July 17-21, 2023

Tactical Signal 9

Sowell’s technical signals continue to maintain a full position (100%) as the key economic factors have consistently shown positive trends, reinforcing their validity. These signals will further seek affirmation through the upcoming indicators and earnings momentum expected this week.

Enthusiasm in equity markets gained, after pausing the prior week, on cooling inflation worries on a lower CPI report of 3%. For the week ending July 14th, the S&P 500 index and Nasdaq Composite gained +2.44% and +3.32%, respectively, accumulating to a YTD gain of +18.41% and +35.47%. That disinflation had the opposite effect towards the broader economy and bond yields as the Core CPI of 4.8% raised concerns that was not sufficient to stop the Fed from raising interest rates. Instead, bond yields tightened as the 10 Yr. yield narrowed from 4.01% to 3.83% resulting in the Bloomberg Barclays US Aggregated gaining +1.51% last week indicative of ongoing skepticism for the economy.

Last week’s major economic report on lower inflation, lower jobless claims and a rise in consumer sentiment continued to support a bullish equity market as 10 out of the 10 largest stocks posted weekly gains. NVIDIA (NVDA) is the monumental leader gaining another +7% bringing its YTD gain to +211% at a current market capitalization of over $1 trillion. Apple, Microsoft, Amazon, Nvidia, and Alphabet are the current Trillionaires Club.

With the kickoff of 2nd quarter earnings season on its way led by the largest financial institutions, JP Morgan, Wells Fargo, BlackRock, Citigroup, and State Street for the most part posted positive earnings surprise. Financial stocks gained +2.36% last week as bellwether banks JP Morgan and Wells Fargo returned +3.76% and +1.85%.

Investor sentiment will gain momentum as 2nd quarter earnings seasons continue its kicks-off this week as companies from broader leading sectors report including the likes of Hasbro, IBM, Morgan Stanley, Netflix, and TSMC. Other critical economic releases led by Industrial Production, Business Inventories and Housing will help shape the forward and improved alignment of both the market and economic spheres.

It is a profound and necessary truth that deep things in science are not found because they are useful; they are found because it was possible to find them.

- J. Robert Oppenheimer, Father of the Atomic Bomb.

When Leading is Lagging

For most of us in the investment world we have relied on tried-and-true economic indicators/signals that have generally been foolproof in helping us get a sense of where we are in the economic cycle. More so today there has been a reliance on these signals given the big moves in inflation and the resulting dramatic, yet slow, action by the FED. We can argue the causes and the path that has gotten us to this point, the pandemic and resulting extreme global uncertainty and the critical risk management decisions – that have even beleaguered the Fed. But there is no dispute the extraordinary fiscal and monetary policy actions taken were unprecedented and we might even characterize that “caution was thrown to the wind” and that it was acceptable to take on lesser and manageable outcomes rather than the complete meltdown that “could have been.”

This most probable outcome would be inflation and then the predictable outcomes after that. Can you say recession? This is where we get into two very recognizable indicators that “experts” follow to not only forecast future economic activity but also use to manage asset allocations between bonds, stocks and other asset classes.

The first is to monitor the slope of the yield curve and particularly when it’s inverted and the depth of that inversion. In “normal” times the yield curve should slope up and to the right, reflecting a healthy economy and investors who have a positive outlook on risk and return. Inverted yield curves have generally forecast recessions. So much so that the NY FED looks at the three-month/10-year bond spread as a forecasting tool to predict an upcoming recession.

Here is the current signal, and the fact is that it has been and continues to flash recession. However, this time, inflation did go higher and has come down since early 2023, but unemployment has not risen like history would predict. One might characterize that unemployment has been relatively unaffected. Taking unemployment out of the equation, we have had an amazing policy success, starting with a fiscal response to the crisis and now a monetary response to that fiscal response. In fact, at the expense of the “recession predicting tool” if we escape with a soft landing or no landing, we might even believe that the FED and its instruments worked. Of course, there are always those that will complain about whether the FED action was too late, too much, too long, not enough, but time and time again, perfection is the enemy of good. At this point we are staring “good” in the face despite what the 10 yr. bond/ 3month spread. Lastly, even now we see the 10yr bond rate rising which should bring the above chart out of recessionary territory.

Let’s now look at the second indicator, known as the Conference Board’s Leading Economic Indicators, the LEI. The LEI is designed to predict the future of the economy.

The 10 inputs comprise of 3 financial components and 7 nonfinancial components, and the LEI has been used to predict in advance a potential recession. See chart. Most recently, the LEI has continued to decline by another 4.3% over the last 6 months and has declined consecutively monthly for over a year. Again, with unemployment still quite low, inflation abating, and consumer spending relatively stout, and markets rebounding, it seems that this signal is lagging. There is as much evidence that in the short run a recession seems unlikely if not a soft landing being highly likely.

So, on one hand policy levers, both fiscal and monetary seemed to have worked quite well while two stalwarts of economic forecasting are in contradictory positions. One thing is for sure, patient investors not obsessed with recessions should view them as insignificant speed bumps. Crestmont Research recently affirmed a study that others have done before but in essence since 1919, investing in something like the S&P 500, there have been 104 twenty year rolling periods and it turns out that all 104-year periods had a positive return. Only a hand full of those periods delivered an annualized return of less than 5% and more than 50% delivered and an average rate of return of more than 9%. Imagine too, that every year one is making new investments of new money and you can see that long-term investors make money. If you are able to overcome your risk aversion, there were also, since 1950, 39 double digit downturns which make declines “common” but potentially exploitable, but we’ll leave that for another day.

Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.


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