We are bringing you a conversation I had the pleasure of hosting with Shannon Saccocia, the Chief Investment Officer (CIO) for SVB Private Bank, in partnership with YCharts, later on in the show. Shannon and I ripped through a few of the most important charts in the world to understand the trends and sentiment moving markets right now, and what to expect next year. That's coming up in a few minutes. But first, let's get into it.
U.S. equity markets added another week of gains last week, but it wasn't calm or orderly. A speech from Fed Chair Jerome Powell on Wednesday, where he indicated that the pace of rate hikes may slow if inflation continues its downward trend—that sent stocks soaring. The Nasdaq jumped 4.4% on the day, one of its largest daily increases in history. Get this—two of the ten largest moves for the Nasdaq Composite over the past decade occurred this past November. That's why November is considered a bear market killer, and that's why it's rarely a good idea to sell in the midst of a bear market.
These big daily rebounds tend to happen in those environments. And speaking of rebounds, the Dow Industrials—they're not all industrials, of course, you know—has climbed completely out of bear market territory. It's up 20% since those late September lows, making that two-month percentage gain the largest since 1938. The S&P 500 is up nearly 14% over the past two months, and as our pal Ryan Detrick points out, that's not the kind of move you see during bear markets. Smells more like the start of a new bull market, because the past 13 times that has happened since 1950, the market was higher a year later, 12 out of 13 times, and up 20.7% on average.
That stronger-than-expected November jobs report that showed 263,000 jobs were added last month versus the 200,000 expected—it reminded investors that the Federal Reserve is not done hiking rates—not by a long shot. Wages increased another 0.6% last month, rising at an annual rate of 5.5%. The Fed is trying to cool that wage inflation down, and help the labor market find some balance. It's way out of balance, as we learned last Wednesday with the JOLTS report for October. That showed that there were still 10.3 million job openings in October, or 1.7 jobs open for every available worker. The openings are in leisure and hospitality, health care, trucking, and the arts and entertainment and recreation sectors.
On the other side of the economy, tech companies continue to lay off workers as they face slowing growth and higher borrowing costs. Yet, the unemployment rate remains at 3.7%, even as the labor force participation rate remains lower than its ten-year average. Now, we know the jobs report is a lagging indicator, and that the unemployment number comes from a household survey that is pretty imprecise. But still, the labor market is strong. Consumer spending is holding up despite high inflation, and retail sales—especially holiday sales—weren't that bad. The Federal Reserve is looking at all of this, likely thinking that staying the course on interest rate hikes still makes a lot of sense. Right now, fed funds futures are pricing in a greater-than-78% likelihood that the Fed will raise interest rates by a half a percent at its meeting next week.
Meet Shannon Saccocia
Shannon Saccocia is the Chief Investment Officer (CIO) at SVB Private Bank, and is responsible for setting the overall investment strategy for the firm. She oversees the asset allocation, research, portfolio management, external manager search and selection, portfolio implementation, trading, and investment risk management functions.
Prior to her current role, Shannon was the Director of Manager Search and Selection for Silver Bridge Advisors, which was acquired by Banyan Partners in 2013. SVB Private subsequently acquired Banyan Partners in 2014. Prior to joining Silver Bridge, Ms. Saccocia worked at State Street Corporation, providing performance and attribution analysis for institutional investors.
Shannon earned a BA in Economics and History from Brandeis University. She holds the Chartered Financial Analyst designation and is a Certified Investment Management Analyst. She is also a member of the Boston Security Analysts Society, the CFA Institute, and the Investment Management Consultants Association.
What's in this Episode?
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We're going to focus on the fundamentals by bringing you a piece of my conversation with Shannon Saccocia that we held with YCharts last week. The focus of that conversation: helping investors reset their expectations and their portfolios as the end of the year approaches, so we can be ready for 2023. Shannon is another one of those super-smart investing strategists who brings common sense, market history, and evidence-based investing to her practice, and I learn something from her every time I read her commentary or see her on the business TV networks. Shannon and I ripped through some of those charts in our chats, and YCharts—to be sure, and we're going to link to those and add them to the transcript of this conversation, which you will find on investopedia.com/the-express-podcast.
Caleb: "Set the table on where we are now. And of course, this is the big tug-of-war, Shannon, going on right now. The fed funds rate versus inflation—that's going to keep raising rates until inflation comes down meaningfully. We heard Chair Powell say it again yesterday; we should expect to hear it again next week, but this is the big tug-of-war. Give us what you see, when we look at these two things pulling against each other."
Shannon: "Yeah, the drumbeat of inflation just will not die. And I think coming into 2022, we all anticipated this inflation, right? I think we knew that the Fed—their idea about this only being transitory—was debunked, pretty soundly, in 2021. And now coming into 2022, we expected this to be, you know, really the biggest challenge. I think a lot of the emphasis was on the higher cost of capital, the pressure on earnings, the pressure on margins, with these higher costs."
"But I think what has been a bigger challenge is that the credibility of the Fed has come into question with that transitory call, but also with the pace that they've had to execute these Fed rate hikes. If you look at the charts, and you just think about what we've seen, historically, in the last Fed hiking cycles—the pace, the velocity of the action that they've had to take is really what is phenomenal and "unprecedented"—we've been using that term a lot in the last decade or so, and it always seems like everything is without precedent these days."
"But the other thing to think about here is that inflation has two sides to it, and one of the things that we need to keep in mind is that, in as much as we have shown that the inflation we've experienced this year is not really transitory, portions of it are transitory. And I think that's going to set the stage for a lot of the conversation over the next 12 months or so, and why the Fed is so committed to telling us that they're committed, because people are starting to see that some parts of these inflation numbers do feel a little bit transitory, and they want to make sure that all of us, as investors, are not keeping our eye on the ball, and really firmly believing that they're going to get to those yields that they've talked about."
Caleb: "Yeah, great call. And then—mind the gap at the edge of the chart here—you see this gap between where the federal funds rate is today, and where inflation is today, at 7.7%. We got a new reading on Personal Consumption Expenditures (PCE) this morning, but the Fed wants inflation closer to 2%, and we're still far away from that. And the terminal rate everyone's talking about, in terms of where the Fed might finish raising interest rates, is maybe north of 5%, closer to 6%. Big gap there, right Shannon?"
Shannon: "Huge gap—I mean, when you think about what the terminal rate has been historically. When you think about terminal rate, what does that mean? That's growth. That's expected GDP growth—the notion that inflation should be similar to GDP growth. And that's where the Fed wants to keep rates, and that's where that terminal number comes in. So, you're sort-of thinking to yourself, well, that implies that the Fed would be looking for the economy to be growing at that pace. But that's not really what we're seeing either."
Caleb: "And that's the other part of the problem, which is money supply versus inflation. Government was handing out trillions of dollars during the pandemic for good reasons, but kept doing that, swelling the balance sheet. The Fed was a buyer of mortgage-backed securities (MBS) and government securities. Now it's a seller, and it's trying to wind down its balance sheet, while it's trying to wind down inflation, and while it's raising interest rates. That's a lot of push-and-pull going on right there. What are you looking at?"
Shannon: "The lever here is clearly trying to roll off some of this balance sheet. And I think it's—and you remember this Caleb—we were coming out of the global financial crisis, and because of what was, at the time, this unprecedented quantitative easing (QE), there was this expectation that we were going to see runaway inflation. You know, how many of us were being asked by clients about gold and other inflation hedges during that period? And we really didn't see it, because we didn't have this other side, this fiscal stimulus side, this significant influx. And some would say that that slowed the economic recovery in 2010, 2011."
"But there's a big difference between what you see here on this graph in 2010, 2011, 2012, and what we've experienced in the last two years. The Fed knows it needs to bring the balance sheet down, because they know the national debt service burden is significant on the U.S. government, but it also creates a ceiling on how high they can really go with interest rates."
"And so, if inflation doesn't start to come down, they are going to start to bump up against everything else they can do." And I think, unfortunately, what could happen if we start to see a lot of economic weakness, they could take their foot off the gas as it relates to bringing this balance sheet down. And that's a problem. I mean, you look at the questions surrounding Japan, right? They've got a demographic problem and a debt problem. And I would say the U.S. is sort-of tiptoeing into that."
Caleb: "We're talking about the Fed raising rates and trying to bring down inflation. We're talking about demand destruction, and that is exactly what we have seen in the housing markets since the beginning of this year, month after month, with lower existing home sales, lower building permits—every metric you look at basically, in housing—except for prices, which have been cracking lately. You like to look inside the housing market at these metrics. What do you see in here?"
Shannon: "Well, I think we talk a lot about the lag, right? And if you listen to Powell's comments, and you listen to and read the minutes from the last Fed meeting, everybody's waiting for the Fed to acknowledge that there's a lag, and there certainly is. But this is really where we've seen it, first and foremost, is in the housing market. You know, mortgage rates react very quickly, and buyer demand reacts very quickly. Refinancing is essentially off the table, which, for a long time, there was a lot of activity from a mortgage perspective going on in refinancing, but it also created a platform for affordability. You know, there was a foundation in the housing market that even though prices were moving higher, rates were so low that there was this affordability aspect that no longer exists today."
"And so, the question that I get often is "Okay, we are starting to see some pressure in pricing," which, honestly, given a lot of the pull-forward that we saw in 2020 and 2021 in terms of home buyers, that was not likely to continue at the same pace. But the other thing to look at is, look at the amount of supply—look at this purple line. And people are asking me, "Are we going to have a similar housing bust to what we experienced going into the global financial crisis?" Absolutely not, because the supply is not there. We have been undersupplying the housing market ever since 2009 in the United States, especially from the perspective of single-family homes. And so, the supply is not there."
"There will be this structural ebb and flow over the course of the next year to year-and-a-half, as buyers adjust their expectations for mortgage rates, as that affordability is adjusted based on these higher interest rates, but they'll re-anchor to that. And housing likely does persist as a catalyst for some growth, not the amount of growth that we've experienced in the last couple of years, but as a positive to GDP five-, ten years out, because we still have a demographic tailwind. Forty-three percent of millennials own a house, 65% of the general population owns a house, and that household formation comes later."
"So the housing market, to us, isn't quite dead yet, but we need to rectify—these prices need to come down a little bit more to increase affordability, and we also need to see some supply come back into the market. That probably happens over the next year-and-a-half or so."
Caleb: "Let's take a deeper dive into some sectors with the next slide. Looking at a lot of the sectors that have had some strength this year, and you can't deny the strength of energy. What a year for energy stocks, especially the oil and gas sector. Some of the top-performing stocks in the market this year, obviously, ExxonMobil (XOM), Occidental Petroleum (OXY), and others. Do you think we are in a secular bull market for commodities, especially the fossil fuel complex?"
Shannon: "I think it's relative to where we've been historically. You know, we go back to our zero spot, our subzero oil spot in the depths of the pandemic. I think that the interesting thing about the energy complex is that there's been so much emphasis on valuations in this last year, especially the re-rating of longer-duration growth valuations at much higher multiples than the market. Energy's the opposite of that, right? You know, there's a lot of really cheap energy stocks out there. And, you know, with oil prices probably a bit rangebound here, we're seeing modest increases in demand, but that ebbs and flows."
"It's really a supply problem. There's an undersupply, particularly of oil, in the next couple of years. And so, with that undersupply, and the fact that OPEC+ is continuing to potentially cut production, you start to think there's probably a floor there. I would say, on the commodity side more broadly, I think that you could look at something like the reshoring of manufacturing here in the United States, and global infrastructure build as potentially being a support for commodity prices. But I think energy, and energy stocks, have continued to benefit just because of those valuations and the margin that they're able to throw off. And they have been an outlier when compared with other sectors that have really been hurt by higher costs."
Caleb: "We could see a lot of those right here. But then let's take a look at some of the "recession proof" sectors, or at least the defensive sectors. You have to look at consumer staples—basically flat for the year, where we've seen the S&P 500 down 15%, and as far down as 27% at one point. With consumer staples, you would expect this type of behavior. What do you expect for 2023 given the behavior so far?"
Shannon: "This has been sort-of textbook performance in consumer staples. You know, you're concerned, you're looking for defensive places to hide out. But the interesting thing about consumer staples as a whole is that they're actually starting to seem somewhat expensive. And if you think about the long-term, higher-cost profile that we're anticipating, with consumer staples—those are fairly lean margins across the board."
"So, I would say we're probably not as excited or optimistic about consumer staples performing really well in the first half of next year. If you do get a significant slowdown or contraction in economic activity, then I think you probably get some flooding back into this sector later next year, but I think we've we've pulled forward some of the performance here in consumer staples. Some of those stocks look a little expensive for low-margin businesses."
Caleb: "Talk about textbook performance, if you look at consumer discretionary, with concerns about a recession—one of the worst-performing sectors this year when we look at just the ETF performance, down 31.5% so far this year. And then there's technology, which, with high interest rates, the rising rate environment—not a friend to growth stocks, especially the tech stocks that borrow a lot of money and need a lot of cheap money for their expansion. Somewhat of a recovery here, but we're not going back to the old days, are we?"
Shannon: "No, and I think that, most importantly, when you think about technology, you want to make sure that you understand where you're getting that exposure. And I think the challenge right now is that, in as much as the S&P 500 was helped by the large concentration of technology stocks in recent years, obviously, that market-weighted index is now being hurt by that. I think that within technology, there's still going to need be the need for disruption in innovation."
"That's a longer-term trend because, in a higher-cost environment, in a hiring-constrained environment, in an environment where companies are trying to find any way possible to be able to increase margins—technology does that, right? That's why we've been in a deflationary environment for 20 years, is due to a combination of globalization and technology. So if you think about that, tech stocks aren't dead.
"But I think you really have to consider profitability, and you have to think about prioritization. Cheap money leads to poor capital allocation, and I think what you're seeing now is a right-sizing in a lot of these big tech businesses, in terms of what they're spending money on. And I actually think that it ends up creating stronger businesses three or four years from now, but it's going to be a little bit painful in the interim."
Caleb: "We hear a lot of people saying—and I'm sure you get this all the time, "It's a stock pickers' market." It's not necessarily a "throw a dart anywhere you want" type of market. What's your take on that—stock picking, index investing, ETFs? I guess it depends on who you're doing it for, but what's your overall vibe on whether it's a pickers' market or not?"
Shannon: "So I think that there are opportunities, particularly in an environment where you have a lot of management teams that are facing challenges that they haven't faced before. They are facing higher costs and wages, they're facing hiring issues, they're facing, you know, maybe a little less constructive capital market environment. And so, I think that's where, in execution—because we've actually seen quality underperform this year, and that's been somewhat surprising, but that probably doesn't persist in a more recessionary environment."
"So you think about quality management teams, you think about capital allocation, you think about shareholder return, not just, you know, capital appreciation on the stock, but what's the return to the shareholder? I do think that's why dividends become more important in this next environment. And so, I would say there are opportunities for stock picking, but I wouldn't be afraid to really, again, go back to sort-of that thematic assessment of your portfolio."
"If we're going back to a slower growth environment, akin to what we were in 2019, but with higher costs, where are the subsectors and industries that could potentially benefit from that? And so, you can do that via ETFs fairly easily. There's a number of different vehicles that you can utilize to be able to get that type of exposure, without having to go so deep into those individual companies. And so, that's an important aspect, the balance between micro and macro, that I think probably makes sense as we move forward into the next two-to-three years."
Caleb: "Dollar versus the stock market, dollar versus any risk asset—that's been the big story really in 2022. The dollar has come off a little bit lately, especially as the Fed is sort-of talking a little bit more dovish here, but as the dollar goes, so conversely, do a lot of these risk assets, right?"
Shannon: "Especially those that are larger, right? So you think about cap here, and you know, it's not 100%, but it's a generalization and it's pretty accurate. The larger the company you are, the more likely you are to have revenues that are generated outside of the United States, and so you have to think about the translation of those revenues."
"You also have to think about it in terms of, you know, what is the strength of that dollar, and what's that tied to? Why has it been so strong? And is it really just interest rates that are driving that, or is there a true risk-off sentiment? And so that's where they tend to move in this fashion. And I think right now the challenge is that the Fed is likely to start to get closer to that pause, and we're going to see interest rates moving higher in other parts of the world, especially in Europe and the U.K., given what they're facing from an inflation perspective."
"And so maybe the shine comes off the dollar, just a touch, going into next year, but we're still in a in a stronger dollar scenario, that currency translation is still going to be an issue, particularly for mega-cap stocks that have significant external international exposure. And so, this dynamic is likely to persist for a little while, because we're not expecting dollar significant dollar weakening next year, maybe just some stabilization."
Shannon: "So I talked a little about China already, and I do continue to think about the uncertainty of policy, and how much not only the uncertainty of policy is related to China's domestic policy, but we've spent the last five or six years talking a lot about our relationship with China, China's foreign policy, how does China feel like it should fit within the global economy? I think we should be paying more attention to that. I think that that is something that could crop up again as a very reasonable either concern or catalyst for 2023."
"The other thing that I would caution is that I think there is a continued expectation that the allocation to equities that we experienced in portfolios, or that we saw in portfolios in 2019, 2020, 2021, that that is going to reemerge. And so that there always will be, you know, constant flow into the equity market. And I would say that there's a lot of investors that we're talking to today, that I wouldn't have panned as being particularly conservative, that with yields where they are today—which are not astounding numbers in a historical perspective, but they're astounding to them in the backdrop of our previous environment—they're really comfortable clipping that coupon."
Caleb: "Four to 5% sounds great."
Shannon: "Yeah, and the cost of their debt is below that, Caleb. There's a delta there, and I would see portfolios maybe not going completely conservative, but I do see people wanting to keep more of that money in conservative assets, clipping a coupon on that. And I think it's going to take a little bit longer before there's a significant amount of push and enthusiasm into the equity markets. I think people forget that, in an environment where you are seeing inflation at even five or 6%, that you want to make sure that you're keeping up with inflation from a principal perspective. And I think people have forgotten that that's a drawback of the bond market, if you will."
"So that's what I would watch for next year. I think there's always an assumption that as flows come out of the equity market, that investors are going to eventually go back into the equity market, because that's what we've experienced for the last decade—I think we could see some slippage there."
Term of the Week: Wash-Sale Rule
It's terminology time—time for us to get smart with the investing term we need to know, this week. And this week's term comes to us from Richie Royce on Instagram, and Richie suggests "wash-sale rule" this week. We love that term, especially as we get close to the end of the year, and as some of us may be considering selling some of the losers in our portfolio. It's perfectly okay to do that, of course, but it's not okay to buy those same securities back within 30 days, and claim the loss deduction on our taxes.
That's because the wash-sale rule, according to my favorite website, is an Internal Revenue Service (IRS) regulation that prevents a taxpayer from taking a tax deduction for a loss on a security sold in a wash sale. The rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss, and within 30 days before or after the sale, buys the same or a substantially identical stock or security, or acquires an options contract to do so. A wash sale also results if an individual sells a security, and the individual's spouse, or a company controlled by the individual, buys a substantially equivalent security during the 61-day waiting period.
The point of the wash-sale rule, stipulated in Section 1031 of the Internal Revenue Code (IRC), is to prevent investors from creating an investment loss for the benefit of a tax deduction, while essentially maintaining their position in the security. The wash-sale rule is one of our nation's oldest security laws—it's been around since the 1920s, but it was broadened by the IRS in the early 1990s. Great suggestion, Ritchie. We're going to be sending you a pair of Investopedia's finest socks for picking this week's Term of the Week winner.