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January 15, 2022
Good morning, Vietnam! This has always been one of my favorite ways of greeting my friends. If you remember from the movie of the same title, Robin Williams played the role of DJ Adrian Cronauer, set in Saigon in 1965 during the Vietnam War. This is how I feel about the start of 2022…Chaos. 2022 welcomed our team with a boom. COVID has ravaged the office, the market is down, and my cruise vacation just got cancelled. I haven’t taken a formal vacation in two years and was really looking forward to taking my 92-year-old mother back to the Virgin Islands. I’ve decided I’m getting back to life, as I’m tired of feeling locked down. As MLK said, “I have a Dream” and so do I, as I have already re-booked our cruise for six weeks from now.
I actually don’t want to talk about COVID anymore, so I promise this might be the last time- I feel so intimate with the virus now I just can’t help myself. It took the medical experts less than a year to develop a vaccine, but almost two years later we don’t seem to have readily available therapies. Shouldn’t our medical experts have been working feverishly (no pun intended) to develop remedies like we do with the annual flu? We all know that it’s common knowledge that viruses mutate, but somehow, we were caught off guard by “Captain Omicron.”
Also, why does the media continue to cover so-called experts talking about this virus when almost two years later we still know nothing? I have experienced people in my inner circle, both vaccinated and unvaccinated, catch this bug with astoundingly different results. You would have expected the results clearly in the other direction as said by these experts. For me, today is “goodbye COVID.”
As we try to move on, did you see in Washington D.C. starting on January 15, they are requiring people to show proof of vaccination to enter a restaurant, indoor entertainment, or gym? What country do we actually live in? This is ludicrous— you mean to tell me we now want to divide the country by vaccination status? Let’s unpack this: You travel to D.C. for meetings or vacation, and you want to go grab lunch. The restaurant tells you to show your vaccination status, which also means you are going to have to present them with your ID. Yet in New York City, you can vote without showing proof of citizenship, and in most places, you don’t have to show ID at all. Trust me, I believe in voting rights, but this makes no sense. Shouldn’t the administration today be working on fixing the supply chain issues and lowering energy and food prices? No, our politicians are only worried about the next election. Wake up folks, we are the next Manchurian Candidate.
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:
December’s U.S. inflation data came in at 7.04%, the highest level since June 1982. This high of a reading will continue to force the Fed’s hand regarding raising rates to combat inflation.
An increasing number of stocks in the three major indices have begun to fall below their 50-day moving average, a key technical level of support. This may imply short-term weakness within these indices.
The AAII Sentiment Survey found only 24.9% of investors to feel bullish about the next six months for the stock market, the lowest reading since the week of September 15.
The One Percent Difference
Results matter. In the age of fee compression, pundits continue to push for investors to invest in low-cost, passive index funds and hope for the best. However, to advise individuals to simply invest in the cheapest funds and cross your fingers because “there is no science to the stock market” is not only irresponsible but can also have long-lasting impacts on their financial futures.
A prevalent obstacle to the average investor is not having any context for their returns. A 2017 Dalbar study titled Quantitative Analysis of Investment Behavior found that the average investor underperformed the market by 4.7%, earning 7.26% versus the market’s return of 11.96%. Now, most investors wouldn’t flinch at a return of 7.26%; it means their investments are growing and beating inflation. However, leaving even one percent return on the table can affect your retirement plans.
In “Results Matter: Even a Small Increase in Returns Can Dramatically Improve Outcomes,” an American Funds analysis from May 2017, a hypothetical scenario using Capital Group as its source was created to discover what the effect of gaining an additional one percent return would have on the average individual’s retirement. In this analysis, it observed how much a 25-year-old investor’s investments would increase by the time they retired at 65, as well as how long it would take for them to run out of money during retirement. It then compared three scenarios of returns pre-retirement and during retirement to see how a half-percent and one percent return difference impacts the growth of the investments.
By having a single percentage point better return, the investor saw over $227,000 in additional retirement savings and 12 additional years of retirement spending before their money ran out. Keep in mind, that is just an average difference using the previously-stated assumptions. An individual that contributes a greater percent, sees larger salary increases, retires later, etc. will see an even larger impact for achieving that extra percentage of return.
While the strategy of “set it and forget it” with cheap, passive index funds can be effective, it leaves potential results on the table, as illustrated by the previously-stated analysis. 401karat believes that it is not about “timing the market, but time in the market.” However, while time in the market is half the battle, being in the correct areas of the market at the right time is critical to the pursuit of that extra percentage point. That is why we observe trends in the market, whether it be sector trends like technology and real estate or style trends like growth versus value.
While the stock market is not an exact science, and corrections can feel as if they appear out of thin air, aspects of it like sector rotation and style trends can be analyzed in a scientific manner. Through our prudent process of investment selection and performance monitoring, we can work towards achieving results for our participants. And, as we know, results matter.
MARKET INDICES
YEAR-TO-DATE RETURNS
LARGE CAP INDICES
S&P 500: -2.25%
Dow Jones Industrial Average: -0.62%
Nasdaq-100: -5.05%
MID AND SMALL CAP INDICES
S&P 400 (Mid Cap): -1.77%
S&P 600: (Small Cap): -1.40%
Russell 2000: -3.82%
INTERNATIONAL INDICES
MSCI EAFE Developed Index: 1.01%
MSCI Emerging Markets: 2.54%
MSCI ACWI ex-US: 1.51%
ECONOMIC SECTOR INDICES
Basic Materials: -1.24%
Communication Services: -2.70%
Consumer Discretionary: -3.59%
Consumer Staples: -0.23%
Energy: 13.60%
Financials: 5.54%
Healthcare: -4.76%
Industrials: 0.60%
Real Estate: -5.71%
Technology: -5.59%
Utilities: -2.36%
2021: THE “STOP-AND-GO” MARKET
Between COVID variants, rampant inflation, and rising interest rate speculation, 2021 once again saw a disconnect between the macroeconomy and the stock market. However, before we put 2021 in the rearview mirror, let’s take a look into what Nasdaq Dorsey Wright nicknamed the year of the “stop-and-go” stock market.
“Stop-and-go” refers to 2021’s tendency to have rollercoaster-like shifts in sector performance based on new COVID and economic data that was continuously released. The “stop” refers to the areas of the stock market that were either resilient or directly benefitted from the lockdowns back in 2020; these areas typically include growth stocks and technology stocks. The “go” refers to the areas of the market that were considered part of the reopening trade, such as retail, energy, and value stocks. The “go” also refers to the areas of the market that are expected to benefit from a rise in interest rates, like banks.
The first quarter saw a dramatic shift into the “go” trade, as rising treasury yields hurt the growth leaders from 2020. In fact, the tech-heavy Nasdaq-100 experienced a -10% pullback during the quarter in response to the rising yields. The top three sectors in Q1 were energy, financials, and industrials. In the second quarter, however, falling yields led to technology outperforming once again, with real estate and energy joining it in the top three for Q2. The third and fourth quarter saw a virtual repeat of the first two quarters, with financials leading the way in Q3 and technology and real estate leading the way in Q4. In short, 2021’s shifts between the “stop” periods and “go” periods were like clockwork, and almost perfectly coincided with the change in quarters.
The shifts in quarters were so pronounced that, other than energy being in first place in Q1 and third place in Q2, there wasn’t a sector that repeated being in the top three in consecutive quarters. This constant shifting of what was outperforming during the year made it difficult for many strategies, as investors who went all-in on the “stop” trade were hit hard in the first and third quarters, while investors who went all-in on the “go” trade were hit in the second quarter and faced more uncertainty in the fourth quarter with the emergence of Omicron. Likewise, the “stop-and-go” environment also affected momentum strategies, as investors who traditionally saw trends in the sectors of the economy last for six to 18 months ended up witnessing trends that only lasted six to 18 weeks.
As we enter into 2022, the story unfortunately doesn’t look much different regarding the economic outlook; there remains plenty of uncertainty regarding the “stop-and-go” economy we are living in. Continued reopening and the Federal Reserve raising interest rates may become a tailwind for the “go” trade, whereas concerns about Omicron and our economy’s ability to withstand infections on this scale may become a tailwind for the “stop” trade. No matter how 2022 will end up, this much is clear: investors will need to remain light on their feet and willing to adapt to the everchanging environment we find ourselves in today.
Chairvolotti Financial, Inc. dba 401karat is a Registered Investment Advisor.
