The Accordion Effect
Stuck in the traffic jam.
Think of this moment as a traffic jam. Last weekend I drove to the U.P. for a couple of nights of camping in the deep woods. At first, we were flying along happy and carefree. Then we saw some break lights, and we came to an abrupt halt. We hit a construction zone, and traffic shifted from two lanes to one. That was Covid 2020. We slowly began to accelerate as traffic completed its merger into the single lane. That was 2021. However, shortly thereafter, we came to another near stop. That was the stock market in 2022. Traffic didn’t stop because of a merger, lane shift, or accident. In fact, in just a few miles, the freeway opened back into two lanes. The delay was caused by vehicles accelerating from the initial stop, some going too fast, and having to put the brakes on, creating an accordion effect. Traffic slows down before finally accelerating again at maximum speed beyond the construction zone. I believe this is where we are now in 2023 – moving past the accordion effect and getting ready to accelerate.
Where we are today.
I believe we are in the early stages of a recovery. Things could develop that send the market lower, like the accordion effect, but back in early October 2022, I believed we had hit market bottom. That has thus far held true, and I’m positioning the portfolio for recovery and future gains.
Categorically the U.S. stock market is divided into either Growth or Value style. Growth investors buy companies that they believe could outperform earnings growth, and value investors purchase stocks in companies that they believe are undervalued. These metrics are determined by comparing fundamentals, such as sales growth, PE ratios, price-to-sales, book value, etc.
One style of investing generally outperforms the other over a given period. For example, value stocks outperformed growth stocks in 2021. Technically, they also outperformed in 2022 because they took fewer losses than growth stocks (*1). I shift a portfolio toward or away from a particular style modestly based on where there might be an advantage. But I do remain invested in both styles. The metrics tended to favor growth stocks vs. value stocks sometime in 2022 (*2).
Large indexes like the S&P 500 have both growth and value stocks within them. That sometimes helps them hold up better during a massive market decline, compared to a portfolio that might be overweight the “other” style. However, the opposite can be true during the recovery. Growth stocks tend to outperform during a market recovery.
Types of stocks are then further divided from growth or value into large-cap, mid-cap, and small-cap equity investments. That distinction has to do with the total market value size of companies. As the names imply, small-cap (capitalization) companies are smaller in total market value than mid-cap companies.
Small and medium-sized companies have yet to begin a recovery relative to what large companies have seen in 2023. They are still caught amid the accordion. Market cap and investing style are important distinctions when evaluating portfolio holdings. In my opinion, the metrics show that these smaller-sized stocks are cheap, compared to large company stocks. Just like growth stocks appeared cheap relative to value and are now outperforming value. I believe at some point later this year, the small and mid-size companies could outperform the large-cap companies. And I want to hold them before that happens, not afterwards.
We currently have an inverted yield curve where short-term rates are higher than long-term rates (*3). That is not normal and will right itself. Think about mortgage rates as an example. We’ve always experienced that 30-year mortgage rates are higher than a 15-year mortgage and that 15-year mortgage rates are higher than a 1- or 3-year arm mortgage. Today, the 2-year treasury yield is higher than the 30-year treasury yield (*3). It’s an anomaly that won’t last and is already beginning to correct. The most likely direction will be that short-term rates decline below current long-term rates.
Right now, we see attractive banking incentives on money market and CDs in the 4% and even 5% range (*4). Those are based on high short-term rates and are likely to be lower in the future. It depends on whether inflation is cooling and returning to levels in the 3% range. If that does happen, then the Fed will likely cut rates, reducing the short-term yields significantly.
A word of caution for anyone considering taking money from equities and moving them into short-term investment paying 4% or 5%. If things continue their course of recovery, a year from now equity returns could be significant while the yields on bank instruments could be cut in half. A win could occur if the market dropped significantly and you reinvested back into the market at a lower level than it is today. But the risk is very acute, in that the market continues to recover and you create a permanent loss by missing out on growth.
Where I believe things are headed.
I think we are in the early stages of a recovery and that the S&P 500 could hit 5,000 in 2024 (maybe not till 2025). I fully expect there will be some bad days mixed with the good, but that we are on a general path toward higher values. I have the portfolio positioned to benefit from that occurrence.
The 12 months from October 2021 through October 2022 ranks in the top three worst markets during my career, alongside the tech bubble in the early 2000s and the financial crisis of 2008 (*5). It indiscriminately wiped out equity gains and hit some sectors even harder. It came at a time of economic prosperity rather than failure. Companies and households went bankrupt during the tech bubble and financial crisis. Not so with this period as we had record savings rates (*6) and a growing economy (*7). This was a decline from the aftereffects of a worldwide pandemic, too much money, war, uncertainty, rebuilding of supply chains, etc. The strong balance sheets made this market difficult to assess and potentially damaging to try to outsmart.
We were moving along just fine and then got delayed by a market traffic jam. I believe we are going through the construction and in the market accordion. Keep driving, and soon we’ll be in the wide-open road again.
As always, call us or email with any questions or ideas. js@jpstudinger.com 248-643-6550.
James Studinger
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. JP Studinger Group, LLC is not affiliated with Kestra IS or Kestra AS. Investor Disclosures: https://www.kestrafinancial.com/disclosures
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.