Monthly Outlook: March 2023

Although markets started 2023 with strength and uptrends, February was a bit soft. The S&P500 lost 2.5%, the international EAFE index dropped 3.1%, and even Bonds gave back 2.6%. If you’re feeling like markets have been back and forth without any sustainable trends for a long time, you’d be right. The fact is that the S&P500, today, is exactly where it was two years ago. The bigger surprise is that Bonds are down 13% over the past two years, so investors with a blend of stocks and bonds are down, overall. The only asset that is up over the past two years is the Energy sector, which is up about 28%. But the Energy sector is only about 5% of the total market and no one puts all of their money in Oil company stocks.

So, what gives? Where are the markets going and how should we position our portfolios? To answer that question, you’d need to answer another question, first. Do you believe the Fed will stay resolute in their fight against inflation and will they keep monetary policy tight until they soundly defeat inflation? If they do, it’s most likely that the economy will slow, earnings will sag, unemployment will rise, and stocks will surely fall. But if they panic at the first signs of a recession and abandon their tightening, inflation won’t be controlled, and stocks would likely rally. Fed members continually state that they mean it this time, that they’re really going to stay tight and knock out inflation. But their actions over the past decade suggest they’re capable of wimping out. This debate is why markets are volatile and trendless. Personally, I’m in the higher-for-longer camp.

S&P 500 is Sitting on Its 200-Day

Many investors, including us, use the 200-day moving average as a long-term trendline. When any holding is above its 200-day, we say its trending higher and should be bought for growth. When it’s below, it should be sold for protection. Trends can last for a couple of months to a couple of years, in either direction. We agree with the axiom, “Don’t fight the trend.” The critical time in trend following is when the trend changes, that is, when the price crosses the 200-day moving average trendline. Today, the S&P500 is sitting right on its 200-day moving average. If the S&P500 drops just a bit from here, it will move from an uptrend to a downtrend, and trigger a sell signal for us. My gut tells me markets will break below their trendlines, and soon, but we don’t invest based on educated guesses. We have sell-stops in place and will let the trends dictate how we allocate funds.

Interest Rates and Inflation

Inflation is the #1 focus in markets these days and interest rates are closely related. Inflation, as measured by the Consumer Price Index (CPI), peaked at 9.1% a year ago. It’s slowly coming back down and is about 6.5%, today. There are other inflation indexes (PPI, PCE, and others) but they all show the same trend. The Fed wants to get inflation back to 2%, which is a long way from today’s 6.5%. If inflation is stubborn, they’ll keep Fed Funds high.

The Fed only sets the Fed Funds rate, which is the one-day rate, used by banks for overnight funds. But the market sets the rates for 2-day to 30-year interest rates. Initially, these longer-term rates rose as the Fed pushed up the Fed Funds rate. But now, we see these longer-term rates start to stall and trade sideways as they’re weighing the risk of a recession in coming months. The 10-year U.S. Treasury rate, for example rose from 0.7% three years ago to 4.2% in October, 2022. It’s been trading in a range of 3.4% to 4.1% for the past five months. The point is, it’s probable that the Fed may raise Fed Funds a bit more, but longer rates may have already peaked. As investors, that means Bonds may finally become a reasonable investment at these levels. We’re carefully analyzing all bonds, from T-bills to 20-year Treasuries, and fitting them into portfolios, as needed.

No Time to Buy & Hold

I’ll close with a familiar reminder: This is no time for a buy & hold strategy. No one knows for sure what the markets will do over the next year. But we do know that the Fed is raising Fed Funds, that the economy is slowing, and stock valuations remain as high as the peak in 2007 and 2001, both peak years. If stock markets do start new downtrends, and they’re close, there is potential for significant loss. The only way to avoid that kind of loss is to sell stocks and reduce exposure. We’ll do that; buy & hold won’t.