December 15, 2021
I start this episode with a heavy heart: our beloved Mooshoo has crossed the rainbow bridge. He came to us from the Bullpen Rescue of Georgia 38 months ago. He was blind, underweight, and suffering from diabetes insipidus. I promise you he spent his last 38 months living his best life! He came to work every day with no complaints, although he demanded that he take the staff with him on his daily walks. He will be missed but never forgotten. He did have one last big request from me: if I could be a little more political on my bi-monthly newsletters. So here goes:
As Janet Yellen was testifying that the U.S. debt ceiling was about to be breached, I realized I did not have a conversation with anyone about fears regarding the debt ceiling being in jeopardy. I feel like I am in the middle of a Rod Serling episode of Twilight Zone. The Twilight Zone is the mental state between reality and fantasy. According to Rod, there is a fifth dimension beyond that which is known to man. It is a dimension as vast as space and as timeless as infinity. Have we lost our minds? The market didn’t even react to the possibility that the U.S. would potentially default on their debt. We know that elections have consequences, and this is what our politicians always do- nothing! Remember, Republicans will be next in line to do the same thing and then blame the Democrats. We just continue to kick the can down the road. Term limits for everyone!
This brings me to Senator Karen and the Squad. Senator, you don’t look very good in green. Elon Musk is not the problem in Washington. You have had a hundred years to change the tax code. Quit complaining and placing blame, and actually do something about it. The Squad wants to now cancel student loan debt after already postponing payments for the last couple of years- over my dead body! I paid back my loans that I willfully borrowed, and I’m not about to pay yours. Additionally, in New York City you now don’t have to be a citizen to vote in local elections; I was always told that membership has privileges. It seems I have answered my own question- we have lost our minds.
As a good Catholic boy, I went to confession last night. I’ll probably have to go again next week, but I leave you with this: what’s the difference between the Titanic and CNN? The Titanic had all of its anchors on board when it went down! Farewell, Mooshoo- my best friend. Merry Christmas to all.
Three Market Drivers
We focus on three market drivers that lead to notable movements in the stock market: economic fundamentals, technical environment, and investor sentiment.
Our fundamental indicator follows 19 economic datapoints that track the underlying health of the US economy. From unemployment to homebuilding, changes in these economic datapoints tend to confirm recession or recovery after the technical and sentiment indicators have already reversed.
Dynamic Asset Level Investing, or D.A.L.I., is a technical indicator that compares each of the major asset classes, sectors, and sizes and styles against each other to discover emerging trends in the market. D.A.L.I. compares daily price action of each of these elements on a point-and-figure chart to illustrate momentum. The chart at the bottom of this page shows the current leadership in D.A.L.I.
Our sentiment indicator tracks how everyday investors currently feel towards the U.S. economy and the stock market. Between our own polling and professional surveys like the American Association of Individual Investors (AAII) Investment Sentiment Survey and Citigroup’s Panic/Euphoria Model, we track the two most dangerous emotions for investors: fear and greed.
Here is a breakdown of where each market driver currently sits:
Yesterday it was announced that the U.S. Producer Price Index, a measure of cost changes from the seller’s perspective, rose 9.62% year-over-year in November, the highest number on record. It will be interesting to see if today’s Federal Reserve meeting takes a dovish stance to ease recent market fears or a hawkish stance to calm fears about new inflation data.
The S&P 500’s 50-day moving average once again served as support earlier this month, following a pattern we have seen throughout this year outside of September’s drawdown.
The most recent AAII Investor Sentiment Survey found that roughly 40% of investors felt neutral about market returns six months from now. A neutral majority has historically led to the strongest returns over the next six months when compared to bullish or bearish sentiment.
“You can’t beat the market.” Time and time again, this phrase is repeated in social circles. While the majority of those in the investing world continue to utilize strategies from the 1950s like Modern Portfolio Theory that encourage owning everything, Chairvolotti Financial believes that owning everything has plenty of drawbacks.
The funds in your 401(k)’s lineup rotate in and out of favor like produce in a grocery store; while they all may be objectively good investment options; it does not mean that every fund is in favor at all times. Chairvolotti Financial finds it counterintuitive to own these “out of favor” sectors as a hedge against downturns in the “favored” sectors. A prime example of this occurred last year: the technology sector saw a return of over 42%, while the energy sector saw a decline of roughly -37%. If you had owned both to hedge your bets, you would have had an average return of around 2.4%. However, if you simply avoided investing in the weakest areas of the market (like energy last year), you would have seen substantial improvement in your portfolio’s performance.
In order to find these “favored” sectors, Chairvolotti Financial utilizes modern investment technology to view which asset classes and sectors exhibiting relative strength. Relative strength simply refers to specific sectors or asset classes that have stronger performance than a broad market index, like the S&P 500. The objective of this strategy is to invest in sectors of the market with relative strength, and to avoid sectors with weak relative strength. One of the easiest ways to envision this strategy is to think of it as a relay race; as soon as a sector loses steam, we pass the baton to a sector that is just beginning to take off. This investment strategy is known as Sector Rotation.
In short, while everyone continues to invest the same way they have for decades, Chairvolotti Financial believes there is a better and smarter way to invest for your retirement. By diversifying amongst “favored” funds in your lineup and avoiding the “out of favor” funds, it is possible to outperform while still being diligent about your retirement allocation. While it may be difficult at times for leadership to appear in the short-term, long-term investors will be able to see these rotations play out amongst the sectors. Paired with modern investment technology, Sector Rotation sheds light on a commonly overlooked fact about investing: it’s not about what you own, it’s about what you don’t own.
Large Cap Indices
S&P 500: 23.38%
Dow Jones Industrial Average: 16.13%
Mid and Small Cap Indices
S&P 400 (Mid Cap): 18.70%
S&P 600: (Small Cap): 20.30%
Russell 2000: 9.36%
MSCI EAFE Developed Index: 5.36%
MSCI Emerging Markets: -5.36%
MSCI ACWI ex-US: 2.79%
Economic Sector Indices
Basic Materials: 20.37%
Communication Services: 18.49%
Consumer Discretionary: 20.21%
Consumer Staples: 12.02%
Real Estate: 34.62%
The January Effect
Building off of the Santa Claus Rally from last newsletter, there is another winter phenomenon in the stock market that deserves review: the January Effect. Like the name suggests, the January Effect simply refers to January’s ability to imply how the year will go for stocks. Does a strong January mean a year of robust returns? Does a weak January signal doom and gloom for the next 12 months? Let’s find out.
For our analysis, we looked back from 1950 to 2020 to observe how each January and year performed over that timeframe. Since 1950, the S&P 500 has had a positive January roughly 60% of the time. In these years in which January has had
a positive gain, the S&P 500 ended the year with an average return of 16.60%, notably higher than the stock market’s historic average. Likewise, years with a positive January ended the year with a positive return over 88% of the time, indicating a significant likelihood of ending the year with a positive return.
Conversely, negative Januarys have been a mixed bag. Since 1950, years with a negative January have finished with an average return of -2.14%, significantly lower than years with a positive January. Also, years with a negative January have ended with a positive return only 50% of the time, making negative January years a virtual coin flip regarding how the year will finish.
There have been many theories as to why the January Effect exists. Some investors believe that the January Effect is due to investors selling winners in December and employing this cash into new investments at the start of the new year. Likewise, it is also proposed that some investors may put their year-end bonus money into the market. Other investors believe the explanation is simply due to psychology, as investors may see the start of a new year as a fresh start and a time to implement a new investment strategy or idea.
Regardless of the root cause, the January Effect has been a consistent phenomenon in stock market history. While a negative January doesn’t necessarily mean the rest of the year will be pessimistic, a positive January has historically provided a reliable indication of a strong year of market returns.
Chairvolotti Financial, Inc. dba 401karat is a Registered Investment Advisor.