Monthly Outlook: December 2022
The U.S. economy is not yet in a recession. But it is getting closer. In the meantime, markets have been zig-zagging lower as investors await clarity on the “Will We – Won’t We” question on recession. The market (S&P500) is down 13.2%, YTD, and we haven’t even started the recession, officially. Plus, investors have endured a lot of volatility along the way. The S&P500 has “zigged” four times (-12%, -17%, -12%, -16%) and “zagged” four times (+11%, +8%, +17%, +13%) to get to that -13.2%, YTD result. As we start December, markets are in a “zag” uptrend and trying to move higher. As more economic data is released and the Federal Reserve’s tightening program evolves, investors will become more certain about the outlook and more sustainable price trends will develop. But which direction? Our trend-following investment strategy (iFolios®) requires us to be invested on the right side of each ETF’s trend, so we’ll be well positioned either way.
There are several key questions that investors need to answer, and these will shape the direction of markets for the next six to 12 months: Is the Fed committed to reducing inflation? If so, how high will interest rates go and for how long? Will the Fed remain stalwart even if the economy slows? Is recession coming or not?
The answers to these questions have been partially answered by the Fed, itself, and by ongoing economic reports. The challenge is that the market seems to only partially believe the answers. The Fed repeatedly declares that they are dead serious about quelling inflation. They’ve created “dot plots” that show Fed Funds will continue to rise to at least 4.5% and stay there for most of 2023. Economic reports including corporate earnings, home sales, job layoffs, retail sales, shipping reports, etc., show early signs of economic slowing. The 2yr/10yr US Treasury yield curve spread is clearly negative at -0.69%. This inversion has only occurred just prior to the last seven recessions over the past 60 years. It’s never missed. Based on this indicator, a recession seems highly likely to develop soon.
If a recession is coming, what can we expect? On average, corporate earnings fall 10% to 15% (they’re still strong), interest rates invert prior to the recession but “un-invert” and rates fall as the recession starts (we’re still inverted), unemployment rises at least 2% (we’re still at a low 3.7%), retail spending slows (airports and restaurants are still packed), stock prices fall 20% to 50% (we’re already down 15%), and inflation subsides (no real signs of this yet). As money managers, we care the most about stock and bond prices and we can easily watch those with no guessing.
No Need to Be an Economist
If you watch the investment news shows, you’ll hear many people making predictions and guesses about the economy, inflation, price moves, political impacts, and so much more. “I think this” and “I think that.” But people are free to think anything they like and, apparently, feel even more free to share their opinion. Why does anyone listen to these non-stop guesses? Why don’t we invest based on what we know for sure?
Trend-following is an established investment strategy that buys up-trending assets and sells them when they start to trend lower. Our iFolios strategy at Ryan Investments is such a strategy. We diversify globally, use a long-term trendline (200-day moving average) as our signal to buy and sell, and are disciplined enough to follow our strategy. Trend-following has built-in risk control because we place sell-stop orders just below each holding’s trendline. Our strategy keeps us fully invested for growth during uptrends and protected during downtrends. The best part is that it’s systematic and requires no economic guessing. Buy-and-hold strategies, by contrast, have no effective risk control and give investors market returns both up and down. That just can’t be acceptable, especially in the face of a likely recession and bear market.
Year-End is Here!
In addition to managing portfolios on a daily basis, we’ll spend the next three weeks reviewing taxable capital gains, calculating any remaining RMDs from IRAs, and year-end planning. We all get busy at year-end, but many tax-saving maneuvers need to happen before year-end, so let us know if you have any questions or issues that we can assist you with.