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The S&P 500 put in a fresh low for the year on October 13th (the day after we sent last month’s commentary) before rallying for the balance of the month to finish October up 8.13% (using the SPY ETF as a proxy). That left the market down 18.69% for the year.

Bear Market Bounces during 2008-09
Click Image to Enlarge

Yesterday, the S&P 500 was up over 5% for the day, because the Consumer Price Index (CPI) was reported at 7.7% vs. an expected 8.0%. The Nasdaq was up over 7%!

For most people (including professional investors and portfolio managers), this creates an emotional response. It shouldn’t.

Remember, from June to August of this year, the S&P 500 rose nearly 20%, only to drop to fresh lows last month.

A one-day 5% rally in stocks is signature bear market behavior. In fact, for perspective:

During the 2008 bear market there were 19 days where the S&P 500 went up by more than 3% in a day (12% was the highest daily move).
During the bull market of 2020, there were 0 days that the S&P 500 went up more than 3% in a day (2.6% was the highest daily move).

Could this turn into more than a one-day rally? Sure. Should we get FOMO over it? Absolutely not.

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If anything, these rallies lead to selling opportunities.

There are a couple things that are very similar about the June-August bear market rally and the current situation. The first is that from June to July, CPI (so far) peaked and dropped from 9.1% to 8.5%, a 0.6% drop.

As of yesterday morning, CPI dropped once more from 8.2% for September to 7.7% for October. A drop of 0.5%.

Also similarly, in both July and October CPI was lower than the market expected. In July the expectation was 8.7% and it came in at 8.5%. For October, as I already mentioned, the expectation was for 8% but it came in at 7.7%.

November 2, 2022 Transcript of remarks and press conference following FED Meeting
Click Image to Enlarge

These “surprises” of lower-than-expected inflation give the market (a very poor) reason to believe that the Federal Reserve Bank (FED) will “pivot” from raising interest rates to cutting interest rates soon.

That belief never materialized last time around and I don’t think it will this time either. With inflation still running hot, at the extremely high level it is, with persistence, in my view gives the FED permission to continue hiking rates until inflation drops further to a more reasonable level closer to their 2% target.

As the market realizes this, I expect the current bounce (we shouldn’t really even call it a bear market rally yet) to fade. Once it does, we could easily see yet another low for the year. And as the idiom says, “markets take the stairs up and the elevator down,” which means the drop could (and often does) happen even faster than the bounce.

Click Image to Enlarge and click here to watch a short video of Shane and Kyle discussing this chart.

I updated my model projecting CPI and FED rate hikes yesterday after the release. After updating to reflect the new data, my expected timing for the real FED Funds Rate to go positive was pushed out one month, to May 2023 from April 2023. You can watch a short video of me and Kyle’s discussion if you click here.

That’s right, yesterday’s news was so “good” that our expectation for the timing of the FED to pause rate hikes actually worsened, yet the market is acting as though the situation improved.

My friends, this is madness.

I will be the first to admit that I have no idea when the FED will actually pause rate hikes. There are many things that could be wrong about my projections and May of 2023 is an eternity away – a lot can (and probably will) change between now and then. So, I will keep updating the projections as new data comes in.

But the point is that “hope” isn’t a strategy and the data from yesterday did not improve the reality that the FED is going to continue hiking rates.

I do personally believe that inflation has peaked for this cycle, mostly due to the base effects (which I have written about before) kicking in.

So long as the FED is hiking rates, there is a limit to how high stocks and bonds can rally, with each rally probably being just another selling opportunity.

And if history is any indication, the market may not even bottom until after the FED pivots to cutting rates, not before. See the nearby chart.

To be clear, I am not a “perma-bear” or anything like that. We have been bullish for most of Elevate’s history, and we have beaten our benchmark returns on the upside. But we invest aggressively when the odds are in our favor and for the time being they are most certainly not in our favor.

Is it possible that the market may have already bottomed? Sure. But I think it is unlikely.

The facts that override this view are at least 3-fold:

Global growth is slowing
Monetary conditions are tightening
Inflation remains persistently high

In the U.S. markets, 3rd quarter earnings grew at their slowest pace since COVID lockdowns. And they are projected to be negative overall in 4th quarter. As of Friday the 4th, according to FactSet 85% of the S&P 500 companies had reported earnings for the quarter with the overall growth rate coming in at only 2.2%. And that is with the energy sector reporting earnings growth of nearly 200%! If you remove the energy sector, earnings actually declined by 5.1% for the quarter… that is not a good sign of a healthy economy.

We have already covered the inflation situation in the U.S., but globally, it is even worse with the Eurozone’s CPI coming in at 10.7% last week – an all-time high.

And central banks around the globe are tightening monetary policy through hiking interest rates.

Meanwhile, in a recent study Allianz found that many Americans are forgoing long-term saving in response to continuing inflation’s impact on everyday expenses:

Key findings:

54% of Americans say they have stopped or reduced retirement savings due to inflation
62% worry that a major recession is right around the corner
More than four in 10 (43%) say they have had to dip into their retirement savings because of rising inflation.

I think we can put that in the “not bullish” category.

Gross Domestic Product (GDP) for the 3rd quarter was reported in October and showed growth for the first time this year. There are two issues:

Growth gives the FED further permission to keep hiking rates to tame inflation, and,
The underlying numbers aren’t that good.

Regarding point #2, the GDP number showed growth of the U.S. economy of 2.6% for the quarter. “Net exports” contributed 2.77% to that number… net exports are calculated as exports minus imports. The odd part is that imports are normally a positive number, meaning we normally import goods to the USA. But this quarter imports were down, which creates (in my view) phantom growth in the overall GDP number.

If you remove the impact of “net exports” GDP would have actually dropped for the third consecutive quarter, by 0.17%.

Furthermore, consumption and investment, which constitutes 89% of total GDP, slowed yet again in the 3rd quarter, and remains well below the 10 year average. See the chart nearby.

It might sound crazy given what I have written so far, but we did add our first new stock to the Growth Strategy in 74 days on October 25th.

Why? You ask…

Well, I analyzed over 140 stocks during the month… and many of them look very cheap (You can review the full list here). But only one made the cut to actually take a small position. We already have a ton of cash (much of which is invested in U.S. Treasuries and paying around 4%) that will dampen the volatility if our open positions drop further. The big reason that I think we should continue allocating capital even in an environment like this one, where I remain bearish, is that I might be wrong. The market might rally from here and this might represent a great opportunity to buy great companies at a low price.

I am very careful and extremely selective about what I add to our strategies in this environment. So, the company we added was only at 1/3rd of its target position size. We will look to add our full exposure as long as it holds above the stop alert I set, and ideally as it continues to go up. “Averaging down” by adding to losing positions is not how you make money. The game plan is to add to winners and sell losers fast.

Another bright spot for our investments is that across the Growth and Value Strategies, we saw not one, not two, not three, but four different positions achieve all-time highs in the past couple of weeks. One of those stocks was in both strategies, two were in the Growth Strategy only and one is in the Value Strategy only.

So, I will continue to search the market with a fine-tooth comb to identify investments that are cheap, hated, and in the start of an uptrend (despite the market being in a downtrend). I will add exposure cautiously through those which meet the criteria and follow tighter than normal stops to protect your hard earned capital.

Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio performed vs. the markets in October.

Until next time, I thank God for each of you, and I thank each of you for reading this commentary.

Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisor

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