Why We Remain Bullish Despite Market’s Fed Worry: Jarvis® Update December 9, 2022

Markets pulled back this week as we were reminded of the uncertainty around us in the economy. We cover this and much more in this week's Jarvis Update. I'm your host, Brian Dress, director of research here at Left Brain, joined as always by our CEO and chief investment officer here at HQ, Nolan Langford. Nolan, welcome to the program.

Good to be here, Brian. Merry Christmas to everybody.

Merry Christmas and happy holidays. Before we get started, I'd like to ask everyone to like and share the video. If you find these videos useful, it really does help others find it and the algorithm on YouTube to figure it out, to get it to everyone. And also subscribe and hit the bell for notifications. That way you find out when the next video comes out. And we're out every Friday with these videos. We'll jump right into our preview. So markets experienced a multi-day losing streak this week as we prep for next week's all-important Fed meeting. Two topics as we're going to cover, as we always do. The first is the week in review, and then the second is a sneak peek into 2023. Before we jump into the meat of the program, a few announcements. First of all, we produce this show for you, the everyday investor, whether you've got a 401(k) or an IRA. If you work with an advisor or you manage your own money, we'd love to be a resource for you and a second opinion on your positioning. Give us a call on the number down below. We'd be happy to take a look at your portfolio and let you know if we could find a way to improve it for you. Also, if you're an institutional investor, we've got something for you, and that's our investment research service. That's Left Brain Investment Research, 6 to 10 of our full-length reports, the same type of reports we use to make investment decisions in-house. And also the Chosen. That's our favorite stock and favorite bond opportunity each quarter. So definitely take a look at that. We'll put the link down below. Either way, we'd love to have you sign up for our biweekly newsletter. That's the Jarvis newsletter, and that's actually off this week, but we'll be back next week with another installment. And with that, we'll jump right into our market recap. First of all, we follow 3 indexes here. The first is the S&P 500. That, that was down 2.8% this week. The tech-heavy NASDAQ was down 3.5% this week. And then the Russell 2000, that's the small-cap index, was down 3.4% this week. The market was moving nervously in anticipation of the U.S. Federal Reserve meeting next week, on next Tuesday and next Wednesday. So definitely a reversal of the positive momentum we've seen over the past few weeks. However, Treasury rates That's the US Treasury long bond. Those rates continue to move lower. We saw the 10-year Treasury touch 3.4% this week after it moved back and it moved back up to 3.5% after. But we're definitely moving down. And also we had a handful of positive earnings coming through. We heard from GitLab, that's GTLB, and we also heard from MongoDB, MDB. These are a couple of our favorite tech names, but they've fallen on hard times this, this year. Nolan, what are your initial thoughts this week and any thoughts on those earnings that we saw?

Yeah, so this week we had a big giveback. I think it's something like every day in December the market's been down. You also mentioned the 10-year Treasury rates back down to 3.4. But if you look at the short end of the curve, the 2-year is actually up and it's actually moving up. So there's this inversion where the short rates are much higher than the long rates. And I believe every time that's happened, it's portended a recession. So it's a recessionary yield curve, and I think that's probably what's driving stocks down. Will be interesting to see next week what happens with the Fed and the Federal Reserve Board meeting, but obviously investors are negatively positioned, or at least at this point heading into the meeting.

Um, we'll jump right into our first topic. So topic 1 is the week in review and a look ahead to the Fed. Uh, first of all, as everyone seems to know, the Fed has driven everything this year in the markets. The question is, how much of a hike are we going to see next week? Will it be 25 basis points? Will it be half a or it'll be 0.75%. We're pretty much expecting it won't be 0.75%. The Federal Reserve has definitely signaled that they're slowing down on rate hikes, but definitely will be an interesting— it will be interesting to see whether it'll be 25 or 50. Employment data was strong last Friday. That threw a little bit of a fly in the ointment. It spooked everyone because now we're in this cycle of good news is bad news, simply because the Federal Reserve is responding to good economic data with more aggressive monetary policy. And also, after a nice run in markets, we were again reminded of uncertainty around rates, inflation. But we also have seen oil pull back remarkably and gas prices as well. Here in Illinois, we're down to about $3.30 a gallon, down from above $5. So definitely huge pullback in gas and oil prices. And also housing. Housing is definitely slowing down over the last 6 months with interest rates going higher. Did this week's action change your views in any way? And then when can we start to move on from that heavily Fed-colored analysis of the markets?

Investors say that markets climb a wall of worry, and my goodness, we're reminded of that this week. We felt so good coming into December, and it's sort of been taken away a little bit. But that's what you get in markets. It's never one direction— stairs up, elevator down. It does not change the long-term view. You mentioned all of the inputs that go into inflation. They're all rolling over and falling. Pretty soon that's going to show up in the data. So it certainly gives the Fed cover to slow down and possibly even pause. So they've been doing a good job not only with the rate increases, but telegraphing to the market, but forcibly moving the economic data down themselves just by how hawkish they've been when they've been talking. And it's been working. And if you look at investors, the way they're positioned along the yield curve, the yield curve would tell you that investors are expecting not only a slower economic backdrop, possibly a recession, but certainly an economic slowdown. So that does give the Fed cover to sort of stop being so hawkish. We'll see if they take the bait next week, but the investors will, will certainly be focused on it. I think there's a lot of positive catalysts as the calendar turns to 2023. You and I talked about a few of these before, and I think that's what investors need to get ready for and position themselves for.

What about this notion about the recession, the impending recession that everyone seems to be talking about? Last Friday, we saw jobs numbers. There were over 200,000 jobs created in the economy in the month of November. What do you think of this idea of having a recession when the jobs market is still strong and buoyant like this?

I don't think we've ever had one. My recollection, every recession has been accompanied by negative job growth, jobless rate actually going up and going up a lot. That's confounding to the Federal Reserve. If you look at the rest of the economic measures, they're all weakening. Except for the labor market. And I wonder if there's something else independent of the Federal Reserve and economic conditions that's making the job market remain tight. I don't know if it's because of COVID A lot of people haven't come back to work. There could just be a talent or supply issue where there's just not as many workers. And the US economy has held up extraordinarily well. Maybe our economy is just creating a lot of jobs and we don't have all of the qualified workers to fill them. So it could be something structural. I'm not really sure, but I agree with you. It's probably the last bastion of economic data point that the Federal Reserve Board is waiting on. And before they check the green light that they've won the war on inflation, we'll have to see.

And we'll see next week what the Fed decides to do and what they telegraph for 2023. That segues us into topic 2. So topic 2 is a sneak peek into 2023. Of course, 2022 has been a tough year, but things do tend to bounce back after a year like this. If you look back in the data over the last 100 years, when we have a tough year like 2022, the next year tends to be strong in the markets. We're looking forward to next year, turning the page on this year. There's also what we call the calendar effect. That means that the worst stocks from the year before, 2022, tend to pop when the calendar turns to January into 2023. There's a concept called Dogs of the Dow, an investment strategy sometimes where investors will buy the worst performing stocks of the Dow expecting them to do well the next year. And we've also learned a new way of looking things in 2022. So for 5 or more years, it really was a growth-led market. We were looking for companies that were growing sales and growing revenues and thinking a lot less about margins and profits. But now profits are key and it should continue to be that way for a long time. Question is, what type of multiples are we willing— what type of multiples are we willing to pay for a dollar profit in a stock market. So, Nolan, what are some of your initial thoughts going into 2023 as far as all that goes?

I think there's a lot of work to be done with investor portfolio positioning. When you look across the landscape, you know, you and I, we've, we've talked to investors, prospective investors over the last year, and they've been very reluctant to hold on to last cycle's winners and to get rid of them and to make a change to them. So a lot of these big-cap tech companies, whether they be in the chip or the software, the traditional growth or the digital space, Now, a lot of these have deflated unbelievably this year. And a lot of these are household names. It's gonna be gut check time we get to 2023 and December 31st here, there will be a— you have to look at the portfolio with fresh eyes. And I agree with you. You know, if you look at a 10-year Treasury chart, and you go back, you know, 40 years or so, we've been in a downtrend on interest rates for 40 years, until this last year. And for 40 years, for that timeframe, if you look at growth, growth has outperformed value. By a very wide margin. And some value managers literally have jumped off buildings, and, um, it's been very frustrating. Could this be the time that the tides have turned? Interest rates are actually back on the move again. Could value be back in vogue? Certainly it is this year. If you take a look at the Dow, there's been tremendous outperformance of the Dow versus the QQQs. Could that be a start of a multi-year trend It certainly could be. You mentioned the focus on profits and profit margins and dividends and cash. That speaks value, in my opinion. Not all value. You still have to have quality. You still do have to have revenue growth, but it doesn't have to be 40%, 50% revenue growth. You're going to have some 10%, 12% revenue growth with high profitability and expanding margins and still look very attractive.

Well, let's shift gears a little bit, um, go a little off script here. No, let's talk about energy. Seen oil prices drop for a number of months here. And in the last couple of weeks, really a crescendo here, a little bit of a pullback in energy stocks. This is an opportunity. I know a lot of, a lot of investors are still way underweight. Uh, we're still overweight. What do you think? Well, how do you, how do you speak to those investors that's still on the sidelines energy-wise?

So I think this is really good time to look at the energy sector. When we talked about value, uh, energy's number one. Now, of course, there's a, a big pot of uncertainty as it relates to energy, and that's oil prices itself. I mean, a lot of energy companies in the short term, not all of them, but especially the EMP companies, the production companies, it's a 1-to-1 ratio almost with their revenue and the price of oil. Price of oil is a worldwide commodity. It doesn't always trade off fundamentals. Sometimes there's geopolitical falls into it. And so it's, it's very tricky. However, the stocks themselves are unbelievably cheap. The companies themselves are laser-focused on not increasing supply into a weakening market. It's the one commodity market that's governed by a cartel, a legal cartel called OPEC. They're actually cutting production. In their last meeting, they cut by 2 million barrels. You know, a lot of people, for a lot of commodities, a declining price is bad for them. Not necessarily for oil. You have demand destruction when oil prices get so high. You have people that switch. And I think the sweet spot, OPEC says, for oil is somewhere in that $60 to $80 range where there's enough profit for oil companies to continue to explore and is not so much where people are going to switch away from using oil. And so, uh, it's probably just an adjustment. The oil companies still have very attractive year-to-date gains as a category. They're still the number one category in the S&P for return. So they are experiencing a little bit of a giveback here. Well, we had the same thing in June, uh, and then they came right back this fall. But if you look at valuation, oil companies are very, very cheap and investors aren't immune to it. Exxon, uh, came out with a report today just talking about their capital plan and updating their business plans over the next 5 years or so with increasing cash flows, increasing dividend models, and investors have responded favorably. So I feel, think it's an area, uh, worthy of investment.

Excellent. Nolan, then one last one for me is people who've been watching us every week, they've heard us talk about cash on the sidelines. But for those of the viewers who are just finding us for the first time, can you speak to the investors that have cash on the sidelines? We do see rates starting to drop, markets starting to move. What's the next move for them?

I think there's a little bit of urgency for people with cash. I know you haven't felt a lot of urgency this year to put that money to work, probably very vindicated in having that money not at risk. Things are changing and changing rapidly. If you take a look at the bank statement, banks still aren't paying up as far as what they're paying us on our bank balances. One of the reasons that financial stocks have really gotten a boost this year, Federal Reserve has increased short-term rates. So banks are making a lot more on your deposits. They're just not forwarding to account holders. I still think there's a challenge in putting that money to work. Inflation is still fairly high at 6, 7, 8%. And if you're still getting less than 2% on your money at the bank, there's still a gap to be filled. We like the idea of taking a look at bonds. Interest rates are up, so bond yields are up. We're finding very attractive bonds both in the tax-free and the taxable space, anywhere between 4% and 7%, depending on how long you want to tie the money up. And we think there is some urgency. We mentioned that there was an inversion of the yield curve. That means for 1, 2-year money getting a higher rate than if you take a look at 7, 8, 9, 10-year money. And the markets are forecasting that rates are going to fall sometime in probably 2023. When and if the economy weakens. And so I think it makes some sense to think about locking the money up in some sort of fixed rate instrument. So if rates do drop, you're locked in at an attractive yield.

We've got plenty of ideas. If you're conservative, moderate, moderate, or aggressive as an investor, definitely give us a call. We'll lay out some thoughts and help you develop a portfolio to take advantage of the current environment. All right, Nolan, we're going to bid the viewers adieu here. Any final thoughts?

Yeah, hopefully everybody's got their Christmas shopping done. We're working on our shopping list of both stocks and bonds that we think are attractive as the calendar turns to 2023. So check us out online. We'd be happy to share them with you.

I see what you did there, Nolan. I like it. With that, we'll say thank you to Nolan and thank you to the viewers, and we'll see you again next week.