Inflation, Rate Hikes, Midterm Cycles, Margin Levels, Reasons for a Rally? Has Mr. Right Appeared?

What Could Go Right?

With the S&P 500 probing its lows for the year, investor anxiety near highs, and sentiment near lows, on Friday, October 14th, the Oak Harvest Investment team released our weekly stock talk podcast and its title? What could go right with your portfolio in the 4th quarter?

I am Chris Perras, Chief Investment Officer at Oak Harvest Financial Group, and I want to recap what we were saying six weeks ago and address where we stand currently.

Before I get into more detail with this week’s video titled “Mr. Right appeared,” make sure you click on the subscribe button as well as the notification bell, so our team can notify you when we upload new content. Recall that back in October, the Federal Reserve was on the move with historically large and fast interest rate hikes. From the lowest level on record to over 300 basis points in just nine months. Since then, they’ve added another 75 basis points, and they’re expected to add another 50 in just another week at the December meeting.

Take a look at the table with their year-to-date moves. Remember that the Fed directly controls short-term interest rates. Ok, I’ll say it. And it’s a much-overused term, but the Fed’s moves in 2022 have been “unprecedented” for the last 50 years. Only Alan Greenspan, in 1994, comes close. Back then, Greenspan doubled rates by 300 basis points in 12 months to slow growth and ensure inflation didn’t perk up.

In 2022, the Fed is raising short-term rates with the sole purpose of trying to cool inflation down. Take a look at the chart with 2022 interest rate hikes compared to prior cycles. Back on October 14th, the S&P 500 was down over -25% year to date. While others were saying the Fed would need to pause interest rate increases for a rally in stocks, our team said that’s not what’s historically needed.

In fact, we specifically pointed to that same 1994 cycle when Greenspan merely slowed the pace of rate hikes in the 4th quarter, and the market accelerated higher. It didn’t wait for a pivot or a pause.

The CPI and many of its components have finally peaked and are heading lower. Even the Fed, which overweights lagging, stale government data, has finally admitted that inflation is past its peak. That is a positive.

The second positive factor we noted was the mid-term election seasonality. Mid-term election years tend to be a mess for the first three quarters, with the average first three-quarter return being down about -20.8%, according to Merrill Lynch. After three quarters in 2022, we were down slightly more than -20% but on pace for a “standard” but not enjoyable, pre-midterm election decline.

However, the best part of the Presidential cycle starts in the 4th quarter of the second year in a Presidential term through the end of year 3. Rallies off the midterm summer lows into year-end have had an average return of 17.6%. Over the last 70+ years, stocks have had a positive return one year after the mid-term elections every time. The average return has been almost 15%. So far, the 4th quarter of 2022 is following that positive script.

Finally, we discussed the contrarian factor of investor sentiment. Right now, it’s far from joyous. Back in October? It was somber. According to Merrill Lynch, inflows to cash accounts were at their highest levels since April of 2020, which was the peak fear of Covid and the lows in the stock and bond markets for the next 18 months.

Currently, margin debt levels have dropped at their fastest pace since near the market’s lows in 2001 and 2009. This is also a positive contrarian factor for investor sentiment. These were a few reasons we gave back in mid-October for expecting a material rally in the 4th quarter which has transpired. So, where do we stand now? Well, take a look at the S&P 500.

I chose the S&P500 because it’s the one most people follow. The Dow Jones chart and performance looks better as its more heavily weighted toward value factor stocks. If one looks at the Nasdaq composite chart and stock performance, that would look worse because it is more heavily weighted toward technology and high-growth stocks, which have been hurt more by higher interest rates.

As you can see, we’ve had a substantial rally in equities since the mid-October lows. The rally has very much mirrored the mid-summer rally.

The mid-summer rally failed in mid-August with the increased Federal Reserve hawkishness on interest rates. This time the rally on the S&P500 did recover to have a few daily closes above the 200-day moving average for the first time since March.

The S&P closed above there on November 30th and December 1st. While I’m no master technician, and I don’t believe that chart technicals are everything, they do matter to many investors, traders particularly.

So, the question now is, were these daily closes above the 200-day MVA a big deal? All we can do is look at history and see what has happened in the past. According to data provided by Ben Carlson,
who writes the great blog “A Wealth of common sense,” It’s been very rare over the last 70 years.

Take a look at the table showing the returns of the S&P500 on the 13 prior occasions that the S&P 500 traded below the 200-day MVA for over seven months and then broke back above and closed above it. Historically, as you can see, this has been a big deal. 12 out of 13 times, the S&P500 was substantially higher 6 and 12 months later, averaging a little over 12% for six months and almost 19% over the next year.

On only one occasion, in 2002, 2 years post the Dot.com bubble top, did the markets post negative returns over the next 6 and 12 months. 12 out of 13 times, over 92% of the time, the market has had healthy returns after regaining the 200-day moving average. Of course, we all know there are no guarantees in the stock markets, but historically that’s both a great hit rate and a good return. We’ve had a substantial rally nearing almost exactly two months, mirroring the mid summers rally.

Given the Federal Reserve’s continued fight on inflation, the market has gotten technically overbought, year-end tax loss selling by individuals is happening, and the corporate stock buyback window will be closing over the next few weeks. It’s time to expect an uptick in volatility again and a pause in the rate of change in gains. Can we continue to rally into year-end? Yes, that would be normal. Lurch and grind. But once again, no guarantees.

With the volatility the markets have experienced in 2022, our investment team recommends that you get on the phone and give our Oak Harvest team a call and ask to speak to one of our financial advisors and planners. Set up a meeting, sit down with one of our team, and let us walk you through how the sequence of returns can affect your retirement plan every bit or more than the average investment return your current advisor is generating.

Give us a call at (877) 896-0040 and give our investment team a chance to help you with your investment allocation and have our financial planning team model your cash needs and greed into and through your retirement years. Whether your cash account is yielding a few basis points or a few percentage points, The entire Oak Harvest team is here to help you navigate into and through your retirement years.

I’m Chris Perras and from everyone here at Oak Harvest, have a blessed weekend.