As always, this is not investment advice! Please do your own due diligence and take your own financial situation into account. Everyone has a different financial situation, which means different tolerances for risk and ability to take risk. What is appropriate for me may not be appropriate for you.
For January, the Paper Portfolio returned 17.2% vs 6.29% for the SPY. Given the significant underperformance of the Paper Portfolio in 2022, the Paper Portfolio remains quite a bit behind the SPY since inception (21.8% vs 44.8% cumulatively since July 2019). Although the gap remains large, Capital Flywheels remains fairly confident that the Paper Portfolio can eventually retake the lead.
Last month we discussed how there were likely many attractive opportunities that can produce exceptional results once the market turns. This likely does not require the Fed to lower interest rates or for economic growth to accelerate. It simply requires the Fed to stop applying pressure on the margin and for the economy to stabilize.
In many ways, that is exactly what happened in January. The significant strength of the markets in January were very much a response to expectations moving in that direction: Investors are now increasingly becoming comfortable with the idea that the Fed is going to slow rate hikes and that economy will continue to slow but not into a deep recession.
One challenge with understanding markets is that there are many different markets and many different sets of investors. The expectations are not always internally consistent, and it is therefore important to understand these differences and what it means.
One that stands out in particular is what futures are pricing in for Fed interest rates. As you may already know or have read elsewhere, futures for interest rates appear to be extremely aggressive with implied rate cuts beginning in a few months.
Source: Federal Reserve Bank of Atlanta
Many cautious investors are pointing to this fact as evidence that equity markets are already too bullish. While these arguments are definitely worth considering, Capital Flywheels also thinks there are very real reasons to wonder if the views of these two markets (equities and Fed fund futures) are internally consistent and adequately capture the views of the same investor base.
It’s quite possible that Fed fund futures investors are way too bullish, while equity investors have only retreated from hell back to halfway-from-hell (and certainly nowhere near euphoria, yet…though meme-like behavior does appear to be resurgent in certain stocks). Just because Fed fund futures investors are expecting rate cuts does not necessarily mean equities investors are expecting the same and pricing stocks to reflect that.
Despite the strong performance in January, Capital Flywheels is willing to bet there is likely more room upwards…eventually.
However, the road to anywhere worth going is never straight.
While I think there is potential for more, it probably pays to be nimble, especially since so much hinges on so little (a few words from Powell and a tenth of a percent in the wrong direction on the next inflation print is enough to move minds and markets). It’s almost impossible to know what is going to happen in the short term, but the medium term picture looks pretty clear: Inflation has already peaked. Rates are likely peaking soon. Inflation may take longer to get back to 2% target, but even if disinflation gets bogged down somewhere in the 3-4% range for a bit longer, we can at least take comfort in knowing that the world hasn’t and won’t end anytime soon.
And if there’s enough time left in this world with a future, companies that matter in that future will eventually be worth something again.
(As a thought experiment, what is more likely to be transformative 5 years from now? AI and ChatGPT and its future versions alongside companies like Nvidia that power it? Or whether we get 25 or 50 more basis points of hikes than expected sometime between tomorrow and the end of the year? Doesn’t even seem like a close comparison to me assuming we all survive into this future 5 years from now.)
We will know more tomorrow (or today, depending on when you read this) about the short term when the Fed announces its next decision on 2/1.
But we’ll need to wait a little longer to know what the medium term holds.
Onward.
Disclosures: Of the stocks mentioned, I own shares in NET, PINS, SE, KIND, MRNA, UBER, OKTA, SNAP, U, SDGR, AYX. I have no intention to transact in any shares mentioned in the next 48 hours.