidding war that the end result would not be worth it.

 

But during the World Cup final in 1970 against Italy, right before the opening whistle, Pelé asked the referee to pause for a moment so he could tie up his sneakers. All eyes were on the greatest footballer of all time and his shoes. Puma shoes. According to Barbara Smit in her book Sneaker Wars, Pelé was paid US$120,000 to just tie his shoes and would go onto earn $100,000 for the next four years, plus a cut of the sales of Pelé brand sneakers.

 

Source: latimes.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

For a PDF version of the below commentary please click here Weekly Letter 12-27-2022

Callahan Capital Management

Weekly Commentary | December 27th, 2022

 

Major Theme of the Markets Last Week: Holiday Trading

With last week being the final full trading week of the year and many investors’ minds on activities other than watching the stock market, it was a pretty low volume and uneventful trading week. The week started with a shock out of Japan from the Bank of Japan (BoJ), more about that below, and the bond markets’ reactions around the world to those actions. Additionally on Monday, former Fed President of New York Bill Dudley spooked the markets a little in an interview when he said that markets being overly optimistic could only result in the Fed tightening more aggressively. This idea that markets performing well could cause the Fed to overact, has been getting more press over the past few weeks and, during a week of slow media headlines, made it onto more people’s radar than it otherwise would have, pushing the equity markets lower. On Wednesday, the equity markets posted one of their strongest days of the past two months as investors cheered the much better than expected reading from the Conference Board on Consumer Confidence for the month of December.

 

The Conference Board had been expected to post a slight decline in confidence from 101.4 in November down to 101.0 in December, but the reading came in at 108.3. This surprise print reversed the previous two-month trend of confidence moving lower and provided a strong boost to the overall markets. Many investors missed one important piece of the news released from the Conference Board, however. The Expectations Index posted a reading of 82.4, up from the November reading of 76.7. Any readings on the index near the 80 level have historically been highly correlated to recessions. So, while things may be okay now, consumers looking out past the holiday season see hard times ahead. On Thursday, the equity markets gave back all of their optimism from Wednesday as investors dealt with a poor report out of Micron, which saw the company experiencing lower global demand for its chips. With microchips being put into so many of our everyday items, chip weakness from one of the largest founders in the world caused many people to wonder if it is just the canary in the coal mine for many other companies and sectors and potentially for the markets overall. Markets recovered some on Friday but by then volumes were so low that hardly anyone noticed.

 

Financial News Impacting the Markets

The big news last week for the financial markets came out of Japan on Monday with actions taken by the Bank of Japan (BoJ). On Monday, the BoJ announced that it would allow the bond yield on the 10-year government bond to float up to 0.5 percent from the current 0.25 percent level. Rather than change a single rate like the Fed does with the Fed Funds rate, the BoJ has long undertaken a policy of Yield Curve Control. This sets a maximum bond yield that is allowed on any government auctions across the yield curve and then defends those bond yields with government purchases or sales of bonds. The policy has not worked in the longer run, but it has been effective while bond yields have been so depressed around the world in recent times. The effect of the change was to push bond yields higher across the curve in Japan and also around the world as investors adjusted their thinking to the actions taken by the BoJ. The move surprised everyone as almost no one was thinking the BoJ meeting last week would yield any changes to current policies. Adding to the confusion about the move was the fact that in the same statement, the BoJ announced it would be increasing the amount of its bond buying up to 9 trillion yen per month from January through March. By effectively increasing rates now, it will end up costing the government even more money when it purchases the bonds during those three months. Most central banks around the world would avoid increasing the costs of its plans immediately before implementing the plans, if possible.

Tesla made headlines last week as the company’s stock continued to push lower. Tesla is one of the most widely held stocks in America, so when the stock is moving lower, many people feel the effects. Tesla started last week around $150 per share and ended the week just above $123, a decline of more than 18 percent. This brings the decline in Tesla from the top seen back on January 3rd at $400 per share to a loss of nearly 70 percent for the year. Much of the recent decline has been due to pressure from Elon Musk, who remains the largest shareholder, but who has been selling billions of dollars’ worth of Tesla stock to fund his other ventures, such as Twitter that has been taking all of his time and focus recently. From a technical standpoint, Tesla is trading in a bit of a no man’s land after having fallen so much. Technical support levels that are in place near these levels are more than two years old and very weak. The business risks are mounting for Tesla and it is not just Elon Musk’s distractions and selling that are the issue. Tesla was clearly the first mover in the mass EV market and, being the first mover, had a major advantage over competition. It had thousands of cars on the road, recording and sending data back before other EV makers had their prototypes completed. As we have seen recently, other auto manufacturers have started to embrace the EV cycle and are turning out EV vehicles at very high rates. Now that there is increased competition, Tesla is losing its first mover advantage as the big auto makers turn decades of wisdom in making cars toward efficiencies that are lacking at Tesla. The online trend of consumers recording themselves cancelling their Tesla orders and posting the videos online are telling of what could be coming for Tesla. China, often pointed to as a major potential market for EVs and Tesla, is still a potential but it brings with it many risks. The government could favor locally produced EVs in the future over foreign owned Tesla, or Tesla could be used as a political chip between the U.S. and Chinese governments through no fault of its own.

 

The final financial news last week that moved the markets came on Friday as the House of Representatives passed the government spending bill for fiscal 2023, only about three months late! The bill passed the Senate on Thursday and the House on Friday before being sent to President Biden’s desk for signature. It was passed as the last piece of legislation that will be passed by the Democratically controlled House of Representatives as control of the House flips to the Republicans early next year. While there is certainly a lot in the 4,126-page spending bill, the very high points are $850 billion for military spending and $773 billion for domestic spending. In total, the bill covers almost $1.7 trillion. The bill includes changes to required minimum distributions from retirement accounts, as it slowly increases the age from 72 up to 75 over the next few years. The bill also changes the 1887 Electoral Count Act to make it much more difficult to overturn the results of Presidential elections following the happenings of January 6th, 2021. As there is more time to go through the bill, more will be revealed about what is actually in the bill, but it is safe to say that the lights will be kept on in government buildings between now and the end of September 2023, when this political football once again comes into play. At that time, with a split Congress, it could make things all the more interesting. The biggest winner from the bill so far appears to be the defense contractors as the government will be spending a significant amount of money on resupplying our inventories of weapons that have been sent to Ukraine as well as building upon the technology advancements of the U.S. military to stay ahead of other countries.  

 

Market Statistics

 

  • Equities: The Dow managed to break the trend of all the indexes posting weekly losses last week as the industrials index was pushed higher by Nike and Chevron, both gaining more than 5 percent for the week. The technology components of the Dow continued to be a drag on the index with Intel, Microsoft and Apple all declining 2 percent or more for the week. This decline in the technology companies was seen in the performance of the other major indexes which all posted losses for the week. Volume was average on both the small cap Russell 2000 and the S&P 500 while light on both the Dow and the NASDAQ.

 

  • Dow (0.86%) – Below Average volume
  • Russell 2000 (-0.14%) – Average volume
  • S&P 500 (-0.20%) – Average volume
  • NASDAQ (-1.94%) – Below Average volume

 

  • Sector Performance: With Oil strongly advancing last week, it wasn’t surprising to see that Energy as well as Oil & Gas Exploration took the top two spots when looking at sector performance. Regional Banks, Financials and Insurance rounded out the top five sectors last week as all three benefitted from the upward movement in bond yields and demand was high for bonds pushing prices lower.

 

When looking at the sectors of the markets that underperformed last week, Semiconductors led the way, falling nearly 4 percent as heavy weight Micron reported falling global demand for their chips. Consumer Discretionary came in second from the bottom last week as the sector was hurt by the continued news that the holiday season will probably end up a bit weaker than expected. Large cap Technology and Software came in third and fourth last week as both were hurt by the continued selling pressure that we have seen on large cap Technology through much of the last half of 2022. Home Construction rounded out the bottom five sectors last week as the sector was adversely impacted by the increase in bond yields despite there being a downtick in the overall mortgage rates that were reported last week.

 

  • Top Sectors: Energy, Oil & Gas Exploration, Regional Banks, Insurance, Financials
  • Bottom Sectors: Home Construction, Software, Technology, Consumer Discretionary, Semiconductors

 

  • Commodities: Commodities were all positive last week, led by a gain in Oil. The Goldman Sachs Commodity Index (a production weighted index) advanced 3.23 percent for the week as Oil gained 6.81 percent. Much of the gain in the price of oil came from increased demand for gasoline here in the U.S. as many Americans took to the roads for the Christmas Holiday. Additionally, China reopening has been boosting demand for oil on the global markets and could continue to do so as long as China continues to push for a reopening. Metals were positive last week as Gold, Silver and Copper increased by 0.28, 2.25 and 1.15 percent, respectively. Soft commodities were positive last week with Livestock posting a gain of 1.79 percent while Grains advanced 1.45 percent. Agriculture overall posted a gain of 2.73 percent last week.

 

  • GS Commodity Index (3.23%)
  • Oil (6.81%)
  • Livestock (1.79%)
  • Grains (1.45%)
  • Agriculture (2.73%)
  • Gold (0.28%)
  • Silver (2.25%)
  • Copper (1.15%)

 

  • International Performance: Last week was a mixed week when looking at global market performance as we saw 53 percent of the global markets posting gains while 47 percent declined. The average return of the global indexes last week was 0.12 percent. When looking at the global index performances for the previous week, the strongest regions of the globe included South America, Central America and the Nordic region. The regions of the world that posted the lowest returns last week included China, India, North America and Southeastern Asia.

 

  • Best performance: Brazil’s BOVESPA Index (6.65%)
  • Worst performance: Russia’s RTS Index (-7.23%)
  • Average: (0.12%)

 

  • Volatility: Trading remained peculiar in the VIX last week as the S&P 500 and the VIX both moved lower. For the week, the VIX declined by 7.74 percent, ending the week just below 21. A reading of 20.87 implies a move of 6.02 percent over the next 30 days for the S&P. As always, the direction of the movement is unknown. With the end of 2023 now in sight for the markets, it is unlikely that we will see a large move in the VIX over the next few weeks as the large institutional traders have largely already done the shifting of their positions needed for the end of 2022 and the start of 2023.

Model Performance and Update

 

For the trading week ending on 12/23/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2022

Since 6/30/2015

(Annualized)

Aggressive Model

0.57%

-11.98%

3.86%

Aggressive Benchmark

-0.04%

-17.68%

4.60%

Growth Model

0.42%

-8.99%

3.49%

Growth Benchmark

-0.02%

-13.49%

3.93%

Moderate Model

0.28%

-5.72%

3.11%

Moderate Benchmark

0.01%

-9.22%

3.16%

Income Model

0.19%

-4.29%

3.01%

Income Benchmark

0.04%

-3.79%

2.06%

Quant Model

-1.07%

-24.41%

S&P 500

-0.20%

-19.33%

8.67%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There was one change in the hybrid models over the course of the previous week and it was adding to the position in the iShares 0 to 3 Month government bond fund (ticker SGOV). The fund takes advantage of the move upward in short term bond yields that we have seen over the past few months; currently SGOV is yielding 3.87 percent. The position is being used as a parking spot for what would otherwise be in cash in the hybrid models as the markets search for direction to start the new year. Being paid a nice yield while waiting for clarity is the current name of the game. In other news, we had a core equity position report its latest earnings last week as Nike, not on a standard fiscal quarter, reported its latest results and beat on both the top and bottom lines. Additionally, the inventory buildup that we had been seeing appears to be moving in the correct direction and slowly being moved through. For the week, Nike was up nearly 10 percent with much of the gains seen on the day following their earnings release. We should now have several weeks of no earnings being reported by the core equity positions.

Looking to the Future

 

  • Santa Rally: Only four more days in 2022 to get the rally off the ground
  • Slow Week: This is one of the slowest trading weeks of the year

 

Interesting Fact: December 2022 Bomb Cyclone

By this point, everyone knows that we have experienced a significant meteorological weather event, a bomb cyclone, over the past week. A “bomb cyclone” occurs when the pressure of a winter storm causes the barometric pressure to fall by more than 24 millibars in less than 24 hours. Temperatures plunged in many parts of the country, sending travel plans awry for many people as more than 7,000 flights were cancelled between last week and the writing of this commentary on Tuesday the 27th. The storm impacted more than 183 million people, according to the National Weather Service, as depicted in the map below:

Source: Time.com

 

 

Stay warm and have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

 

 

For a PDF version of the below commentary please click here Weekly Letter 12-19-2022

Callahan Capital Management

Weekly Commentary | December 19th, 2022

 

Major Theme of the Markets Last Week: Lump of Coal for Santa Rally

Last week, the markets were keenly focused on the December FOMC meeting held on Tuesday and Wednesday. More than determining the strength of the Santa rally through the end of the year, investors were listening closely to what Chair Powell might reveal about future actions of the Fed. At the FOMC meeting, the Fed decided to raise the Federal Funds rate by 50-basis points up to a range of 4.25-4.5 percent. This was entirely expected by the markets. What was not expected were some of the figures in the Summary of Economic Projections (SEP) and Chair Powell’s press conference. The big surprise in the SEP came in the form of the Fed funds rate projection for 2023 being 5.1 percent, up from the September SEP of 4.6 percent. The figure was well above market expectations and yet still on the lower bound of the Fed’s Central Tendency projection of the rate, which printed 5.1 to 5.4 percent. The equity markets quickly and negatively adjusted to the Fed statement with the Dow giving up more than 500 points while investors anxiously awaited the Chairman’s press conference.

 

During Chair Powell’s press conference, the markets were initially soothed, but quickly realized that Chair Powell is fully willing to risk a more impactful recession in order to stop inflation, sending equity markets lower once again. Also mentioned in the press conference was that the Fed funds rate may stay higher for longer than expected with the odds of a rate cut during 2023 by the Fed now having evaporated. The equity and fixed income markets had been hopeful, going into the FOMC meeting, that the SEP could signal that the Fed will cut rates toward the end of 2023 but that was not the case. The SEP does, however, have the Fed funds target rate falling by a full 100 basis points during 2024, but how often are economic forecasts that far out ever correct? The Fed’s own numbers seem to change by at least 50 basis points every three months with their projections. In addition to the rate projections, the SEP also held projections for both U.S. GDP and the unemployment rate. For 2023, the Fed took down its estimate of GDP for 2023 from 1.2 percent growth back in September to only 0.5 percent growth. On the unemployment side, the unemployment rate in the U.S. was raised from 4.4 percent for 2023 up to 4.6 percent. For comparison, the current rate is 3.7 percent.

 

The U.S. equity markets traded on a sour note throughout the remainder of the week with the four major indexes posting declines of nearly 5 percent across the board between the conclusion of the FOMC meeting and the end of the trading week. During the last two trading days, and adding pressure to the downside for the markets, were speeches and interviews given by Fed officials who reiterated what was said both in and about the FOMC meeting.

 

On Friday, San Francisco Federal Reserve President Mary Daly gave an interview about the current state of the economy to the American Enterprise Institute with many sound bites being reported that the markets reacted to. When asked about the fixed income and equity markets looking ahead to projected rate cuts, President Daly responded with “I don’t know why markets are so optimistic about inflation.” She also noted that the Fed’s biggest concern going forward is inflation in the services side of the economy. Lastly, President Daly turned some heads when she stated that “demand for labor not only needs to slow, but that unemployment has to rise to temper a surge in wages that is now making inflation harder to suppress.” The comments by Fed President Daly seemed to be a little at odds with New York Fed President Williams who on Friday told Bloomberg that inflation had just started to slow but that it has to “slow a lot further before the Fed eases up on the brakes.” So, it seems the Fed didn’t deliver great presents for the financial markets last week, rather a lump of coal was delivered for many.

 

Financial News Impacting the Markets

 

Prior to the FOMC meeting last week, the U.S. equity markets got a positive surprise in the Consumer Price Index (CPI) data that was released before the market opened on Tuesday. Overall CPI increased only 0.1 percent during the month of November, slower than the anticipated 0.3 percent. Core CPI also came in better than expected at 0.2 percent versus expectations of 0.3 percent. On a year-over-year basis, CPI increased 7.3 percent while Core CPI increased 6.1 percent. Following the CPI print on Tuesday morning, the market spiked higher with the Dow gaining more than 700 points at the open. The spike was short-lived as the equity indexes gave back much of the gains for the day, ending the day with the Dow gaining just over 100 points for the day. The economic news was not all positive last week as the retail sales figures for the month of November posted a loss of 0.2 percent compared to expectations of gains of 0.2 percent. This poor reading on retail sales during at least part of the holiday season caused alarm for some investors as alarms about weaker than expected retail sales for the holidays are now becoming louder. On Thursday, the Empire Manufacturing index posted a horrible -11.2 reading when the market was expecting a 0.1 and the November reading was +4.5. The Philly Fed manufacturing survey also posted a large negative number and the overall Manufacturing PMI for December came in at 46.2 on Friday. Remember that a reading below 50 on the index signifies a decline in manufacturing activity during the month while a reading over 50 signifies an expansion in manufacturing activity. The Services PMI figures on Friday were also worse than expected, coming in at 44.4 for the month of December. Inflation remains the primary concern and reason for the poor economic data as rising prices are forcing consumers to change their spending habits.

 

Last week was a busy week on the international front as well as central banks around the world had to adjust to the changes made by the U.S. Fed. The European Central Bank (ECB) echoed the Fed as it raised its target rate by 0.5 percent up to 2 percent. In the ECB statement, President Lagarde said that rates “will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive.” While at the same time she said that, the goal of the ECB is to bring inflation rates back to their target rate of 2 percent. The situation for the ECB is arguably more difficult than the road ahead for the Fed as it has to deal with inflation due to rising energy costs as the region enters the cold winter months with dwindling supplies coming from Russia, if at all. The Bank of England (BoE) also raised rates last week by 0.5 percent, the Bank’s 9th rate hike in a row, leaving its target rate at 3.5 percent. It too is battling high inflation (more than 10.5 percent in November) and has the hardship of dealing with a shrinking GDP at the same time. The Swiss National Bank as well as the Norwegian Central Bank also raised their central rates last week and there will probably be three more central banks that do so this coming week. Not getting in on the rate hiking action last week was the People’s Bank of China (PBOC), which left its key rate unchanged at its meeting as China is dealing with its own set of unique circumstances and problems. The PBOC is also still boosting its monetary stimulus as it tries to pull the Chinese economy into comfortable growth with the changes recently made to the COVID-19 restrictions.

 

Market Statistics

 

  • Equities: Equity markets last week experienced a bit of a mountain shaped week. For the first two trading days of the week, all four of the major U.S. indexes posted gains of between 1.9 and 2.3 percent. These gains were short lived as, following the conclusion of the FOMC meeting on Wednesday, the equity markets started to decline, falling between 3.5 and 5 percent over the final three trading days of the week, ultimately ending with all four indexes in the red for the week. Volume was average on a weekly basis last week as we move into what is typically a slow trading week this week and then a busier week the last week of the year as big institutions do their year-end rebalancing for going into the new trading year.
    • Dow (-1.66%) – Average volume
    • Russell 2000 (-1.85%) – Average volume
    • S&P 500 (-2.08%) – Average volume
    • NASDAQ (-2.72%) – Average volume

 

  • Sector Performance: With Oil advancing by more than three percent last week, it was not surprising to see that both Oil & Gas Exploration as well as Energy overall made it into the top five sectors in terms of performance last week. Home Construction came in second place last week following earnings results from Lennar which posted better than expected revenues for the 4th quarter, driven by higher-than-expected home sales and higher selling prices. Biotechnology was driven high by a name that became a household name during the pandemic as Moderna released very strong data related to a drug in development for people with melanoma cancers. MRNA jumped almost 30 percent following the news, with partner company Merck moving higher by more than 3 percent. Aerospace and Defense is a relatively small sector of the markets in terms of the number of companies in the sector, so when one jumped more than 100 percent, the sector moved as well. Last week, it was Satellite imagery company Maxar Technology being bought out by Advent International for $6.4 billion, a 129 percent price increase from pre-announcement levels that took the sector overall higher.

 

When looking at sectors of the markets that underperformed last week, Telecommunications led the way lower as the Liberty Media complex declined by about 20 percent along with Charter Communications, and Roku declined more than 10 percent. Regional Banks reacted negatively to falling bond yields and mortgage applications, despite the decline in rates that we have seen over the past few weeks, coming in second from the bottom. This lack of mortgage movement last week also brought the Mortgage Real Estate sector into the bottom five sectors for the week. With concerns building over consumer spending, it wasn’t surprising to see that Consumer Discretionary made it into the bottom five performing sectors as well, led mainly by middle market consumer product companies. High end retail continues to do well, as does low end and discount retailers. It was the players in the middle that felt the pain. Rounding out the bottom performing sectors last week was the Multimedia Networking sector with Inseego falling more than 25 percent and Netgear falling almost 10 percent for the week.

 

  • Top Sectors: Oil & Gas Exploration, Home Construction, Energy, Biotechnology, Aerospace & Defense
  • Bottom Sectors: Mortgage Real Estate, Multimedia Networking, Consumer Discretionary, Regional Banks, Telecommunications

 

  • Commodities: Commodities were mixed last week as all of the traded metals moved lower for the week. The Goldman Sachs Commodity Index (a production weighted index) advanced 2.71 percent for the week as Oil gained 3.26 percent as there continued to be problem getting the Keystone XL Pipeline restarted in Kansas. Metals were negative last week as Gold, Silver and Copper decreased by 0.16, 0.88 and 2.01 percent, respectively. Soft commodities were positive last week with Livestock posting a gain of 0.84 percent while Grains advanced 1.14 percent. Agriculture overall posted a gain of 1.02 percent last week.

 

  • GS Commodity Index (2.71%)
  • Oil (3.26%)
  • Livestock (0.84%)
  • Grains (1.14%)
  • Agriculture (1.02%)
  • Gold (-0.16%)
  • Silver (-0.88%)
  • Copper (-2.01%)

 

  • International Performance: Last week was a negative week when looking at global market performance as we saw 74 percent of the global markets posting declines while 26 percent advanced. The average return of the global indexes last week was -0.97 percent. When looking at the global index performances for the previous week, the strongest regions of the globe included The Middle East and Eastern Europe. The regions of the world that posted the lowest returns last week included North America and Western Europe.

 

  • Best performance: Montenegro’s MONEX Index (4.78%)
  • Worst performance: Russia’s RTS Index (-5.50%)
  • Average: (-0.97%)

 

  • Volatility: With there being some positions expiring last week and some investors making adjustments for the coming end of the year, it was not surprising to see that the VIX traded a bit out of whack last week. The oddities started on Monday with the S&P 500 gaining about 1.5 percent and the VIX spiking upward by almost 10 percent. On Tuesday, the VIX fell by almost 10 percent while the S&P 500 gained less than 1 percent. When the market declined on the FOMC meeting on Wednesday, the VIX also fell, but some of this could have been due to one unknown for the markets turning into a known on that day, as the FOMC meeting was behind the market. Thursday and Friday continued to trade oddly for the VIX with the S&P 500 falling 3.5 percent while the VIX gained only 7 percent. Between now and the end of the year it would not be surprising to see the VIX continue to trade randomly as volumes on options contracts will vary widely, depending on larger underlying movements by large financial institutions. For the week, the VIX declined by 0.92 percent, ending the week at 22.62. With closing the week at 22.62, the VIX is implying a move of 6.53 percent for the S&P 500 over the next 30 days. As always, the direction of the movement is unknown.

Model Performance and Update

For the trading week ending on 12/16/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2022

Since 6/30/2015

(Annualized)

Aggressive Model

-0.63%

-12.49%

3.79%

Aggressive Benchmark

-1.92%

-17.65%

4.62%

Growth Model

-0.51%

-9.38%

3.44%

Growth Benchmark

-1.48%

-13.47%

3.94%

Moderate Model

-0.41%

-5.99%

3.08%

Moderate Benchmark

-1.03%

-9.23%

3.16%

Income Model

-0.36%

-4.48%

2.99%

Income Benchmark

-0.48%

-3.83%

2.06%

Quant Model

-3.14%

-23.58%

S&P 500

-2.08%

-19.17%

8.73%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week. Overall, the models performed very well during the downward movements of the week and, as usual, lagged a little during the strong performance of the first two days of the week. For the week, the biggest gains came from the hedging positions in the hybrid models, the short term and floating rate bond funds as well Zimmer Biomet and Quest Diagnostics. Marriott, Disney and Nike were the three largest detractors in performance for the week. There were no changes in either the potential purchase list or the list of holdings being watched closely for a potential sale last week, and it is unlikely that there will be any significant movements in these lists between now and the end of the year.

 

If you have any money movements that need to be done in your accounts between now and the end of the year, for tax purposes especially, please let me know as soon as possible so that we can get everything taken care of in time. If you are unsure if you need to do anything, please give me a call.

 

Looking to the Future

 

  • Santa Rally: It is starting to come down to the wire to see if Santa shows up for the markets this year
  • Downward Pressure: According to Bloomberg, there is about $100 billion in stock selling that needs to take place between now and the end of the year for indexed mutual funds that run a balanced 60/40 portfolio because bonds have performed so poorly this year
  • Government Spending Bill: Currently working under a continuing resolution, Congress is still working at passing an actual budget for the next year
  • PCE: On Friday, the latest PCE print is released and could have a meaningful impact on the overall markets

Interesting Fact: More Pyramids than Egypt

Sudan was once home to the Kingdom of Kush, a rival to Egypt that embraced its neighbor’s culture and beliefs. The city of Meroë became its capital, where over 30 kings were buried amid 200 pyramids. In comparison, there are only 118 pyramids in all of Egypt. The Meroites built temples, palaces and royal baths in their capital, but their grandest achievements were the more than 200 tall, slender pyramids built at the necropolis at Meroë, giving Sudan more pyramids than all of Egypt (255 in total compared to Egypt’s 118). 

 

Source: Theafricainsider.com

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

 

 

For a PDF version of the below commentary please click here Weekly Letter 12-12-2022

Callahan Capital Management

Weekly Commentary | December 12th, 2022

 

Major Theme of the Markets Last Week: Inflation Weighing on the Holidays

With the Fed in a quiet period prior to the December FOMC meeting, investors last week focused on economic data, downturns in 2023 and inflation as we once again heard from several different executives related to the subject. Last week, JP Morgan CEO Jamie Diamond was in the media with an interview during which he said that “Inflation is eroding everything,” while at the same time he said that U.S. consumers have “$1.5 trillion in excess savings.” The $1.5 trillion figure is about 10 percent higher than it was in 2021, despite there not being a significant amount of government stimulus (checks directly to consumers) during 2022. Diamond went on to say that he estimates that the $1.5 trillion will run out at some point during the middle of next year and “could derail the economy causing a mild or hard recession.” Diamond’s sentiment was echoed by Goldman Sachs’ CEO David Solomon who warned that pay and jobs cuts for Americans could lead to “some bumpy times ahead.” Bank of America CEO Brian Moynihan was slightly more positive when he spoke to the media last week, saying that he thinks that with the strength in the labor market and consumer spending, the U.S. economy will probably only see a “mild” downturn.

 

The economic data released last week was mixed, with investors viewing some of the releases as good, which had an inverse impact on the markets as good news was seen as bad for what it could mean to the Fed. Other releases were clearly bad and had a negative impact on the markets. On Monday, the Services PMI for the month of November here in the U.S. posted a decline, but the reading was slightly better than expected. At the same time, the ISM Non-Manufacturing PMI beat both the expectations and the previous month while ISM Non-Manufacturing employment came in better than expected. This higher-than-expected employment figure looked about the same as what we saw in labor market data two weeks ago and investors took this as a negative development for the Fed pulling back on its rate hiking cycle as the rate hikes do not seem to be adversely impacting the labor markets. The only spot that we really seem to be seeing a tightening of the labor market is in large cap technology as layoffs were announced last week at several large technology companies. However, it is normally these companies that act first in a downturn to shed employees so their actions may just be a canary in the coal mine. On Friday, the big releases of the week, the Producer Price Index (PPI) and the Core PPI, both for the month of November, came in higher than expected, signaling that inflationary pressures remain at the producer level. This was seen also as a negative development to the theory that the Fed will slow down on the size of the rate hikes and the duration of hikes during 2023. The rate hike for the FOMC meeting is largely anticipated to be only 50 basis points. The markets now are trying to game out what the size of the hikes will be in 2023. Given the data last week, it looks like more 50 basis point hikes could be in order. This is why the equity markets moved lower as the markets prior to last week had been anticipating the size of the hikes to decrease from the start of the 2023 FOMC meetings.

 

Financial News Impacting the Markets

 

With more of the holiday season now behind us and Christmas almost upon us the consumer spending data is starting to come out in droves. According to research firm Ipsos, the two words to describe this year’s holiday season are anxiety and anticipation. Despite U.S. consumers anticipating a return to “normal” in some respects, post-pandemic, the sentiment of anxiety this holiday season remains. U.S. consumers are anxious about what is happening around the world with rising inflation, COVID-19 still in the news, politics and all of the talk about a potential recession in 2023. In the latest CNBC poll about holiday shopping, 41 percent of American shoppers plan on spending less this year than they did in 2021. This figure is the most cautious that consumers have been since the 2013 CNBC holiday spending poll. What is also concerning is that 30 percent of consumers said they plan on using credit cards that they don’t intend to pay off immediately or other debt to finance purchases for the holidays this year, up from only 8 percent doing the same last year. There has also been a huge uptick in the “buy now and pay later” promotions from retailers that have attracted a lot of consumers this year. While this may not have much of an impact on the U.S. economy in 2023, it is certainly a warning sign as consumers overspending around the holidays can lead to tough times at the start of the following year. Some other inflation that the CNBC survey found was that 65 percent of respondents think we either already are in or soon will be in a recession and only 14 percent of respondents said that the U.S. economy is currently good or excellent, the lowest percentage since 2013.

 

One bright spot last week was oil prices and what it could mean at the pump and for heating oil during the coldest parts of this winter. Last week, oil prices declined by almost 11 percent, falling to $72 per barrel for WTI crude. This is the lowest price for WTI crude that we have seen all year and the lowest since the middle of December 2021, before the Russian invasion of Ukraine. Oil has now declined by almost 23 percent since its peak at $92.61 back on November 4th. We are starting to see the slide have a meaningful impact at the gas pump for everyday Americans as well. According to AAA gas tracker, prices nationally have fallen more than $0.50 per gallon over the past month. We could also see these declines in fuel prices start to put downward pressure on inflation readings going forward but they will likely be slow to show up starting in the December data and moving into the first part of next year. One of the main reasons for the decline in oil prices is that the Keystone XL pipeline, a major U.S. pipeline that moves oil from Canada down to Oklahoma for processing, reopened after having been closed due to a leak for the past few weeks. However, late on Friday and over the past weekend, another large leak was found in Kansas that has now led to the pipeline once again being shut down. We could see a rebound in the price of oil when the markets open on Monday morning. Technical oil traders are watching the $70 per barrel level very closely as there is almost no technical support for oil prices until $50, should the $70 be breached to the downside. The big wildcard for the price of oil remains China and the country’s demand and where it gets its oil from. With the oil price cap now in place for Russian oil, it will be very interesting to see if it has any impact on the global oil markets.

 

China made headlines last week as the government rolled out a 10-point plan to “soft roll back” its Zero COVID policy. The biggest change is that individual households will be subject to lockdown in their own homes rather than city-wide lockdowns being enforced. This end of mass lockdowns was one of the primary demands of the protests which took place in China over the past few weeks. Another point in the plan announces that “It is strictly forbidden to block fire exits, unit doors, and community doors in various ways to ensure that the public’s access to medical treatment and emergency escapes are unobstructed.” This was a second significant win for the protestors. In another major change, the government is now allowing the use of Antigen testing kits at home rather than demanding that everyone line up in mile long lines to be tested by local medical staff. While the changes are nice, it appears that many members of the government are holding their breath to get through the Chinese New Year celebrations without a massive spike in cases that overrun their feeble hospital system. From an investors standpoint looking in from the outside, it appears the changes that have been announced could have a meaningful impact on China reopening its economy and being able to keep its economy moving forward.

 

Market Statistics

 

  • Equities: Equity markets moved lower last week as investors digested mixed economic data and what it may mean to the Fed this week and at future FOMC meetings. Index performance was clearly a risk-off sentiment as the most volatile of the major indexes saw the worst performance while the Dow turned in the best performance. Volume saw an interesting mix last week with two indexes, the Dow and the NASDAQ, posting below average volume while both the S&P 500 and the Russell 2000 posted average trading volume. As we move closer to the end of the year, it would not be surprising to see volume begin to taper off a bit as year-end portfolio positioning has already been completed.

 

  • Dow (-2.77%) – Below Average volume
  • S&P 500 (-3.37%) – Average volume
  • NASDAQ (-3.99%) – Below Average volume
  • Russell 2000 (-5.08%) – Average volume

 

  • Sector Performance: The risk-off sentiment of the major indexes was clear in the sector performance last week, as classically defensive sectors of the markets—Utilities, Healthcare, Healthcare Providers, Real Estate and Consumer Goods—took all five of the best performing spots, albeit still posting losses for the week. There was not anything specific about the sectors that caused investors to move into them; it just seemed like a risk rotation.

 

When looking at sectors of the markets that declined last week, they were led lower by Oil & Gas Exploration, which declined by more than 10 percent following an equally impressive 10 percent decline in the price of oil. Energy overall came in second worst, also drug down by the fall in oil prices. Regional Banks made it onto the bottom list, largely due to the decline in bond yields during the first half of the trading week as rates hit multiple month lows before moving up slightly to end the week. The Software sector is made up of many companies that performed well during the COVID-19 market downturn and investors continue to dump these stocks. Zuora last week was -26 percent, Trade Desk -12 percent and Zscaler -9 percent as unprofitable technology companies are very out of favor with investors currently. Transportation rounded out the bottom five sectors last week as Smith and Wesson led the group lower, falling nearly 25 percent.

 

  • Top Sectors: Utilities, Healthcare Providers, Healthcare, Real Estate, Consumer Goods
  • Bottom Sectors: Transportation, Software, Regional Banks, Energy, Oil & Gas Exploration

 

  • Commodities: Commodities were all negative last week except for Silver which managed a small gain. The Goldman Sachs Commodity Index (a production weighted index) declined 6.22 percent for the week as Oil fell 10.01 percent with much of the decline coming due to the restart of the Keystone XL pipeline running through the heart of the American Midwest. The pipeline had been largely closed since the middle of November when a leak was discovered. Metals were mixed last week as Gold and Silver decreased by 0.12 and 0.10 percent, respectively, while Silver bucked the trend and posted a second week in a row of gains, advancing 1.27 percent. Soft commodities were negative last week with Livestock posting a loss of 2.33 percent while Grains declined 0.08 percent. Agriculture overall posted a loss of 1.51 percent last week.

 

  • GS Commodity Index (-6.22%)
  • Oil (-10.01%)
  • Livestock (-2.33%)
  • Grains (-0.08%)
  • Agriculture (-1.51%)
  • Gold (-0.12%)
  • Silver (1.27%)
  • Copper (-0.10%)

 

  • International Performance: Last week was a negative week when looking at global market performance as we saw 67 percent of the global markets posting declines while 33 percent advanced. The average return of the global indexes last week was -0.56 percent. When looking at the global index performances for the previous week, the strongest regions of the globe included China and Eastern Europe, both for the second week in a row. The regions of the world that posted the lowest returns last week included North and South America.

 

  • Best performance: Hong Kong’s Hang Seng Composite Index (7.14%)
  • Worst performance: Saudi Arabia’s Tadawul All Share Index (-5.32%)
  • Average: (-0.56%)

 

  • Volatility: After closing below 20 two weeks ago, the VIX didn’t stay there very long as it bounced off of this low level to the upside last week. For the week, the VIX gained 19 percent and closed back above 22 for the first time in the past three weeks. The movement seemed slightly outsized, but it could have just been that the markets’ fear gauge was adjusting for the past few weeks when the VIX moved lower than it looked like it should have given all that was going on. The VIX closed last week at 22.70 which implies a move of 6.55 percent over the next 30 days. As always, the direction of the movement is unknown.

Model Performance and Update

For the trading week ending on 12/9/2022, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

 

Last Week

YTD 2022

Since 6/30/2015

(Annualized)

Aggressive Model

-1.15%

-11.93%

3.89%

Aggressive Benchmark

-2.01%

-16.04%

4.90%

Growth Model

-0.92%

-8.90%

3.52%

Growth Benchmark

-1.55%

-12.18%

4.16%

Moderate Model

-0.69%

-5.60%

3.15%

Moderate Benchmark

-1.09%

-8.28%

3.32%

Income Model

-0.62%

-4.13%

3.05%

Income Benchmark

-0.51%

-3.37%

2.13%

Quant Model

-4.02%

-21.07%

S&P 500

-3.37%

-17.45%

9.06%

 

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like hybrid model’s actual holdings. The hypothetical models are rebalanced daily to model targets and include dividends being reinvested. Performance calculations are my own.

 

There were no changes in the hybrid models over the course of the previous week. Despite the equity markets moving lower for the week there was not much movement on the watch list of companies to buy as many of the companies on the list held up better than the equity markets. Going into the end of the year, with investors concerned about a potential recession, the value tilt of the hybrid models should play well on these fears. Within the hybrid models the core positions all pay solid dividends and have done so for years. It is these dividends, plus the lower volatility than the equity markets, that are attracting investors. This is especially true for people who were hurt in bonds last year, many unexpectedly, as they incorrectly assumed that bonds are less risky than equity positions and offer less risky returns and income. The positions with the most to gain or lose within the models between now and year-end are Walmart and TJX as both companies have exposure to U.S. consumers and any pull back in spending that may occur due to anxiety about the future.

 

Looking to the Future

 

  • December FOMC Meeting: What Powell says could move markets
  • Santa Rally: Seasonal volatility should start to slow this week as markets slowly glide higher to the end of the year.
  • CPI: On Tuesday, the latest CPI print is released and could have a meaningful impact on the overall markets

Interesting Fact: Happy Birthday!

The future began 75 years ago this week with the invention of something small that’s considered the most manufactured item in human history. The transistor was born in December of 1947, in New Jersey, and it has defined the last half of the 20th century and the first quarter of the 21st. Our information and communications world owes a debt to a team of physicists who took theories that had been kicked around for decades, and — after years of false starts and dead ends — got the first transistor to work early in the postwar era.

 

Source: marketplace.org

 

Have a great week!

Peter Johnson

 

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.