5 Early Trends Developing In 2023
Growth, high beta and emerging markets look strong. A strong January might not lead to a strong 2023.
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If you managed to ride out last year’s bear market and remained invested in stocks, congratulations! You’ve been rewarded with a strong rebound rally that’s seen gains almost across the board. The S&P 500 (SPY) is up about 6% year-to-date, but growth sectors are doing even better. The Nasdaq 100 (QQQ) is up 11%. Tech has gained 10%. Small-caps are up 9%. High beta is up a whopping 16%. Even long-term Treasuries and gold, two of the market’s biggest scourges in 2022, have returned 7% and 6%, respectively.
If you’ve overweighted last year’s winners, such as utilities, dividend and low volatility stocks, you’ve probably been disappointed. The risk-off sentiment that dominated last year has done a 180 as inflation is coming down and a recession doesn’t appear imminent (yet….more on that in a moment!).
You don’t want to put a lot of emphasis on what happens in a single month, but there are a few early trends that have emerged that could carry forward later into the year.
A Strong January Is Generally A Predictor Of A Strong Year, But Maybe Not In 2023
I hear a lot of chat nowadays about how the bear market is over and we’re ready to begin the next bull market. Some of that is predicated on the Fed pulling off a soft landing (I just don’t see that happening), but January has shown us that many investors have used the turning of the calendar as a way to put the bear in the rearview mirror.
The data even backs it up. In years where we’ve gotten steady and positive gains throughout January following a year of losses, it’s historically been a harbinger of strong returns for the full year ahead.
Before we get too excited and hit the gas here, I need to reemphasize a very important point. 2022 was a year like no other. Never have we had a year where both stocks and bonds were down more than 20% at the same time. Inflation hit its highest level in nearly 50 years. The Fed was initiating one of its most aggressive rate hiking cycles ever. There’s never truly been a precedent for it, which is why we probably shouldn’t use history as a comparison here.
Here’s the other thing. We haven’t really even hit a recession yet. Sure, we had two consecutive quarters of negative GDP growth last year to meet the technical definition of recession, but this economy hasn’t experienced some of the factors that traditionally come with a recession, such as higher unemployment.
I think the real risk is ahead of us, not behind us. The good times are back for now, but I see them fading as the year goes on, not getting better.
Growth May Be Able To Extend This Rally Before Starting To Fade In Q2
If you’ve paid attention to the data we’ve gotten over the past couple of months, it lays out a clear narrative - the U.S. economy is slowing quickly. But there’s a difference between short-term and long-term opportunities.
Long-term, the recession narrative is likely to continue playing out and that will have a downward pull on risk asset prices. In the short-term, however, investor sentiment is pretty positive. We’ve got inflation coming down. The latest headline GDP print will have investors feeling like a recession is still a ways off. We’ve got China finally reopening. There are a number of short-term catalysts fueling January’s strong returns.
Now you look forward to what could halt the rally. The first is this week’s Fed meeting. We’re almost certain to see a quarter-point hike, which is already priced in, but it’s the meeting minutes that come later that could have the biggest impact. If the Fed sounds dovish, stocks could be off to the races. If the Fed reiterates its hawkish stance, as it has consistently done over the past year, the rally could be over quickly and the recession narrative might take over again.
From there, it’s probably on to the March meeting. Most of the data until then will probably look bad and I think the market pretty much expects that at this point. The Fed is the big unknown. I think we could see bullish sentiment persist for as long as two months before things start souring after that.
Emerging Markets Look Set To Have A Big Year
If you pay attention only to the S&P 500 and the Nasdaq 100, you might have missed out on the fact that the best-performing region year-to-date is emerging markets (IEMG). Thanks to the strength of the China reopening trade, they’re up 11% year-to-date. Even if you take China’s gains out of the equation, they’re still beating the S&P 500 by nearly 3%.
I’ve beaten the drum for emerging markets for years now based on valuations and the fact that U.S. stocks have outperformed them for more than a decade. So far, it still hasn’t paid off, but there’s a reason why I think conditions could swing in their favor (other than just “it’s time”).
I read a macro piece this last week that suggested U.S. stocks outperforming emerging markets consistently started when the Fed launched QE3. When Bernanke said that it would provide as much liquidity as is needed to support the economy - a significant shift away from its mandate to balance unemployment and inflation - it was off to the races for U.S. stocks. Those conditions essentially were maintained throughout the past decade (save for an attempt to raise rates around 2018) and large-cap growth stocks were consistently the market leader.
What happens now that global central banks are withdrawing liquidity from the economy and raising interest rates? The complete opposite? Are we setting up for the decade of emerging markets now? It’s hard to predict what will happen 8 years from now let alone in the next 11 months, but this could be a big turning point for this group.
Treasuries Will Be Unsteady Until The Fed Says It’s Going To Stop Raising Rates
I still maintain that Treasuries could be one of the best trades of 2023. The 7% gain it’s already experienced in 4 weeks proves as much, but it won’t be a steady ride. Any time the Fed adds a dose of uncertainty onto the market or takes a hawkish tone, rates tick up again and bonds lose value.
That narrative will probably be present in some form or another throughout 2023, but at some point it’s not going to hold. The Fed pausing its rate hiking cycle will be the first step. Investors moving past short-term bullishness and realizing that the recession story is getting worse will be the second step. If the Fed continues to hold rates high even as the economy is deteriorating, then you’ve got the recipe for a big Treasury rally.
Current conditions aren’t necessarily conducive to Treasury outperformance, but the overall path of what 2023 will likely end up being suggests there’s much more upside potential here.
The Year Of ETF Closures Has Already Begun
One of my 13 predictions for 2023 was that we could see a wave of ETFs closing after a huge launch boom over the past two years has created a lot of small niche funds with few assets. The first domino may have already dropped. Invesco announced last week that it’s closing more than two dozen of its ETFs, including one that has more than $400 million in assets.
There are more than 1,000 ETFs in existence with less than $40 million in assets, a general benchmark where an ETF could be at risk of closing. Most of those won’t close, obviously, but I wouldn’t be surprised to see at least another couple hundred more closing before the end of the year.
ETFs in Focus
Here’s a look at the weekly net flows/RSI matrix, where I try to get a sense of what the markets are doing relative to what investors are doing to see if there are disconnects.
Note: Most ETFs will fall above the 0% flows/AUM line because, well, ETFs take in hundreds of billions of dollar annually. So I’m looking at 1-month flows to focus on the short-term (1-week flows are too choppy to have high confidence in the results). Upper-left quadrant would identify ETFs that are performing poorly but are seeing investor money moving in. The lower-right quadrant would be ETFs that are performing well, but seeing money leaving. Both could provide contrarian opportunities. I wouldn’t call them buys or sells. Just more of a way of potentially identifying trends.
There aren’t any huge outliers this week, except maybe for materials (XLB). This sector has been looking fairly strong, but investors already seem to be pouring money into it. There might be some opportunity in tech (XLK), which has turned into one of the best performing sectors of 2023 so far, but has still seen a negative outflow over the past month.
All of the best performing sectors of the moment are seeing inflows to some degree. Emerging markets (IEMG) have seen strong inflows to start the year and high beta (SPHB), which identified as an outlier in the lower-right quadrant last week, has seen inflows quickly catch up to performance.
On a different front, I recently refreshed my dividend ETF rankings for the start of 2023, which I’ll be writing about soon. We’ve seen a few changes near the top, but it’s still the heavyweights that are represented. Here’s the latest top 10 that I posted to Instagram last week.
Overbought: XLC, XLY, SHV, FLOT, PFF, BITO, DBB, REMX, SPHB, ARKK, ARKF, ROBO, FXI, FDN, ICVT, METV, ESPO, JETS, EWG, EWP, EWJ, EWS, ARGT
Near Overbought: SPY, MGC, IWM, IWC, XLF, XLK, EMB, MUB, GLD, CPER, QUAL, BLOK, SKYY
Near Oversold: PALL, UNG
Oversold: INDA, UAE
Note: Oversold/Overbought developed using a combination of RSI and Longbow dashboard.