January 2023 Market Outlook

On the other hand, other expectations have panned out-if only on a relative basis. We expected an increase in market volatility on account of a hawkish Fed, and on this score, markets did not disappoint (stocks and bonds). Large caps outperformed small caps, if only just a little.  But value meaningfully outperformed growth by about 20%, and while "concept" stocks are less easily defined by an index, the meltdown in crypto, blockchain, SPACs, and frankly any industry which blossomed and flourished under the last cycle's permissive interest rate levels was utterly flattened, while "quality" cashflow-generators generally outperformed the market.

500 words into this Outlook and we think parsing the details of last year any further is likely unproductive. 2022 has left an indelible mark on many of us (akin to 2008, and perhaps 2001). As always, the question which should be pondered is, 'What Have We Learned?'

Here is a summary of some lessons that come to our mind:

• "Plans are useless, but planning is indispensable". Understand that being a "long-term investor", while necessary to achieve long-term financial goals, should not place your feet in cement. Investors should invest reflectively, not reflexively. Markets move in cycles-they always have. We pointed out in October that the NASDAQ Composite Index took 15 years to break even after the Dot-Com bubble burst. The broader-based S&P 500 accumulated an 80% return over this same period. If your largest holdings are out of favor and have declined 50%, 60%, or 80% over the last year, do not assume they will be market leaders in the coming year, or years. It's time to get serious.
• A $0 tax bill applies to investors who do not gain from their investments.
• Beware the Celebrity CEO(s). Beware the Founder-CEO(s). The "G" in ESG stands for Governance. In our view, this is where investors should commit their attention and resources, yet this is the area least scoured by the financial media and investors.
• Never underestimate the potential impact of geopolitics on the markets. We feel this will be increasingly important in the years ahead as globalization increasingly becomes regionalization, and strategic competitors become military opponents. While supply chains have largely undergone normalization over the last year, their continued fragility should be well understood by investors in this context.

• Don't fight the Fed. This is ancient market wisdom, but it hasn't sunk in for many market participants.

A recurrent theme in the media over the last few months has been the "demise" of the 60/40 portfolio. We read two separate articles in the Wall Street Journal on the subject in just the last three months. In fact, this theme has been with us for much longer. The premise itself was born out of the "financial product factories" on Wall Street roughly 20 years ago. Not content with the declining costs of investing (meaning the ever-declining revenue from traditional investment vehicles in the "60" or the "40" categories), investors and investment advisors have been subjected to countless lectures about the need for more complex strategies than a simple allocation to stocks and bonds.

"Alternatives", or "Liquid Alternatives", as these strategies are known, may include market-neutral, long/short, macro-driven (managed futures), event-driven, commodity, or even distressed debt approaches to investing. We know of a firm that simply classifies these categories as "Hedge Funds" on their statements (though they are not, they are mutual funds). Thirty years ago, these strategies were the purview of hedge funds alone. One of the characteristics that made them work (when they worked) was a built-in illiquidity that allowed for the time factor to play its important role. Today-most have been nicely packaged into funds that comply with regulations (and daily liquidity requirements) of the Mutual Fund Act of 1940 to be delivered to the least-sophisticated investors among us, who are also perhaps least-equipped to understand the tactics, their purpose, or allocation and weighting justifications in their own portfolios. But of course, the trade-off to "upgrading" the portfolio is the inclusion of strategies that charge significantly higher fees to own. Expense ratios can range from 1.50% to 3.00% (even higher), compared to the passive alternatives of stocks and bonds (0.05%-0.20%).

We will pause here to inform you that CCR Wealth Management has made use of select "alternative" strategies in our Low Correlation Model portfolio since its inception 10 years ago (we have a full understanding of the underlying strategies, the limitations inherent in their "1940 Act" configurations and the impact of higher fees on the overall portfolio expense ratios). One of the responsibilities that we jealously guard in this capacity is that of gatekeeper or "goalie" to our client portfolios from the marketing departments of Wall Street.

We expect the drumbeat of obituaries for the 60/40 portfolio will become louder in the coming quarters-the reason being that many of these strategies far exceeded the return of a simple 60/40 allocation in the last 12 months, our Low Correlation Model included. But the past doesn't necessarily indicate prologue, in our view. In most cases, these alternative strategies have long track records of underperformance relative to the major asset class indices, punctuated occasionally with exceptions like 2022.

Our October Outlook indicated a renewed optimism in the outlook for the US bond market. In fact, you may have read that 2022 was the worst year for US bond returns ever-in history! This fact is certainly baked into your 2022 returns, and this fact will be the ammunition for the renewed, more aggressive push for investors to cast aside less expensive, simpler portfolios for the promise of continued outperformance-if you will only pay the higher fees. But 2022's bond market performance belongs to 2022 and is not at all indicative of likely performance going forward.

While we feel there is room for these strategies if utilized thoughtfully, we are also of the mind that the simple 60/40 allocation is now poised to deliver promising returns to investors without the complexity and expense the alternative universe adds. Indeed, given the carnage in both stock and bond markets last year (and the inherent valuation improvements in both), investors switching to these strategies may find they are closing the barn doors long after the horses have left. The last time stocks and bonds simultaneously performed this dismally (or close to it) was in 1931. Ultimately, strategy questions like this are best to reflect on with your financial advisor.

Economic cycles, market cycles, and business cycles advance and age on a continuum apart from the calendar year. So, while we have turned the page on the calendar, our themes from a year ago still hold sway in our investment strategy: Value over growth, large over small, quality over concept, and US over non-US. We would also reiterate our supposition from October that given the still-large swath of market participants looking for the Fed's next "dovish" turn (hope springs eternal), we expect the markets will continue to advance and retrace in a rather "trendless" saw-tooth pattern for much of the next two quarters. We agree with the bulls who say the Fed is closer to the end of its rate-hiking cycle than the beginning. But we find more value at this time in much of the bond market based on this outlook. Philosophically, CCR Wealth Management is more concerned with a favorable risk-adjusted return, relative to an equivalent return that comes with higher volatility. In our view, bonds check this box today. We think it is far too early to be anticipating Fed easing (don't fight the Fed). But bond yields today are as attractive as they were back in 2008, requiring less emphasis on central bank assistance in providing a return for this allocation of your portfolio-a state of affairs that has been missing for the last 24 months, at least.

We think the lag effect of interest rate hikes, and what we surmise will be the stubbornness of inflation will color the return pattern of the equity markets well into 2024. Recall that interest rate hikes, Fed minutes, and Fed speeches all tend to have an immediate impact on financial markets (intended by the Fed as "financial tightening", a part of the process). Near-immediate responses to these elements are seen in things like mortgage and credit card rates, with more-lagging effects on related housing prices and consumer spending. But the "hard" impact on the economy in the form of higher cost-of-capital can take many more months. It is this impact we anticipate showing up in earning reports in the first quarters of this year.

We often talk about the equity markets in terms of valuation, and we often use the relative P/E (Price/Earnings) relationship to describe these valuations. If we were to sum up our view of equities over the last 12 and the next 12 months, we would say 2022 was about the P, and 2023 will be about the E. Markets revalued on a massive scale last year, with loftier valuations feeling the most pain. Over the next two quarters, we will begin to surmise the impact on earnings. Similarly, we see 2023 as a year of transition, and 2024 as a year of normalization.

We also see evidence that business leaders are preparing for a significant economic slowdown. Two recent economic data points from December, the Non-Farm Payroll report (Dept. of Labor) and the Purchasing Manager's Index (Institute for Supply Management) illustrated conflicting signals. While 223,000 net new jobs were created for the month, a stronger-than-expected showing which inched the unemployment rate down to 3.5% from 3.6%, the ISM report (a forward-looking survey of business managers) showed significant disappointment for Services activity (49.6% down from 56.5% in November) and New Orders (45.2% from 56% in November). Both readings below 50 indicate a significant expectation of economic contraction expected by the business community. Even the labor statistic of 233,000 new jobs (a backward-looking data point), if we read beyond the headline, indicated large job losses in temporary jobs (-35,000) and administrative support (-28,000). Both categories tend to feel the first thrusts of wider job losses during economic downturns.

Our previous expectations of a "saw-tooth" pattern to broad equity indices will likely continue to be inversely tied to economic news (where markets rally on negative data points, in anticipation of rate cuts ahead, and decline on good economic data points, anticipating higher rates for longer).