The long game remains undefeated 💯
Plus a charted review of the macro crosscurrents 🔀
Stocks made record highs last week, with the S&P 500 climbing 1.2% to close at 4,839.81. The index is now up 1.5% year to date and up 35.3% from its October 12, 2022 closing low of 3,577.03.
The S&P was last at a record high in January 2022. Wall Street was bullish coming into 2022, with most strategists convinced the S&P would end the year north of 5,000. However, high inflation — widely believed to be transitory — persisted and continued to heat up in early 2022, as hot demand remained out of balance with tight supply chains.
Consequently, monetary policy tightening from the Federal Reserve became much more aggressive than initially expected. Fed Chair Jerome Powell even warned winning the fight against inflation could require economic “pain.”
All this was a conundrum for the stock market, as hawkish monetary policy meant tighter financial conditions — which meant higher interest rates, tighter lending standards, and pressure on stock market valuations. It became clear that Fed-sponsored market beatings would continue until inflation rates improved.
The stock market bottomed in October 2022, months before the Fed stopped hiking rates and even before it clearly signaled a dovish pivot in its approach to monetary policy — which makes sense when you remember the stock market is a discounting mechanism.
For the remainder of 2022 and all of 2023, inflation rates continued to cool amid tight monetary policy. Impressively, economic growth persisted during this time, and evidence mounted suggesting the emergence of a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy sinking into recession.
Meanwhile, the stock market surged in 2023, with the S&P 500 booking an impressive 24% gain.
Wall Street came into 2024 relatively constructive, mostly predicting mid- to high-single digits gains for the S&P for the year. But the market once again caught many on their heels: Strategists at Goldman Sachs, RBC, and UBS have already revised up their year end targets, and January isn’t even over yet.
Zooming out 🔭
Will the rally continue? In the near-term, that’s anyone’s guess.
“[T]he S&P 500 Index has hit 1,176 new highs since its 1957 inception,” Invesco’s Brian Levitt observed on Friday. “That’s the equivalent of a new high every fortnight, or 14.3 days. History suggests that investors should expect the market to ascend to many new highs over their lifetimes, even if the path isn’t always a straight one.”
Maybe things will get bumpy again in the coming days, weeks, or months.
But history continues to show that the stock market rewards investors who are able to put in the time.
Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🛍️ Consumers are spending. Retail sales increased 0.6% in December to a record $709.9 billion.
Categories leading growth included department stores, online, clothing, cars and parts, and building materials. Gas stations, furniture, and electronics saw declines.
For more on what’s driving personal consumption activity, read: Consumer finances are somewhere between 'strong' and 'normal' 💰
👍 Consumer sentiment surges. The University of Michigan’s consumer sentiment index jumped in January. From the survey: “Consumer sentiment soared 13% in January to reach its highest level since July 2021, showing that the sharp increase in December was no fluke. Consumer views were supported by confidence that inflation has turned a corner and strengthening income expectations. Over the last two months, sentiment has climbed a cumulative 29%, the largest two-month increase since 1991 as a recession ended.”
For more on sentiment, read: The economic vibes are healing 😀
💼 Unemployment claims fall. Initial claims for unemployment benefits fell to 187,000 during the week ending January 13, down from 203,000 the week prior. This is barely above the September 2022 low of 182,000, and it continues to trend at levels historically associated with economic growth.
⛽️ Gas prices tick up. From AAA: “The national average for a gallon of gas squeaked out a two-cent gain since last week to $3.09. A likely culprit could be wintery weather, which hampers refining operations and gasoline distribution. This has resulted in some frigid regions seeing pump price jumps.”
For more on energy prices, read: The other side of the surging oil price story 🛢
🏠 Mortgage rates tick down. According to Freddie Mac, the average 30-year fixed-rate mortgage fell to 6.60% from 6.66% the week prior. From Freddie Mac: “Mortgage rates decreased this week, reaching their lowest level since May of 2023. This is an encouraging development for the housing market and in particular first-time homebuyers who are sensitive to changes in housing affordability. However, as purchase demand continues to thaw, it will put more pressure on already depleted inventory for sale.”
For more on home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
🏠 Home builder sentiment improves. From the NAHB’s Alicia Huey: “Lower interest rates improved housing affordability conditions this past month, bringing some buyers back into the market after being sidelined in the fall by higher borrowing costs… Single-family starts are expected to grow in 2024, adding much needed inventory to the market. However, builders will face growing challenges with building material cost and availability, as well as lot supply.”
🔨 New home construction data was mixed. Housing starts declined 4.3% in December to an annualized rate of 1.46 million units, according to the Census Bureau. Building permits rose 1.9% to an annualized rate of 1.49 million units.
🏚 Home sales cool. Sales of previously owned homes declined 1.0% in December to an annualized rate of 3.78 million units. From NAR chief economist Lawrence Yun: “The latest month's sales look to be the bottom before inevitably turning higher in the new year. Mortgage rates are meaningfully lower compared to just two months ago, and more inventory is expected to appear on the market in upcoming months.”
For more on housing, read: The U.S. housing market has gone cold 🥶
💸 Home prices ticked lower. Prices for previously owned homes declined month over month, but were up from year-ago levels. From the NAR: “The median existing-home price for all housing types in December was $382,600, an increase of 4.4% from December 2022 ($366,500).“
👎 Regional business surveys continue to look dismal. The NY Fed’s Empire State Manufacturing Survey’s January General Business Conditions index fell to its lowest level since May 2020.
The Philly Fed’s Manufacturing Business Outlook Survey’s January current activity ticked up, but still signaled contraction. Meanwhile, the future activity index sunk to its lowest level since May.
Keep in mind that during times of stress, soft data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊, Sentiment: Finally a vibe-spansion? 🙃, and 4 different ways of looking at the exact same economy 🪖👒🎩🧢
🛠️ Industrial activity picks up. Industrial production activity in December rose 0.1% from November levels, with manufacturing output climbing 0.1%.
For more on economic activity, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
😬 The pros are worried about stuff. According to BofA’s January Global Fund Manager Survey, fund managers identified “geopolitics worsen” as the “biggest tail risk.”
The truth is we’re always worried about something. That’s just the nature of investing.
For more on risks, read: Sorry, but uncertainty will always be high 😰 and Two recent instances when uncertainty seemed low and confidence was high 🌈
📈 Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.4% rate in Q4.
For more on the forces bolstering economic growth, read: 9 reasons to be optimistic about the economy and markets 💪 and Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to bring inflation down. While it’s true that the Fed has taken a less hawkish tone in 2023 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened or is near, inflation still has to cool more and stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 during the first half of 2023. As you stretch the time horizon, the numbers get more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 85.6% underperformed. And over a 20-year period, 93.6% underperformed.
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 318 large-cap equity funds were in the top half of performance in 2020. Of those funds, 39% came in the top half again in 2021, and just 5% were able to extend that streak through 2022. If you set the bar even higher and consider those in the top quartile of performance, just 7% of 156 large-cap funds remained in the top quartile in 2021. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2022.
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.