A well-known phenomenon in the stock market known as "loser's reversal" typically occurs in January. This means that stocks with negative price momentum in the previous year tend to perform better in January. We put this thesis to the test in the 2022/2023 market, and the results were quite surprising. We selected the best 100 and worst 100 performers from 2022 and tracked their performance in 2023 so far. While both groups had positive returns, the "losers" from 2022 delivered an astonishing year-to-date return of +44.5% and reached a peak of +70% in January.
We take a sharp look at the recent state of the financial markets, critically examining how inflation, the Federal Funds Rate and the returns of the S&P 500 are inter-related. Digging in and exploring the correlations of various asset classes. Cryptocurrency focus is a technical analysis of Bitcoin. You can visit last weeks market review here.
Can the Fed get inflation under control without derailing the economy?The Federal Reserve has the ability to significantly impact the market by adjusting interest rates. When interest rates increase, it can lead to reduced market liquidity and higher borrowing costs for both businesses and consumers. The chart below compares interest and inflation rates with S&P drawdowns since 1965. It indicates that interest rates typically trail inflation, and that the S&P 500 has historically experienced its largest drawdowns during periods of relatively high interest rates. Notable instances where interest rates exceeded current levels include the period leading up to the 2007-2008 Financial Crisis and the Dot Com Bubble in 2000. Based purely on these two data points, it could be argued we are unlikely for the S&P 500 to hit only a 25% drawdown, as was observed in October 2022. However we need to look at today and really consider if we are in as much of a tech meltdown as the dot-com bubble and it also seems sensible to suggest we certainly are not in the leveraged environment of the GFC.
Notice the extraordinarily high inflation rate of the 1970s, the average print was 7% over the decade. Many investors are pointing to similarities between the 1970s and today. The US inflation rate for January 2023 came in at 6.4%, down slightly from 6.5% in December, but less than market forecasts of 6.2%. It’s the lowest reading since October of 2021 but still much higher than the Fed's 2% target.
By analyzing the correlation matrix of various asset classes over the past year, we have found that among the equity-based asset classes (market, energy sector, momentum, low vol, value, quality, and yield), only the energy sector showed a limited diversification of risk from the market. On the other hand, gold exhibited almost no correlation with any other asset class. When it comes to Bitcoin, the strongest correlation was observed with the quality style factor.
The indices experience mixed returns last week, the Russell 2000 (IWM) saw a 1.5% gain while the Nasdaq-100 (QQQ), S&P 500 (SPY), and Dow Jones Industrial Average (DIA) gave up the gains made earlier in the week, to remain flat for the period.
Looking at sector performance, we can observe that the technology services sector is leading the way this year with an impressive average return of 29%. It is followed by consumer durables and health services, both of which have positive returns of around 20%. In contrast, the energy minerals and utilities sectors are lagging behind with an average return of approximately 2%.
To provide further insight into sector performance, we have graphed the percentage of stocks in each sector with positive year-to-date returns. Consumer durables sector leads with more than 60% of its stocks exhibiting positive momentum. Meanwhile, the technology services sector has fallen back to fifth place, from the previous chart, indicating that the year-to-date returns in tech are concentrated in a smaller number of stocks (e.g TSLA, META).
Last week, the Low Vol and Dividend Yield factors delivered strong performances, with positive returns of 0.6% and 0.47%, respectively. Although Value also recorded a positive return, whilst not the stand-out this week, it has been consistently outperforming this year. On the other hand, Quality experienced a negative return of 0.14%.
If you'd like to learn more about equity style factors then you can visit our topic here.
The previous week witnessed a surge in cryptocurrency prices, with all major currencies experiencing gains. Bitcoin and Ethereum saw a rise of 15%, while BNB and Polkadot recorded returns of 10.6% and 20.9%, respectively. Bitcoin's increase places it in the top 13 percentile of all weekly returns since late 2017, when our dataset begins. Historically, when Bitcoin has performed similarly well, it has returned an average of 2.22% in the subsequent 4 weeks.
Taking a technical analysts approach to Bitcoin, it has just completed a golden cross, which is the first time since September 2021. Could this be the start of the next bull run? There are more pronounced macro headwinds to overcome this time.
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