January 9, 2023

Wesley Chapel, FL

Happy New Year!

Before getting into the monthly commentary, I want to briefly congratulate our client and my very good friend John F. on winning the 2022 S&P 500 prediction contest! He predicted that the index would finish the year at 3,841 and it finished at 3,839.50. John was less than two points off! Second place goes to Susan T. (my mom!) and third place goes to our client and another very good friend of mine, Zack G!

Each of them must have a close contact in the investment business! 😉

First prize is a Yeti Water Bottle or Coffee Tumbler. Second and third place get super comfy Bella+ Canvas t-shirts and hats! Thanks to everyone for playing along. 2023 Predictions are due by the time I publish the February commentary – likely on the 6th or 7th of Feb.

Moving on…

The S&P 500 Index* finished the month of December down 6.19%, more than erasing the gains from November. Despite at least three bear market rallies that saw the market rise 12%, 19% and 17%, respectively, the index finished the year 2022 down 19.48%. At its low, it was down 26.71% mid-day October 13th.

There isn’t really a better way to say… it was a brutal year. For many, the bear market rallies were particularly demoralizing as is often the case.

There could easily be more pain to come in 2023 given that inflation remains stubbornly high, global growth continues to slow (perhaps at an accelerating rate) and central banks around the world keep tightening monetary policy through hiking interest rates and taking money out of circulation.

This is not a recipe for the beginning of a bull market… quite the opposite, in fact.

Just like bull markets don’t die of old age, neither do bear markets like the one in which we are stuck.

Bull markets die on euphoria. They end just when everyone who wants to buy is certain that the market will never go down big again… when everyone knows that the best strategy, the only strategy, is just to “buy the dips,” with total disregard for valuation, fundamental analysis, or economic theory. Sounds like November 2021, right?

Bear markets die on despair. Hopelessness. They end just when everyone who wants to sell is certain that the market will never go up again… when everyone knows that stocks are for suckers and cash is for kings. When stocks are down so much that nobody wants to own them, let alone buy them, that is when the a bear market typically ends.

So, I will ask you, rhetorically, does it feel like we are in the despair phase yet? Is the situation hopeless now?

Let me go ahead and answer my own questions – NOPE and NOPE.

Every time I turn around, I just keep reading about how the FED (The Federal Reserve Bank) is going to pivot (to cutting rates from hiking them) and the lows are in! Or I read about how there is “too much cash on the sidelines” and everyone just wants to get into stocks. Another good one is that it’s a new year and the stock market is rarely down two years in a row, so it must go higher in 2023!

There are still so many hopeful folks out there. Hope is not a strategy. Hope is an indicator though. And what it indicates to me is that there is still a chance for the market to go lower… perhaps much lower.

I know this probably isn’t what you were hoping to read in my January commentary, what with all the hopefulness and optimism of a new year and a clean slate and resolve about how we are all going to be better about our health, and our wealth, and our relationships, this year.

But my goal in this commentary is to tell you what I’d want to know if our roles were reversed. And what I’d want to know right now is that Mr. Market doesn’t care one bit that we humans flipped the calendar page into a new year. Nor does he care about the hopes of so many for the FED to come to the rescue with more easy money.

To be fair, if our roles were reversed, I would also want to know that my portfolio manager doesn’t think he can actually predict the future.

So, let me be clear, I could absolutely be wrong. The bear market may be over, and the market may climb a wall of worry to race higher from here for the rest of the year, never looking back.

And that is exactly why we don’t just sell everything and buy US Treasuries with all we have, earning a relatively safe 4.7% return for the rest of the year in the process. Also, for the record, we had more than a few stocks across both the Growth and Value Strategies achieve new all-time highs in 2022. Hershey (HSY), McDonalds (MCD), Novo-Nordisk (NVO), WR Berkley (WRB) and Travelers (TRV) are some examples. NVO actually hit another all-time high in 2023 already!

Another thing I might want to know is that the start and end of a calendar year is mostly irrelevant to our success (or failure) as investors. The only timeline that really matters is when our time on this Earth comes to an end.

Will we run out of time before we run out of money? Ideally, yes.
Or, will we run out of money before we run out of time? This would represent an epic failure.

Perhaps even more importantly though, is where might we spend eternity once we inevitably reach the end of our earthly timeline. While that topic is certainly outside the scope of this letter, a wiser man than me (C.S. Lewis) wrote:

“Christianity, if false it is of no importance, and if true, is of infinite (or eternal) importance. The one thing it cannot be is moderately important.”

Anyway, back to the point I was trying to make about investment timelines… When you get to the end of your time on Earth, if you haven’t yet found the bottom of your “bucket o’ money,” you will have succeeded. You won. You won’t be thinking about what your return was during the bear market of 2022, or how much that return differed from the market return. You won’t be thinking about your return over any timeframe. It’s mostly irrelevant. Instead, you’ll be happy that you never ran out and (depending on your plan) you’ll be happy to either bounce the last check on your way out, or leave a nice inheritance to your heirs.

There is a LOT more that goes into enjoying success in that game, the financial planning game, than just the annual return of your investment portfolio.

Just a couple of the factors that matter as much, if not more, than the portfolio return are the sequence of returns and plan design. One of these things (sequence of returns) is totally out of your control while the other (plan design) is totally within your control.

Can you guess which one you should spend time on?

For those of you who don’t know, the sequence of returns is simply the order in which you receive returns, both positive and negative. You may remember I covered this concept briefly back in July, but it is worth repeating. And yes, even though I spent a bunch of time writing about how calendar years are mostly irrelevant, we humans do need to separate things somehow – so just know that whether we use years that start in January, years that start in August, months, or even weeks – this factor doesn’t change. If you receive poor returns soon after you begin taking distributions from your investments you will be at a greater risk of running out of money before you die than if you had received relatively higher returns early on.

Good returns early on. Starting with $1 million, withdrawing 5% per year adjusted for inflation. End up spending $1.3 million over the 20 years, and still have $812 thousand left over at the end.
Click image to enlarge

Poor returns early on. Starting with $1 million, withdrawing 5% per year adjusted for inflation. This time the ***returns are in reverse order*** with the 20th year return happening in the 1st year. End up spending $929 thousand over the 20 years, and run out of money completely in 15 years.
Click image to enlarge

The reason for this is straightforward. If you are forced to sell investments to generate income during a down market early in your retirement, those investments are no longer in your portfolio to recover when the market eventually, and inevitably recovers. On top of that, you had to sell evermore shares as prices declined just to generate the same amount of income.

For example, if you need $1,000/mo and your stock is trading at $100 you must sell 10 shares to create the required income. But if the stock drops by 20% to $80, you must sell 12.5 shares to generate the same $1,000. You must sell 25% more shares even though the investment is only down 20%.

This is what we at Elevate like to call “financial suicide.” It comes highly recommended by many other firms – but they call it a “systematic withdrawal plan.”

So, how do you protect yourself against a suboptimal sequence of returns? Answer… plan design.

It’s called a “cash buffer.” You take a systematic withdrawal from a cash account instead of from your investment account. If you start with three years of income in that cash buffer account you have three years to ride out any sort of bear market that you may encounter, whether early or later in your retirement. When the market, and therefore your investment portfolio later recovers, you look for opportunities to sell investments that are overvalued to refill your cash buffer thus buying yourself another three years of worry free income!

If it sounds simple, that is because it is. Why doesn’t everyone do it? Honestly, I don’t know. Perhaps because the financial services industry has spent untold amounts of money marketing to people that they can’t time the market, and that everyone should have all their money invested in stocks and bonds no matter what. As the saying goes, “if you repeat a lie often enough it becomes accepted as the truth.”

It simply isn’t good for the financial services industry for you to hold cash. So, study after study is sponsored to prove that the best you can ever hope to do is pay an “advisor” to buy for you an index fund, or a pie chart of index funds, and forget about it for a few decades.

Speaking of the “pie chart prison” model, the standard balanced 60% stock and 40% bond portfolio finished 2022 down a whopping 19.9%. Stocks and bonds both got smoked at the same time. So much for “safe and diversified.”

The most recent Elevate Market Chat was recorded on January 5th. The next one is scheduled for tomorrow, January 11th - a day earlier than normal. We usually record and post on Thursdays.

And sure, this might work out for the investor. But it also might not. The one thing we know for sure is that it always works out great for the advisor, and the financial services industry, in the aggregate.

I should probably finish by clarifying that it isn’t as though returns are totally meaningless. Returns matter, and it is a worthy endeavor to try to lose less than the market when the market is down and/or to make more than the market when it is up.

We dedicate a lot of time and effort to this at Elevate. Sometimes it works out (especially on the downside where it is easy to outperform by holding cash) and other times it doesn’t. And while I maintain that one can get a better idea of portfolio manager skill by looking at “full cycle” returns by evaluating risk adjusted performance from one market top to the next market top, I recognize that many people simply consider one calendar year at a time.

We certainly can’t make any promises about returns – nor can anyone else. In fact, anyone who promises a higher return than the market without any material risk will probably deliver right up until the point where they end up in prison and all your money is gone – as was the case with Bernie Madoff (I just started the new Netflix documentary last night) or more recently, Sam Bankman-Fried whose fraud we are only just starting to learn the details of. Sam’s Netflix documentary is probably right around the corner.

The last thing I will say about returns for now, is that I think I could have done a better job for you last year. I had a relatively high conviction early in the year that the market would not recover or bounce back to new highs quickly and even though I held a lot of cash for much of the year, I could have, and should have held even more.

I could have and should have trimmed or exited more securities sooner, either through tightening stops more aggressively or just outright selling positions.

I could have and should have tried to buy fewer new stocks along the way, particularly in the Growth Strategy. I should have bought an inverse S&P 500 ETF (that goes up when the market goes down) earlier. And I should have bought more treasuries to generate more interest return, sooner.

That is not to say that I did a poor job. But there is always room for improvement and I am thankfully not afraid to take an inventory and analyze my mistakes. That is how I get better. I (like many) learn far more from my mistakes than my successes. If I ever stop trying to get better, that is when either I should consider passing the baton to a new portfolio manager, or you should consider passing that baton for me.

I pray that neither of those considerations are in the near term!

Wrapping up…

The entire investment world is focused on the upcoming Consumer Price Index (CPI) inflation data which will be released for the month of December on Thursday, January 12. It shouldn’t be that important. At least not anymore. CPI should decline once more from all-time highs. This is mostly due to base effects (starting with a higher number) and partly due to the FED’s actions over the past 9 months, or so.

End of the day, inflation is going to be high on an absolute basis. It will also be relatively high compared to the FED’s long-term target of 2%. Prices will be anything but “stable.” There will be little cause for the FED to pause its rate hikes, let alone “pivot” from hiking them to cutting them.

In December, the FED backed off from consecutive increases 0.75% to only hike by 0.50%... the market still dropped by more than 6% in the following few days. Folks, hiking by less is still hiking. Its still tightening. Its still hawkish. Translation: not good for stock or bond prices.

I have been sharing my projections for CPI and the FED Funds Rate for months in these commentaries. And since the beginning, I had always expected a drop from 0.75% to 0.50% at the December meeting. I am not special in that regard – the whole market was expecting it. It wasn’t a surprise. What is surprising (to me) is that anyone would think that would be a bullish development. A hike of 0.50% is not bullish.

X’s on the left indicate months with a FED meeting
Click image to enlarge

I now expect that the FED will hike by only 0.25% when their next meeting wraps up on February 1st, down from 0.50% last month. Guess what… this isn’t bullish either. Hiking rates is not bullish for asset prices, I don’t care what the prior hike was. And hiking by less than last month is still not a “pivot” to cutting rates. So, don’t let anyone tell you otherwise.

I do expect one more rate hike of 0.25% in March. At that point, depending on how the inflation numbers come in I currently expect the FED to “pause” (again, pausing is not pivoting) rate hikes at their meeting in May.

Arguably, deciding not to hike rates further in May is still not bullish. But it is also not hawkish in and of itself. It’s nothing. With that in mind, even if the FED does pause rate hikes in May, I expect them to still be tightening monetary policy via reducing the size of the balance sheet. This behavior is most certainly not bullish. Admittedly, May feels like an eternity away – and a lot can happen between now and then.

In the meantime, we’ll make sure we have lots of US Treasuries maturing before then so we can take advantage of any bullishness that should develop in the markets while also making sure that we are earning an excellent rate of interest on our cash.

Don’t forget to reply, call, or otherwise let us know your prediction for where the S&P 500 Index will finish the year 2023 before Monday, February 6th!

Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio performed vs. the markets in December.

Until next time, I thank God for each of you, and I thank each of you for reading this commentary.

Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisor

* We use the SPY Exchange Traded Fund (ETF) as a proxy for the S&P 500 Index

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This commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Elevate Capital Advisors, LLC (“Elevate”) has no duty or obligation to update the information contained herein. This information is being made available for educational purposes only. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elevate believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elevate. Further, wherever there exists the potential for profit there is also the risk of loss.