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Jan 24 2023

Is Value Still A Value?

  • Jan 24, 2023

Deflating valuations in the Technology and Innovation space produced ghastly results for growth investors in 2022, with the S&P 500 Growth index experiencing an agonizing 29.4% loss. Meanwhile, last year’s bear market was no more than a mild irritation for value investors as the S&P 500 Value index lost just 5.2%. The collapse in exuberantly priced growth stocks produced a 24.2% return spread between the value and growth styles, which goes into the record books as the second biggest annual win for value since 1975.

Read this week's Major Trend. 

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The defining characteristic of last year’s bear market was the collapsing valuations of speculative growth stocks. A mania for themes such as cloud computing and disruptive innovation during 2016-2021 drove those names to fantastical valuations and bestowed market capitalizations of tens- and even hundreds of billions of dollars on such companies, many of which had yet to turn a profit.

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This year is off to a much stronger start than suggested by the 3-4% gains in the blue-chip averages: Through January 12th, the Value Line Arithmetic Composite—an equally-weighted index of about 1,700 stocks, was up 7.0%.

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Both the headline and Core CPI were in line with expectations.
Sticky ex-Shelter CPI has rolled over and EM inflation surprises are negative now.
Disinflation remains the dominant theme but some inflationary pressure can be quite sticky.

 

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A signal from the newest addition to our Technical category seems to have gone awry. On November 30th, the percentage of S&P 500 stocks trading above their 50-day moving average topped 90%, thereby issuing the second “breadth-thrust” signal in four months.

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2022 was a nasty year for the stock market, but a wonderful one for market numerologists. This year is a different story. Two of the three calendar patterns are bullish, including the one in which we put the most stock (pun intended): The Presidential Election Cycle. 

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Hopes that this decade might see a repeat of the “Roaring Twenties” took a hit last year. But there’s plenty of time to recover, and bulls will be encouraged to learn that cumulative stock market performance for this decade, thus far, is better than at the same point in the Roaring 1920s.  

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Frequently, there’s money to be made in the stock market in the months following the initial curve inversion. After the inversions of August 2006 and June 2019, the S&P 500 rallied another 23% and 19%, respectively, into its final bull market high. If this cycle plays out in textbook fashion, the business-cycle peak would arrive in September.

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Market veterans know there’s just one thing more probable than a recession after the yield curve inverts: Yield curve denial among a large group of sell-side economists and market strategists! Indeed, the earliest of those dismissals occurred last March—a month before the first of more than a dozen iterations of a yield curve inversion. 

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We’ve heard for eons that “Low bond yields justify high equity valuations.” Value-conscious investors might have described this conundrum another way: “Low future returns in one asset class justify low future returns in another.” (Mysteriously, only the first rendition became a CNBC catch-phrase.)

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The 2022 bear market will be remembered as a year when collapsing growth stock valuations and rising interest rates doomed almost every asset class to return purgatory. Hopes for avoiding a second down year rest with a potential top in interest rates and solid earnings underpinning the stock market. Wall Street strategists have a year-end 2023 price target of just over 4,000 for the S&P 500, a few percentage points of upside from today but hardly reason to toast a prosperous new year.

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Today, we are announcing that our Chief Investment Strategist, Jim Paulsen, will be retiring at the end of the year. Jim has been a popular counselor to our firm's institutional clients and a regular commentator in financial media. He will be stepping back from publishing and other day-to-day duties, but will remain a partner and senior advisor to our firm, which he joined over five years ago.

Jim is such an original thinker and provocative market forecaster, and we feel fortunate he chose to wrap up a long and distinguished career here at Leuthold. Our research clients and the millions of people who followed his work in hundreds of TV and print interviews were equally fortunate, having benefitted from his insights and, frankly, his knack for being right.

We’re going to miss Jim at a professional level — he has legions of fans on Wall Street and Main Street, but none bigger than the members of our own research and investment teams — and personally, as a friend and colleague. His family, the philanthropies he cares about and the Minnesota Timberwolves basketball team are all lucky to be getting more of his time and focus.

We wish him well with his new endeavors.

-John Mueller and Jeff Leadholm – Co-CEOs

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Both the headline and Core CPI were weaker than expected. Wealth effect and employment indicators also suggest lower inflation. Inflation pressure should ease further as recession becomes the dominant concern.

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It will be years before policymakers know the long-term effects of the COVID experiment with Modern Monetary Theory. However, the episode has helped answer, once and for all, a question that’s troubled psychologists forever: Money can buy happiness! But it can’t buy hope.

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Read this week's Major Trend Index update...

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The Federal Reserve has not yet begun easing, but “Easing” is a multi-dimensional event, and increasingly, the outlines of a new cycle (often associated with the beginning of a bull market) are coming into focus.

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Economists who believe a 2023 recession will be avoided, may not know it but they are “messing with perfection.” Since August, we’ve chronicled several developments that have, without fail, correctly forecasted past recessions, or confirmed that one was already underway. 

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Nearly everyone would cite high inflation as the dominant theme of 2022. But we think that the evaporation of a one-time ocean of liquidity better explains the horrendous backdrop for stocks and bonds. High inflation sped up the rate of evaporation, but it was going to occur anyway. 

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The mid-October market bounce extended through November. The S&P 500’s monthly gain (+5.4%) stretched both of our downside-to-median estimates by congruent amounts. Since September 30th, downside for our “New Era” (1995-to-date) weighted average widened from -5% to -17%.

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This earnings season has not been free of concern, and profit margins are clearly weakening from last year’s highs. Our earnings waterfall template highlights several themes coming out of third quarter results.

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A new study looking at the relationship between inflation and profit margins is introduced. The goal is to understand how the latest margin peak was reached in mid-2021 and what impact inflation might have on margin forecasts underlying next year’s earnings estimates. Full report will be sent mid-month.

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The yield curve (i.e., the 10-year bond yield less the 3-month bill yield) finally “INVERTED” in late October, raising significant fear among investors. It is a scary-sounding word. Consider some of its synonyms: upended, capsized, backward, upset, confused, disordered, jumbled, haywire, and wrong-side-up.

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When Jerome Powell took the reins of the Federal Reserve in early 2018, many commentators cheered the fact that he does not possess a Ph.D. in Economics. It will be many, many years before historians are able to conclude whether that’s a good or bad thing.

Yesterday’s action, though, left us wondering whether Powell might stealthily be in the process of earning a different designation—that of Chartered Market Technician (CMT). 

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Since the dot-com crash, there has been general disappointment with government economic policies—both fiscal and monetary. In the aftermath of the 2008 financial crisis, apprehension about economic programs surged, and after a brief respite from 2016-2020, the outlook since the pandemic has again darkened considerably.

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Read the latest MTI update...

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There is still considerable debate about whether the bear market has yet set its low. Certainly, if the U.S. economy is headed for a deep recession, stock investors will face additional, significant downside risk. Several smart bears on Wall Street suggest the S&P 500 could decline to about 3,000—or -25% from today’s level—as analysts are forced to cut earnings estimates. However, if the economy manages to avoid recession or experiences only a modest contraction, a new bull market may already be unfolding. While, understandably, downside risk typically gets the most attention, investors should also consider what the “upside risk” could be in the coming year if the “low is already in?”

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The 2022 bear market has been driven by collapsing valuation multiples, particularly for expensive growth stocks and unprofitable companies. Coming into the year, U.S. stocks stood as one of the most egregiously valued equity markets around the world, motivating investors to look elsewhere for more reasonably priced alternatives. Fortunately, international stock markets offered much better valuations that could serve as havens from the coming U.S. valuation collapse. Unfortunately, the strategy of seeking refuge in moderately priced foreign markets was foiled by an unusually strong U.S. dollar, leading us to take a closer look at how moves in the USD affect investment outcomes for domestic investors.

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Our studies of economic and stock market history are meant to provide perspective, not an investment roadmap. But occasionally a current trend will resemble the past so closely it’s eerie.

Take the current inflation cycle. If (as we believe) June’s CPI inflation rate of 9.1% represents the peak for this business cycle, then many of its characteristics have lined up almost perfectly with the “average” of past inflationary episodes.

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The debate surrounding “how long” U.S. inflation could remain elevated and how quickly or slowly it will return to “normal” is far from over. However, at the very least, it appears that inflation has peaked. During the last few months, the annual CPI, PPI, and wage inflation rates have declined noticeably and significantly from their respective cycle highs. Several concerns still need to be addressed. Will inflation persist at its current unacceptable level and require much more aggressive policy action? Could inflation expectations yet become unanchored? Is a recession inevitable? Or, now that we’ve seen the inflation peak, will conditions promptly return to normal?

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Inflation has been slowing for the last several months and finally appeared in the “headline” numbers last week. Although a single comforting CPI report will not eclipse ongoing concerns about inflation, leading up to that report, there was a broad array of evidence that inflation was moderating and has probably peaked—e.g., falling commodity prices, decelerating wage inflation, declining import and export prices, renewed deflation in the Adobe Digital Price Index, various private sources (like Costar and RealPage) illustrating that rents had decreased, a downturn in used vehicle prices, a complete collapse in shipping rates, and increasing numbers of retail price discounts due to inventory overhangs.

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Read this week's Major Trend. 

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Lower than expected CPI figures give the Fed an opportunity to ease the pace of tightening. Markets, probably bracing for yet another higher than expected reading, shoot higher. Our Scorecard sees inflation’s downward trajectory continuing.

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