Strategy and Positioning written by Steve Orr, Chief Investment Officer; and Essential Economics written by Mark Frears, Investment Advisor

As of market close November 4, 2022. Returns in percent.

 Strategy & Positioning 

 — Steve Orr 

Hike & hold

A key driver of October’s big rally was variations on a Fed “pivot” narrative. Each week brought a different flavor of “the Fed will stop raising rates soon.” Last week the FOMC and Chairman Powell finally brought those balloons back to earth. The meeting’s press releases excited traders with a line that the Committee may consider slowing down the pace of rate increases. 

Chairman Powell took away the punch bowl by explaining that changing the pace of rate increases would not mean rates would drop or stop rising. He was very direct in his remarks that rates would likely go higher and stay high longer than markets expect. The official language for that point: “Restoring price stability will likely require a restrictive stance of monetary policy for some time.” We take the Fed at their word, they are not finished raising rates, the economy is getting weaker, and we should be ready for falling employment.

Weaker

November is usually one of the strongest months of the year. The first three days were one of the worst starts on record, as the S&P 500 fell nearly 4%. Friday’s post-jobs report rally helped a bit, closing the week with a 3.35% drop. The Dow Industrials kept value investors’ hopes alive, only declining 1.4% while the growth and tech NASDAQ sawed another 5.5% off its value. Tech is all about Musk’s moves with Twitter — a number of companies are reporting softer order books and lowering revenue forecasts. 

That Friday rally was partly in response to the Bank of England saying that they would not raise rates as far as markets expect — exactly the opposite of our Fed. Europe may lead the way in social trends, and England is well ahead of the U.S. in terms of poor financial health. Let’s not follow their lead. 

The October payrolls report had a nice headline gain of 261,000. Mark digs into the data in his column; the short answer for traders is that 244,000 of those jobs were a “seasonal adjustment” by the BLS. Bad news is good, though, when looking at the details. 

From a seasonal perspective, stocks usually do well after election day. Also, November usually ranks second or third best in overall performance. We cannot help but wonder if this year is different. Perhaps all that post-election excitement was pulled into October. At risk of repeating ourselves, this is our first November with war strains, inflation, fuel shortages and strike threat headwinds. It is as if most of the ’70s decade were rolled into one month. At least there is no disco. 

Globe

We have addressed events in past writings from a standpoint of market surprise. Generally, events shake markets temporarily, but do not alter their long-term trend. Some surprises are surely on the horizon between the New Axis of Russia-China-and a few others Versus Out-of-Fuel Europe and Out-of-Weapons U.S. The bridge between the two groups is Taiwan — which China covets for national pride and over a third of the world’s computer chip manufacturing. Expect more bellicose rhetoric from China and increasing escalation of “trigger” events like aircraft near misses in the coming months. 

This week’s event is our mid-term elections. Usually divided government brings gridlock that at least stalls regulatory and tax growth. Wall Street loves divided government and stocks usually do well when D.C. does not do much. Unfortunately, a quiet, divided D.C. is likely a low-probability outcome. The military and defense contractors need a budget so they can restock munitions sent to Ukraine. Funding for Ukraine is also increasingly contentious. Another debt ceiling battle looms in the summer. Divided Govt, Yes /  Stability, No. Expect several days to count ballots while parties file suits over chads again.

Fall?

Our High Case for markets remains a rolling recession starting now (Fall) through mid-2023. Stocks would find a bottom over the next several months and begin basing. Value, Momentum and Small Cap stocks would continue to outperform. Our Sector Rotation Strategy is following these areas through Healthcare and Energy exposure.

Our Base Case — at least 60% probability — the Most Anticipated Recession Ever formally gets underway in the Spring. Interest rates peak in the front end around 5.25% and 10-year Treasuries finally make it up to 4.5% before rolling over in the summer. Unemployment touches 5% and earnings fall at least 15%. Stocks break through last September’s low and bottom near 3,000 for a true Recession Bear cycle.

Our Low Case — we will wait until our Astros happiness wears off.