Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Tuesday January 3, 2023. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Latest Market And Trend Review

As we just had a major rebalance last week, it’s pertinent to review the latest market and economy trend.

Major asset trends

As of the last Friday, major stock asset trends were encouraging:

Description Symbol 4 Weeks 13 Weeks 52 Weeks Trend Score
International Developed Stks VEA 10.87% 10.93% -6.28% 3.33%
US High Yield Bonds JNK 4.2% 3.78% -3.83% 1.29%
US Stocks VTI 7.97% 4.6% -9.69% 0.97%
Treasury Bills SHV 0.3% 0.97% 1.45% 0.85%
Emerging Market Stks VWO 8.37% 1.5% -14.25% -0.78%
Total US Bonds BND 5.38% 0.14% -10.31% -0.89%
US Equity REITs VNQ 7.31% -2.51% -14.11% -3.27%

Among US stocks, other than high growth stocks, most had positive trend scores:

Description Symbol 4 Weeks 13 Weeks 52 Weeks Trend Score
Russell Largecap Value IWD 6.78% 8.0% 2.68% 4.1%
Russell Midcap Value IWS 7.26% 6.58% -1.21% 2.64%
Russell Midcap Indedx IWR 8.08% 6.62% -7.27% 2.03%
Russell Smallcap Value IWN 4.71% 6.52% -3.32% 1.77%
Russell Largecap Index IWB 8.2% 4.58% -9.17% 1.08%
Russell Midcap Growth IWP 9.41% 6.44% -18.24% 0.82%
Russell Smallcap Index IWM 5.24% 5.51% -10.41% 0.76%
Russell Smallcap Growth IWO 5.77% 4.43% -17.61% -0.25%
Russell Largecap Growth IWF 9.57% 1.14% -19.57% -1.69%

Notice that bonds are still in a negative trends. This corroborates well the Federal Reserve’s interest hike. However, investors seemed to have a high hope that the year long stock downtrend will be over. Let’s continue to look at what happen in the US economy (which usually leads the world economy)

Economy indicators

Some of the major economy indicators had been very resilient so far. Let’s review some of them that are considered in our quantitative strategies like Asset Allocation Composite (AAC).

  • Unemployment rate: this has turned out to be one of the most resilient (or stubborn) indicators that has been ‘stuck’ at a very low level:

Wage pressure, which represents labor cost, has been steady high. The latest job report on November also indicated that average hourly earnings rose 0.6% month over month, doubling the estimated 0.3%.

  • Retail and food sales: it dipped year over year in March and April this year, but has since recovered. This again indicated that consumer spending is still very strong:

  • Industrial output: it’s been rising year over year throughout the year, defying expectation of many experts:

However, amid the strength shown by these indicators, there have been some under currents that show the economy is slowing. The most obvious one is the Challenger job cut report on November:

Layoff or job cuts are usually a leading indicator. It points to a rapidly rising unemployment rate in the coming months. Other weaknesses include housing reports.

Inflation and interest rates

Let’s turn our attention to inflation. The most obvious one is the Consumer Price Index change:

The above chart shows year over year CPI change. It’s obvious the change has slowed down recently. However, one should keep in mind that even though the change has slowed a bit, it’s still very high. Nevertheless, considering the recent consecutive interest rate hikes have some lagging effect, one can expect much more decline (of the change) to come.

On the other hand, the bond market has shown that future economy will slow down significantly. This is shown by the deepest 10-year-3-month Treasury yield curve inversion (i.e. the 3 month Treasury bill interest is much higher than that of the 10 year Treasury note) since 1982:

In the past, when the above yield curve was inverted, the economy went into a recession 100% of time. However, the tricky part here is how long it will take after the yield curve becomes inverted. For example, the yield curve became negative in May 1989 and it took 15 months for the economy to go into a recession in August 1990. This year, the yield curve started to turn negative in October. So a recession might come  as late as later next year.

Recession or soft landing?

So the question is whether we will encounter a recession very soon or we are going into a so called soft landing. Here are our subjective opinions:

  1. The persistent wage growth and elevated price pressure (inflation) will force the Federal Reserve to continue to raise interest rates and eventually keep interest rates high enough to drive down wage pressure (labor cost) which will very likely to force a recession. This is also indicated by the negative (inverted) yield curve as shown above.
  2. On the other hand, if the economy has weakened enough (as most indicators discussed above are lagging indicators), the Federal Reserve will probably start to level off interest rate hike very soon. However, it’s likely to be too late to prevent a recession.
  3. There is, of course, a slim possibility that the inflation has come down or will come down rapidly while the economy just more or less stays in the current expansion state — a ‘soft landing’ scenario. We certainly can’t completely rule out this possibility. It seems that the recent stock market strength reflects investors’ guess and hope for this outcome.

To summarize, the most likely path going forward for the economy is that it will go into a recession sometime next year but there’s still a slim chance for the ‘soft landing’. Furthermore, even if the economy goes into a recession next year, the question remains when — maybe it can be as late as in the second half of the next year. So it’s just likely the current market strength, however how transient it might be, can last a few months or quarters. One can say that we will also have an interim soft landing in this case. But on the other hand, the weakness of the economy can accelerate and a recession can be imminent.

Our portfolios turned tactically bullish recently. However, based on the above discussion, we need to be prepared for a possible seesaw — this tactical stance can last as short as a month or two. At any rate, we’ll let our strategies decide based on market and economic trends.

Market overview

Stocks went into an immediate reversal right after they breached above (or touched) their 200 day moving average (to be precise, for S&P 500 index). This reflects investors’ nervousness on the current convoluted state of the economy, the inflation and the financial markets. We note that the corporate earnings expectation is still high: for example, the latest Factset S&P 500 earnings insight showed that analysts still expected S&P 500 earnings per share (EPS) for 2023 to be $232.53. If the economy indeed goes into a recession, a run-of-the-mill earnings decline in a recession would be 20% or so. This would imply the EPS for S&P 500 would be around $200. If you then apply the price earnings ratio 15 that’s the average PE ratio during a recession,  you would see that see that S&P 500 price would be around 3000, a 25% decline from the current level.

Currently we are in a touch situation that even has befuddled the Federal Reserve bank and the alike. At the moment, the best way forward is to stay the course with our strategies and reiterate the following:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still not cheap by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

We wish everyone a pleasant Thanksgiving Holiday! Stay Healthy!

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