Positive Inflections Everywhere: Short-term Overbought, Intermediate Term Still Oversold

The best returns tend to come from buying great assets AFTER periods of underperformance.

Key Summary:

• 2023 has NOT gone the way most investors expected leaving them under-exposed.
• Markets have performed strongly since November leading to overbought conditions.
• As rates fall & inflation normalizes, positive inflections are occurring.

Important thesis: If equities generate roughly 8-10% a year over time, the leaders of industry should, in theory, compound at 13%+ over time. We have significant proof on this topic where top brands are concerned. For a variety of reasons, the last few years has been difficult for the average stock. Betting against consumption-focused stocks after a poor two-year period has been a poor investment decision. We see massive opportunity across the consumption landscape as great companies play catch-up to reach more typical annualized return metrics.

2023: The year that caught many investors off-guard.

2022 was a dreadful year and consumer and investor sentiment was poor coming into 2023. The masses, including “Wall Street Strategists”, expected a continuation of poor equity returns for the first half of 2023. That caused portfolio’s to be under-exposed to risk and overweight money markets and defensive assets, most of which, underperformed significantly in 2023. I can feel the FOMO brewing. It’s only going to get more acute once HNW clients see their year-end 2023 statements that look quite different than the headlines indicate.  Will they try and force their advisors to get more engaged with stocks? Will they de-anchor a bit from their heavy cash and bond positions? If they do get more exposed to stocks, where will they focus? Will they chase what’s worked and expensive or will they widen their lens and invest more broadly across markets and industries that offer better potential upside? So many questions to ponder.

2023 YTD returns as of Thursday, December 14^th:

Equal weight S&P 500 Index: +11.5%

S&P 500, market cap weighted Index: +24.4%

S&P 500 Largest 50 companies: +36%

Nasdaq 100 Index: +50%

Large Cap Value Index: +9%

Russell Small-Cap Index: +12% – the vast majority of this coming since October 27^th!

Average “safe and defensive” Dividend strategies: +2-5%

Long Duration Treasuries 20+yrs: +0.33%

Average Short Duration Bond strategies: +3-5%

Since late October, laggards and lower quality stocks have played major catch-up.

Small caps (+19%) & lower quality stocks have staged a massive rally after being left for dead in just over 2 months. This is TWO years of typical performance folks, all in 2 months. Moves like these are not normal but they highlight how crowded the market was in the largest, quality stocks as well as how crowded the “rates are rising and staying high for longer” trade had become. As rates began to fall, massive positioning started to unwind with participants running through a narrow door all at once. Then, a few days ago, the Federal Reserve took off their “talk tough” hat and hinted at policy restrictions getting easier on the margin with rate cuts likely in 2024. That really sent animal spirts into overdrive, particularly across highly leveraged stocks. Since October 27^th, the most interest rate sensitive stocks and industries staged one of the most robust rallies I have ever seen. REIT’s are up about 27% in 2 months, dividend strategies +12-15%, and small-cap stocks (40% of which are unprofitable and leveraged) are +20-25%. On a short-term basis, the laggards, turned to leaders are quite overbought and extended and likely due for a pullback. I suspect the market will soon begin to differentiate between what should have staged a rally and what simply rose as the tide lifted all boats. That’s called stock picking BTW. Some companies didn’t deserve to be beaten down so badly and needed to mean revert, some are raging sells in our eyes. Later, I’ll describe why I think the coming pullbacks offer very strong 1+ year investment opportunities.

A 2-3 year look-back highlights how far away from normal returns the markets still are.

I’ve been investing for 30 years now. I’ve made every mistake one can make, probably multiple times. This business can be incredibly humbling, yet I can’t imagine doing anything else. 30 years of experience plus some data mining tells a very powerful story that could just be beginning to emerge. Because of the Pandemic, an incredible number of distortions to virtually every industry and company have occurred. From supply chain disruptions, to forced cost cutting initiatives, to 50-year highs in temporary inflation, to a historic Fed Funds hike from 0% to >5% in record time, to an epic rise in the cost of capital for individuals and corporations, companies had a lot to address over the last few years. Common sense should tell us multiple 100-year storms and outlier events in a few short years probably might take the average stock off its long-term return course. The data supports this thesis, as the market overall (S&P 500 Index), has annualized at 2.3% for 2 years versus the +8-10% long term average. The small cap index has annualized at -3.7% even including the recent spike in prices. This simple datapoint plus the evidence of potential economic healing, indicates the large opportunity in front of investors.

Bottom line:

Most investors have been caught flat-footed and under-exposed to stocks. More and more stocks, sectors and industries are breaking 2-year downtrends with fundamentals positively inflecting after a tough few years of rolling recessions and slowdowns. You have NOT missed the opportunity in our eyes. Yes, markets are short-term overbought.

We should all expect, and hope markets pause after this wicked positioning switch. It’s most important for investors to widen the lens to 2 and 3 years.

The average stock has radically underperformed the “typical” experience over long periods of time. As the economy, rates, Fed policy, and inflation normalizes, stocks should continue to play catch-up so the forward 3-year look-back shows a more typical annualized return environment.

In the global consumption economy, we focus on, it’s very rare to see a 2-3 year period when the average consumer stock underperforms this significantly. When an asset class with a history of outperformance lags badly for a few years, that’s the signal to get more exposure. Great brands outperform long-term, there’s plenty of room left in the tank!

Disclosure: The above report is a hypothetical illustration of the benefits of using a 3-pronged approach to portfolio management. The data is for illustrative purposes only and hindsight is a key driver of the analysis. The illustration is simply meant to highlight the potential value of building a consumption focused core portfolio using leading companies (brands) as the proxy investment for the consumption theme. This information was produced by Accuvest and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed. Any sectors or allocations referenced may or may not be represented in portfolios managed by the author, and do not represent all of the securities purchased, sold or recommended for client accounts.  The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results.