US Profit Recession is Here.
I would like to take a moment to look back at 2022 and, really, say thank you.
I am truly grateful for the growth Ivory Hill had in 2022. I want to thank all of my clients, old and new, and let you know that we will continue to push ourselves, improve our strategies and process delivery, and continue to evolve how investors and advisors continue to think about investment management. We greatly appreciate your trust as we continue to grow together.
I especially want to thank those who introduced us to some great new families and businesses. We are very selective when bringing on new relationships which is why we prefer to grow through our existing clients.
We continue to believe that our active and tactical approach is universal, and letting others know about our unique offering means a lot, so from the heart thank you.
The Ivory Hill RiskSIGNAL® is still red and we are sitting on roughly 73% cash and money market for our wealth management families and select group of institutional clients.
We are coming up on almost a year of sitting in this position. We didn't panic chase bear market rallies or buy growth stocks because CNBC said they were cheap. We stuck to our quant-based signal and unemotional process based on mathematics and data in order to protect your hard-earned capital.
Santa never showed up to give investors their year-end rally. After what has been one of the most volatile years in history, we are relieved that it is behind us.
The S&P 500 ended 2022 down -19.44% for the year. That makes 2022 the worst year for the S&P 500 since 2008 and the fourth-worst year since the index was expanded to 500 companies in 1957.
Bear markets are expected; it’s just part of the process. The only sector that closed up in 2022 was energy. You don’t see just one sector end up positive for a year that often, in fact you probably have to go back to 1929 or 2008 to find this occurrence.
2023 Market Outlook
The first two quarters of 2023 will be extremely volatile. Ending a year in the red has historically lead to volatility carrying over into the first quarter.
But, there is very good probability that markets will see double digit returns by the end of this year. Historically, the market has only closed lower 2 years in a row 4 times, so the odds are very high for a positive year in 2023.
The latest FOMC minutes state that the Fed does not think it would be appropriate to start reducing rates and are very cautious against loosening monetary policy in 2023.
As I said in my post back in October of 2021, this tells us that the Fed is going to do what they always have. The Fed will remove accommodation and it will hike rates to the point where it chokes off economic growth, just like it did in 1999/2000, 2005/2006, and 2018.
And by definition, the Fed literally needs the labor markets and the capital markets to break wide open in order to tame inflation.
In other words, I do not expect any sustainable upside in the market for the next two quarters. But the downside could get monstrous, especially if the Fed continues to hike rates into declining economic conditions. As I have been saying a lot lately, if the Fed raises by 1 basis point or 50 basis points, it does not matter to me because the Fed is still tightening and every time the Fed has gone into a tightening cycle, a major market crash and recession has followed.
When the Fed does pause, this will be the trigger for bonds to rebound. I do expect the bond market to overshoot and finish up in 2023.
There is a good possibility that the flight to safety trade will happen before the Fed pauses rates as long-term Treasuries are not as impacted by the Federal Funds rate as short-term bonds are.
Expect high volatility in both directions. There is only one back test in history that shows four straight quarters of declining growth. The last time we had four straight quarters of declining growth was coming out of the 2000 tech bubble.
When key technicals are broken, that squeezes short-sellers, forcing them to cover their short positions while bullish traders start buying around the same time. It's basically a competition of which side can put more pressure on the other side.
Beware of FOMO. We have been sitting in this position for almost a year now so let's stick to our process.
The ISM Services report on Friday was the worst deceleration since the 2008 recession with new orders crashing from 56 in November to 45 in December.
This might be surprising for some but when consumers stop buying things, the price of that thing goes down and the people who sell those things are selling less things at lower prices.
This will be a big problem for growth stocks and we are about to see those stocks get hit even harder as earnings are announced.
The US money supply is contracting on a year over year basis, meaning there is less money and less spendable credit in the US.
To give some context, 2022 is the only one year since 1960 when we have ever seen declining liquidity. This is a big a deal and something we have never seen before. Even Volcker didn't have a negative money supply.
Lack of available liquidity leads to widespread defaults and even bankruptcies.
If liquidity is contracting (money supply and spendable credit are both declining) what happens to the things priced into that liquidity (I.e. profits and asset prices)? They crash.
The Fed is very focused on the labor market and they need to see unemployment skyrocket from current levels in order to start cutting interest rates.
Temp staffing and overtime hours are hyper-cyclical components of labor and they are a signal for the broader cycle. Temp help employment has been negative for four months in a row and overtime hours are now approaching recessionary levels.
This matters because it will be very easy to monitor this on the short-term basis for us but very difficult for the Fed to justify cutting interest rates until its too late.
This phase of the cycle we're going to see a wrecking ball take out corporate profits. This is when earnings revisions collapse and companies start reporting earlier and earlier.
Earnings growth estimates are currently at -12% and this could get a lot worse by the end of this week.
An earnings collapse this will increase credit risk to corporations because they will have less cash on hand and risk defaulting on their debts. You guessed it, the next phase of this thing is going to be a credit crisis.
See below. I am sure there is no reason why BNY Mellon, JP Morgan, Bank of America, Wells Fargo, Citigroup, and BlackRock all decided to report on the same day. This is very out of the ordinary for top brass banks to report on the same day.
Precious metals are in play and we have been taking small positions in Silver, Gold, and Platinum ETFs because during a declining growth environment, precious metals show strong relative outperformance to stocks because their volatility is trending lower. Remember, low volatility is good so to have it trending lower is a bullish indicator.
Having been mostly bearish for the past two years on China, I am currently Neutral. Since the onset of the pandemic, China has tended to run a quarter ahead of the broader G20 countries. That remains the case. Looking ahead to the first nine months of 2023, of all the G20 countries, only China has an accelerated growth setup for Q2 of this year.
By contrast, every other developed economy is looking at a declining growth setup. The unleashing of COVID is likely to magnify this condition set as it will increase the probability of stimulus in China.
BUT, wait our signal flipped green on China last Friday.
I am not in a huge hurry to chase this rally so we are going to monitor this for other positive indicators and we might start bleeding into China related ETFs on pullbacks. There are some great Chinese related single stock longs that would be good play here if you can handle the volatility. I do not expect this positive growth scenario to last much longer than the end of Q2 2023.
Turkey was a great trade for us last year and will likely continue to be. While our position sizing has been intentionally very small across the board, this is yet another reason why you have to look outside the US because these types of opportunities do exist.
How do we end 2023?
I predict, based on current market conditions, in Q3 of this year, the US markets will be in an accelerating growth environment and we will end 2023 up double digits.
Some might consider that a bold statement after what I just covered. To oversimplify, the apocalypse is here and we are waiting for the storm to come and pass. We just need to remain patient for about the next six months or so.
There are a lot of good deals out there, such as $AMZN, $META, $GOOGL, and $NFLX to name a few. And they will likely be even better deals a few months from now.
The time is NOW to start loading your accounts with more cash. We are about to have a generational buying opportunity and we stand ready to fire a bazooka at this market when that time comes.
Until then, we are going to sit on our giant pile of cash and take small nibbles at macro opportunities until the Ivory Hill RiskSIGNAL turns green.
And remember—the one fact pertaining to all conditions is that they will change.
Feel free to reach out to me and use me as a sounding board.
Looking forward to meeting with everyone this quarter.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President