February 2023
Market Update

A Classic Game of Chicken

By Jake Eggett

Perhaps you’ve heard this one…

A battleship was on exercise at sea in bad weather. The captain was on the bridge. It was foggy. Just after dark the lookout spotted a light on the starboard side. The captain asked if it was steady or moving. The lookout replied the light was steady meaning they were on direct collision course with that ship! The captain ordered the lookout signal to the other ship:

“Change course 20 degrees. We are on collision course.”

The signal came back “Advisable for you to change course.”

The captain signaled “I am a captain. Change course 20 degrees.”

“I am a seaman second class. You had better change course 20 degrees” came the reply.

The captain was furious. He sent back “I am a battleship. Change course!”

Back came the signal, “I am a lighthouse. Your call.”

We have a classic game of “chicken” occurring right now in the financial markets. This clash between investors’ hopes and what the Fed has been saying is one of the biggest question marks for 2023.  The Fed has reiterated that it will continue to hike interest rates to around 5.1% and no cuts this year, while the stock and bond market seem to be betting that the Fed will start to cut rates by the end of 2023.  Historically, once inflation goes above 5%, it has never come back down without the Fed Funds Rate exceeding the inflation rate (CPI).  Inflation, at this level, tends to be persistent and is difficult to bring down quickly.  With the latest CPI coming in at 6.5% for December 2022, we may be in store for several more hikes in the quarters to come.  How this will turn out will likely depend on how fast inflation falls and how well the economy is able to hold up over the coming year. 

While we agree with the consensus that the Fed is near the end of its hiking cycle, we think the market is underestimating the Fed’s willingness to hold rates higher for longer. A mild recession remains our base case but given that inflation is moderating, and labor growth remains strong, a soft landing remains feasible.

Market Performance

Since the beginning of the year, most markets have been in a strong uptrend which has allowed market participants to recoup some of the losses from last year.  As anticipated, last week the Fed hiked rates by .25% to a range of 4.50% - 4.75% and the markets have seized the opportunity to move higher in the hope that the Fed is near the end of their hiking.   January was a very good month for equity markets with International outperforming the S&P 500 mainly due to weakness in the dollar.  Growth companies, such as those found in the Nasdaq, were the big winners in January and part of that is likely attributed to what we mentioned at the first of the year could happen… buying pressure from individuals that had sold their positions at a loss at the end of last year for tax purposes and now are buying those same securities to reestablish their position.

Fixed Income also rallied due to long-term rates declining and both the Aggregate Bond Index and Junk Bonds posted very solid numbers for the first month of the year.  Due to the higher yields, we believe that bonds may have the best risk/reward opportunity this year if rates can stay flat or decline, which they were able to do in January.

The Bottom Line

At Copperwynd, given the market trends, we are fully invested in most portfolios.  If the Fed is about done raising rates AND inflation will soon return to 2% AND the economy slows without a recession—well, that is truly a goldilocks situation, but there is a lot that can go wrong.  What we see now is a shift in focus from inflation on goods and services to the labor market.  With over 500,000 jobs created last month and an unemployment rate now at 3.4% - the lowest since 1969! – a tight labor market generally means higher wages to attract workers.  To get inflation under control, a recession is probably necessary, so the Fed may have to choose between accepting above target inflation or risk raising rates too much and triggering a deep recession.  As a result, the market seems to be expecting that the Fed can finely tune the economy so that neither is necessary.  That is a tall order, and the Fed does not have a strong track record for that degree of precision. 

Although we are fully invested in our equity models, we have continued to remain defensively positioned given our view of the economy.  We maintain our overweight in large cap domestic stocks and have a small allocation to International stocks and alternatives to aid in diversification. 

In our Total Return Bond strategy, we continue to be fully invested and we have overweighted our allocation to bank loans with a decent amount of exposure to high yield.  Most of these positions are yielding between 6-7% and if rates continue to stay stable, we’ll be content in just picking up the dividends each month.  As always, if that trend breaks down, we’ll go back into treasuries or money markets for risk management purposes.   Market conditions are positive at this time, but we remain concerned that the bear market of 2022 may resurface sometime in 2023.  This is not the time to throw caution to the wind.

Upcoming Events

Q1 Economic and Market Update

For additional insight into our thoughts on the market and the economy, please join Copperwynd for our upcoming Q1 Economic and Market Update on Wednesday, February 15th at 12:00 PM Mountain Time.

Register in advance for this webinar: CLICK HERE

Client Appreciation Spring Training Games

Please join us for one of the following games:

• Saturday, March 4th at 1:10PM – Arizona Diamondback vs San Diego Padres, Salt River Fields, Scottsdale

• Friday, March 17th at 1:05PM – Chicago Cubs vs Los Angeles Dodgers, Sloan Fields, Mesa AZ

If you would like to join us, please email kcostlow@copperwyndfinancial.com or give us a call at the office 480-348-2100 to reserve tickets.  In an effort to let as many clients attend as possible, please limit your initial request to two per family.  Once you have reserved your tickets, more information will follow.

Hope to see you there!

If you have questions, please contact us.

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To download the February 2023 Newsletter: CLICK HERE