“Time In The Market” Vs. “Timing The Market”
Markets continue to act unsettled ahead of this week’s election, with the S&P 500 registering its second straight weekly decline (-1.4%) and seeing its five-month winning streak end in October, finishing the month -1.0%. The Nasdaq also had its streak of seven straight up weeks come to an end, losing -1.5% last week on the back of mixed results out of four of the Mag7 names that reported. Amazon reported an acceleration in its AWS business, solid e-commerce margin leverage, and high-margin ad growth on Prime video – all of which were well received by investors. Google entered its earnings report with the worst sentiment among the MegaCap Tech names but delivered strong numbers, which boosted the stock that trades at a cheap 22x P/E relative to the rest of the group. As for Apple and Microsoft, both are guided lower for future revenue guidance, and that isn’t what thoughtful investors want to see from two companies that trade at premium multiples of more than 30x forward P/Es. Don’t get too downbeat on the names, as they are the index's two largest market cap companies. I expect that within days, they will revert back to benefitting from passive flow dynamics, irrespective of fundamentals.
As for other markets, the small-cap Russell 2000 index was flat on the week as odds of a Trump victory or GOP sweep moderate heading into Tuesday evening. Moreover, the “broadening out” narrative paused over the past week, with the S&P 500 Equal Weight Index sliding nearly 1%. As for treasury yields, they continued their rise, which has been a one-way street since the 50-basis point cut by the Fed in mid-September, where the yield on the 10-year T-note traded as low as 3.65% and has since risen to 4.38% on November 1st. That’s a 73-basis point rise for those counting at home and likely not what the Fed thought would play out with this recalibration cut. Lastly, we have the volatility index for both the bond and stock market at recent highs heading into this week’s election results. Aside from an extended period in which we don’t know the winner, I expect volatility to subside in the aftermath of the election results, which should provide some support for markets once the results are digested.
Beyond the election, we have an FOMC meeting on Thursday, which should be a non-event. The election will have far more significant consequences for markets in general and even the path of Fed policy. Wall St. Journal Fed reporter Nick Timiraos penned a piece over the weekend, Fed Prepares Rate Cut Amid Economic Contradictions, indicating that a 25-basis point cut is expected at this meeting. I will say that the rise in yields over the past two months has created some opportunity in the fixed-income markets for investors to act upon. The economic data has been mixed, and you could argue that it will trend toward further weakness if Friday’s jobs report is taken at face value. The Fed confirmed over the summer that the labor market, not inflation, is now governing its policy actions. This should provide enough cover for the Fed to continue its rate-cutting path, albeit at a slower pace – markets were priced for 25bps per meeting as of late September but have since shifted to less than 25bps per meeting.
The only other data point of note is the rally we’ve seen in the U.S. dollar index, which was up more than +3.0% in October (its single biggest monthly move higher in over two years). A further rise in the DXY from here, especially when combined with the rise in yields, will start to apply some real pressure to markets, financial conditions, and global economic activity. This is definitely on the minds of Chair Powell (even though he’ll never say it) as he thinks about the word salad he’s going to deliver at Thursday’s press conference.
The only thing insightful I have to say about Tuesday’s election is how markets are positioned heading into it. While most polls are well within the margin of error, the betting markets show Trump with a slight edge. This is also the way markets are leaning, so the biggest repositioning adjustment will come from a Harris win, which would see the Trump trade unwound: lower Treasury yields, a modestly softer stock market, firmer oil prices, a weaker U.S. dollar, and profit taking in gold and Bitcoin. The presidential race is undoubtedly important, but what happens in Congress matters just as much. Here, it looks like the Democrats will lose their majority in the Senate, and the House is expected to go blue, but also a close race. Gridlock is the highest probability outcome, and markets can operate just fine with that – a sweep, either way, gets a bit more complicated in that it invites the possibility of the most extreme policy options for either party to become possible.
As an aside, history suggests that betting markets have generally been good forecasters of U.S. elections this close to the vote. And while both candidates appear to have no issue with hawking the family silver if it gets them more votes, the fact that Donald Trump intends to fully extend the relief from the Tax Cuts and Jobs Act during his 2017-2021 term, along with breaks on tips, overtime, corporate taxes, and social security income, had the Committee for a Responsible Federal Budget estimate that his policies will boost the national debt by $7.8 trillion through 2035 versus $4 trillion for the Democrat fiscal package of goodies. Hence, the fiscal premium is embedded in the interest rate structure, alongside inflation fears from steep tariff hikes and more restrictive immigration policies. If not for the fact that there are some disinflationary items in the Trump plan, including efforts to expand energy production and broader deregulation efforts further, the stepped-up risk premium in the bond market would likely be even higher than is currently the case.
It's worth pointing out that nobody should wake up on Wednesday morning and expect to know who won the election: Pennsylvania and Wisconsin will begin counting mail-in ballots only on Election Day. These are hotly contested, must-win swing states, and the winner will not be officially announced by news organizations until it is crystal clear which candidate secured the most votes.
As for last week’s jobs report, it was a headscratcher, to say the least, where a total of 12k new jobs were created, and private payrolls fell 28k for the month of October. This followed a shockingly strong September report, which we learned wasn’t nearly as strong as it was revised lower by -31k (from +254k to +223k), and the August jobs reported was also revised lower by -81k (from +159k to +78k). Most of the analysis I read or heard following the report was dismissive of the weak reading, chalking it up to the hurricanes and strikes. Still, I’d push back on this notion because estimates were already trimmed to around +100k coming into the report. This was much weaker, and the negative -112k in revisions to the past two months is a better reflection of where the labor market is as it is calculated with more accurate data.
To be fair, one data point does not make a trend, but the 3-month average for non-farm payrolls now stands at 104k, barely above its long-run breakeven rate (private is just 67k). In addition to the moderation in hiring activity, the household report was soft. The u-rate held at 4.1%, but employment tumbled, and unemployment rose. It should be duly noted that the parts of the labor market with the most cyclical attributes declined outright by nearly -40k in October, and the YoY trend has been sliced in half over the past year to +0.7% from +1.45% (strip out government and health care/social services/education, and payrolls sagged -85k in what was the biggest drubbing since December 2020). Two years ago, that comparable pace was running at +4.2%. So, while the official recession has been held at bay, the labor market is signaling a notable turndown in economic growth.
Look, I’m not suggesting that recession risks must make their way back into investors' models as high-probability scenarios that need to be gamed out. However, that can and should change quickly if we get another jobs report like this in November. I still find the probability of an economic recession in the next six months as too low to worry about, but it doesn’t mean that it shouldn’t be on investors’ minds beyond that time horizon. I see the potential for several significant economic and market tailwinds to change course in the middle to the back half of next year, and that is worth starting to think about right now. Corey, why worry about a hypothetical recession 6-12 months down the road?
For starters, don’t worry about it, but do think about it. Why? Economic recessions are the most destructive part of an economic cycle for investors' capital. It’s been a hell of a run in the last four years, where the S&P 500 gained more than 20 % in three of the last four years, with the only exception being an 18% decline in 2022. Nobody wants to give a significant chunk of that back in the next downturn. Who knows if such a scenario would play out as they have in the past, given that this post-GFC / passive-driven investment era has upended many tried and true investing / economic theories?
But this does bring me to a marketing trick our industry has been great at spinning for years, where I rarely see them present all the information. We’ve all heard the saying that it’s impossible to time the market, so why try? On the surface, I do not disagree with this sentiment. Market timing is an inexact science; in most cases, it puts you in a poorer position than if you had done nothing. However, the data below is the whole story and shows the incentive structure for why it's worth it for some people to try and time the market.
The table below shows the S&P 500 returns by decade, excluding the 10 best days, excluding the 10 worst days, and excluding the 10 best/worst days per decade. As you can see, if you road all the ups and downs without doing a thing, your money compounded +24,826% since 1930. If you missed the 10 best days per decade, your return over this 9+ decade period drops to a lowly +76%. This proves all the marketing literature most of us have heard. However, had you missed the 10-worst days per decade since 1930, your return is an eye-popping 5,352,135%. That is more than 200 times higher than the buy-and-hold strategy -which is not a bad return by any means. The last column shows the result for an investor that missed the 10-best and 10-worst days per decade since 1930, which amounted to a cumulative return of 37,631% - also better than the buy-and-hold investor.
This is the full picture behind the incentive structure that motivates investors to attempt to time the market. The payoff structure or compounding differentiator is enough to compel investors to try.
Another piece of this great analysis by BofA’s Quantitative Strategy team was that these 10 best days and 10 worst days tend to cluster together. The 10 best days typically follow a period of market weakness, particularly three months and one month prior. Moreover, many of these weak equity market periods coincide with an economic recession.
So yes, buy and hold is a viable, prudent, and proven strategy for long-term compounding. But don’t be so quick to dismiss an investor’s incentive to try and time the market. And no, I’m not talking about day trading here; we’re talking about periods where these clusters of upside and downside volatility wreak havoc on an investor's capital base. Those typically occur during recessions, which is why so many investors spend a significant amount of time and energy measuring and mapping the business cycle. Making strategic allocation adjustments to minimize the downside impact on a portfolio’s capital base will significantly improve your overall compounding rate.
The articles and opinions in "Capital Market Musings and Commentary" are for general information only, and not intended to provide specific investment advice. Performance, dividends and other figures have been obtained from sources believed reliable but have not been audited and cannot be guaranteed. Past performance does not ensure future results. Investing inherently contains risk including loss of principle. Advisory services offered through Casilio Leitch Investments, an SEC registered investment advisor.
Copyright © 2023 Casilio Leitch Investments. All Rights Reserved.