Late-February Lull Looms As Inflation, Wage Pressure Persist

Late-February Lull Looms As Inflation, Wage Pressure Persist

February 22, 2023

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The last two weeks have not been a continuation of the New Year celebration that has been experienced in the first six weeks of 2023. There has been some “hotter” inflationary economic data lately, and it is too easy and tempting for the inflation-istas to jump on this and think inflation is surging ahead. A triple shot to the gut of the market in the form of higher-than-expected labor numbers, higher-than-expected CPI numbers, and higher-than-expected PPI numbers have been the fuel to the fire for the inflation-istas. But the Fed is data dependent and not “data reactive” and since the core drivers of inflation are roaring ahead—energy, housing, and wages—the Fed is set to raise rates, but in a predictable path. This measured pace is what allows analysts time to adjust, drives lower volatility, and allows multiples to expand this year.

Our base case remains that equities gain in 2023, and the breadth expansion that we are noticing (more and different companies joining the uptrend party) is supportive of this. As we noted in the past, there was a trifecta of factors on 1/12/2023 that have only been seen at major turning points in markets and this confirms our view that October-December of 2022 was the major low for this cycle could have been seen. This may be true, but we need to respect seasonal market actions as well.

As shown below, we think 2/16-3/7 remains a period where markets could stall. This is confirmed by the cycle work of Larry Williams, as well as the historical reference to February being historically the worst month of the year. February tends to be better in the third year of an election cycle, but still not a particularly friendly one. Below is a composite of the seven precedent-setting years where markets gained >1.4% on the “rule of 1st five days”

Just a rough sketch but highlights that equities are probably going to need to digest the strong gains seen in the first six weeks of this year. Note the red highlighted areas of February market softness, and March market resting:

In the shorter term, we think January borrowed from February. As shown below, in those years when markets are up 5%+ through Day 25 (like 2023) into month-end:

  • Win-ratio into month-end is only 53% and is lower than 67% for other months so,
  • January strength borrowed from February,
  • But it doesn’t change the positive outlook into year-end

MARKET STRUCTURE: Vast improvement in market structure – 5 SIGNALS now

Lastly, the S&P 500 has seen vast improvements in market structure. This is something that Mark Newton, Head of Technical Strategy at FundStrat, has been commenting upon. Take a look:

  • on 1/9/2023, the “rule of 1st 5 days >1.4%” triggered
  • on 1/12/2023, the trifecta of market breadth triggered for, the first time since 1950 (see past reports)
  • on 1/23/2023, the 3rd day S&P 500 close >200D, first time since Jan 2022
  • on 2/2/2023, S&P 500 “Golden Cross” where 50D > 200D, first time since March 2022
  • on 2/7/2023, S&P 500 closed above 50% retracement of the entire decline for 2nd day

The list is growing to validate that the internal market structure of the S&P 500 is vastly improving.

On top of these statistical data points that I have been discussing in my weekly notes for the past few weeks, there are also economic issues that I feel lend themselves to the markets being able to generate positive performance in 2023. The first one is the financial conditions; interest rates rising at a slowing rate and about to be finished increasing, supply chain issues have been abating and the bumpiness between order peaks and valleys and consumption stockpiling have smoothed out, and although CPI and PPI (measures of inflation) keep on rising, they are rising at a declining rate.

It must be remembered that the consumer is still flush with cash. This is predominately true amongst the higher-end consumer as luxury items continue to be devoured, yet basic supermarket and discretionary items seem to have peaked in their price acceleration. 

There isn't a lot more to say as the international environment turmoil, although not over, hasn't unraveled any more than the continuous chatter on the Russia / Ukraine conflict, China shutdown, and the feared Taiwan invasion for semiconductor control by China.

Therefore, some sectors of the market got very hot in the first six weeks and are digesting while some sectors were a source of funds for these appreciating sectors and those are starting to recover. So, to come back to the first 5-day rule of the year, if the markets are strong for the first 5 days of the year (over +1.4%). then there has been a 100% success rate of the year being positive and up over 25% for the entire year. 

So, we will continue to:

  • Take advantage of high short-term interest rates.
  • Water our flowers- add to winners.
  • Pick our weeds- exit the flat to decliners. 
  • Build portfolios that generate positive returns with a combination of income and growth.

Should you have any questions, please don't hesitate to call. We look forward to helping you through your 2022 tax season and making sure we are focused on addressing the positioning of your portfolio for the best 2023 we can!

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Important Disclosures: 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. 

Investing involves risks including possible loss of principal.

The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The Nasdaq-100 is a large-cap growth index. It includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.