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TCM Market Outlook and Strategy - April 5, 2024

Fri, 05 Apr 2024 05:00:00 +0000

Stephen M. Mills, CIMA_®Partner

Chief Investment Strategist

The performance of the U.S. stock market has been nothing short of remarkable for the past five months as March marked the fifth consecutive month that the U.S. stock market recorded a positive gain, as measured by the S&P 500 Index.¹ Since 1950, there have only been 30 instances where the S&P 500 posted a five-month winning streak. In all but two of those instances, the S&P 500 was higher 12 months later with an average gain of 12.5%.² (Past performance is not a guarantee of future results)

Since bottoming out in October 2022, the S&P 500 has increased by nearly 50% after suffering a decline of 27% from January 2022 to the October ’22 low.¹ As we pointed out in our January 2024 letter, the majority of the gains for the market S&P 500 Index in 2023 were attributed to a few mega-cap large-company growth stocks, particularly companies that were involved in artificial intelligence (AI) related technologies. However, since the beginning of the fourth quarter of 2023, we have seen broad-based participation among many sectors of the market. Value stocks and higher dividend-yielding sectors like utilities, energy, financials, consumer staples and REIT’s (real estate investment trusts) which lagged growth stocks for most of 2023 have begun to participate in the market rally. Even small company stocks, which have been badly lagging behind their large cap counterparts, have started to show some signs of life so far in 2024.

This year, the stock market is off to its best start since 2019 with the S&P 500 rising nearly 10% and the closely watched Dow Jones Industrial Average (DJIA) gaining 5.5% as of March 31.¹ Any weakness in the market has not lasted more than a few days, with investors buying the dip and sending both the S&P 500 and the DJIA to new highs again and again. The S&P 500 posted 22 all-time highs in the first quarter.² In our observation of the stock market over the past 30 years, strength tends to beget strength. We wouldn’t be surprised to see stocks continuing to make new highs over the near term, though we could see a period of consolidation of the recent gains at some point in the near future. The S&P 500 has not fallen more than 2% since the rally began in October of last year.³ A 3-5% correction in the major stock market averages could certainly occur sometime in the next few months. However, we would view such a correction as a potential buying opportunity.

We believe the strength behind the move in stocks over the past five months is a combination of the Federal Reserve (Fed) ending its rate-hike cycle in the fourth quarter of last year, the potential of Fed rate cuts in 2024 and 2025, and the anticipation of stronger corporate earnings this year. The Fed paused rate-hikes at the September FOMC meeting last fall after raising the benchmark Fed funds rate from .25% at the beginning of 2022 to 5.5% as of the July 2023 meeting. The Fed kept rates unchanged in its November meeting and also indicated that with the improvement in the inflation data, it may begin lowering the Fed funds rate in 2024. This set off a wave of stock buying that has carried over into 2024. In addition, corporate earnings have been surprisingly strong despite higher interest rates. Fourth quarter 2023 earnings grew by approximately 7% as of March 18, significantly higher than the consensus estimates of a 1.5% increase.⁴ Many market analysts expect companies in the S&P 500 to report the third straight quarter of earnings growth in the first quarter of 2024. For the year, analysts expect earnings to grow between 7% to 11%.⁵ A combination of more favorable monetary policy and stronger corporate earnings is a recipe for higher stock prices in our view.

We believe another factor contributing to higher stock prices is the resiliency of the U.S. economy. Many strategists and financial advisors, including ourselves, began 2023 anticipating that the U.S. economy would fall into a mild-to-moderate recession by the end of the year. Thus far, the much-anticipated recession has yet to materialize. In fact, we are becoming more and more convinced that we may be able to avoid a recession altogether. Although the jury is still out, the latest economic data is signaling continued economic growth. One indicator we like to look at is the Conference Board Leading Economic Index. (LEI). The latest release on March 21 showed a .1% increase for February 2024.⁶Although that is not much of an increase, it is the first time the LEI had risen on a monthly basis since February 2022. The increase was fueled by strength in the manufacturing and residential construction sectors, two components of the economy that often lead more robust economic activity. Employment growth has continued to be positive with the overall unemployment rate remaining below 4% at 3.9%, according to the February 2024 Employment Situation report released by the Bureau of Labor Statistics (BLS). The U.S. jobs picture remains healthy and supportive of continued economic growth.

Going into 2024, we were cautiously optimistic about the outlook for the U.S. economy and financial markets. Our optimism was based on the resilience of the economy in spite of the sharply higher interests from the Federal Reserve’s 18-month monetary tightening strategy to combat high inflation. The economy grew at an inflation adjusted rate of 2.5% in 2023, according the Bureau of Economic Analysis February 28, 2024 revised GDP report. We believe the growth is due largely to consumer spending which accounts for approximately two-thirds of U.S. economic output. Business spending and manufacturing output has also remained robust over the past year, helping the economy to avoid a recession. We believe that U.S. economic growth will slow in the first half of 2024 but begin to reaccelerate as we move into the second half of the year. At this point, we don’t see a recession developing in the next 12-18 months.

With the stock market is making new highs almost daily, many investors are concerned that valuations are getting too rich and that we may be setting ourselves up for a significant fall in stock prices. As indicated on the accompanying chart, the S&P 500 is trading at a price-to-earnings ratio (P/E) of 20.9 times projected earnings of $245 for 2024.⁷This P/E ratio is somewhat higher than the 30-year average of 16.6 but below the P/E ratio of over 24 times earnings at the peak of the dot com era of the 90s. However, if you strip out the top 10 companies in the S&P 500 that trade at over 30 times earnings, the current P/E of the remaining stocks falls to 18 and closer to the long-term average.⁸

Another concern on investors’ minds is the upcoming Presidential and Congressional elections. Many investors worry that inability of Washington to address major policy issues like the budget deficit, immigration, and geopolitical crises in Ukraine and Israel, as well as the uncertainty surrounding the two Presidential candidates, could have a negative effect on both the economy and the stock market. However, historically the stock market has shrugged off these types of election year concerns. Since 1950, the S&P 500 has risen in a presidential-election year 83% of the time with an average gain of 7.3% gain in those years.³ (Past performance is not a guarantee of future results) It’s difficult to say what impact the election will have on the stock market in the short-term, but we believe that regardless of the outcome and who occupies the White House in 2025 and which party controls Congress, we feel the positive fundamentals of the economy and the strength of corporate America will provide a favorable environment for stocks. More than likely, we end up with no party controlling the White House and Congress resulting in continued grid-lock in Washington. Frankly, in our observation, grid-lock is good. It means that it is unlikely that there will be any major legislation coming out of Washington that could harm business or the economy like tax hikes, or massive spending bills or anti-business legislation.

While the situation with this year’s election may not have much of a impact on the financial markets this year, we believe the direction of the Fed’s monetary policy will certainly play a key role in both the economy and stock market for 2024 and 2025. Coming into the year, investors were expecting the Fed to cut its benchmark short-term rate six times in 2024. That turned out to be overly optimistic, as Fed officials indicated in their March FOMC meeting that they are forecasting only three rate cuts this year. They also indicated that any rate cuts will be dependent on inflation continuing to move toward the Fed’s 2% target annual inflation rate. Inflation, as measured by the Consumer Price Index (CPI), has fallen from an annualized rate of 9% in July 2022 to about 3% at the end of 2023. However, the January and February CPI report indicated a slight uptick in the annual inflation rate which certainly caught the attention of the Fed. The Fed will continue to closely monitor the direction of inflation as well as the employment data in determining when to begin cutting rates. Any further downshifting in the Fed’s rate cut forecast could lead to volatility in the market. We feel this is perhaps the area where the stock market is most vulnerable in the near-term.

While the stock market has been very good for many equity investors lately, the fixed-income markets have been fairly steady this year. Interest rates for money funds and shorter-term securities, and yields on intermediate-to-long-term bonds remain where they started the year in the 4-5% range.¹ We continue to see good value for investors in the fixed-income markets. The current level of interest rates for high quality fixed-income instruments provide historically attractive risk-adjusted returns for conservative investors in our view. For investors seeking to generate income as well as for portfolio diversification purposes, we continue to favor U.S. Treasuries, high-grade corporate bonds, mortgage-backed securities, prime money market funds, and tax-free municipal bonds. We view tax-free municipal bonds, with current yields ranging from 3% to 4% for intermediate and longer-term maturities, as very attractive for investors in higher tax brackets. Those tax-free yields calculate to a taxable equivalent yield for investors in a 40% tax bracket of 5% to 6.6%. Investors who are holding significant cash in money funds may want to consider locking in the current yields on intermediate fixed-income instruments in the event the Fed begins lowering the Fed funds rate in 2024.

In summary, we remain very positive on both stocks and bonds for the next 12-18 months. We will likely see greater volatility in the financial markets as we get closer to the election and the uncertainty regarding who will be in control of government weighs on investor sentiment. It is important that investors not overreact to this volatility but continue to focus on long-term goals and objectives and maintain asset allocations. We could use any corrections in stocks and/or bonds as an opportunity to put cash to work where appropriate.

As always, we are very grateful for the confidence and trust you place in us!

Your Trinity Capital Management Team

Tyler TX Location
821 ESE Loop 323, Suite 100
Tyler, Texas 75701
903-747-3960

Webite:www.tcmtx.com

Footnotes

¹Thompson charts

²Yahoo Finance, “The S&P 500 is up 5 months straight…” March 27, 2024

³ The Wall Street Journal. “The S&P 500 Is Poised for Best Start to Year Since 2019.” March 28, 2024

⁴ Wells Fargo Investment Institute, Investment Strategy report, March 25, 2024

⁵Barron’s, The Stock Market Rally Keeps Going. March, 27, 2024

⁶https://www.conference-board.org/topics/us-leading-indicators

⁷Factset, Earnings Insight, March 28, 2024.

⁸ Professor Jeremy Siegel interview on CNBC.

To view the above links, press and hold the Ctrl key on your keyboard, hover over the link and left click your mouse.

Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and separate non-bank affiliate of Wells Fargo and Company. Trinity Capital Management, LLC is separate entity from WFAFN.

Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations. Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.

The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income securities may be worth less than the original cost upon redemption or maturity. Yields and market value will fluctuate so that your investment, if sold prior to maturity, may be worth more or less than its original cost. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment. Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax (AMT).

The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns nor can diversification guarantee profits in a declining market.

The Consumer Price Index (CPI) is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics.

P/E Ratio is a valuation of a company or an index’s current value compared to its earnings per share. It is calculated by dividing the market value per share by earnings per share.

S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.

Index return information is provided for illustrative purposes only. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment.

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

P/M Tracking Number: 10022025-6521254.1.1

TCM Investment Outlook Strategy - April 2024.pdf

TCM 2024 Investment Outlook & Strategy - January 12, 2024

Fri, 12 Jan 2024 06:00:00 +0000

Stephen M. Mills, CIMA® Partner

Chief Investment Strategist

Executive Summary

Introduction (Page 2)

Overall, 2023 was a positive year for investors after a difficult 2022.
We begin 2024 with a cautiously optimistic outlook for the U.S. economy and financial markets.

U.S Economy (Page 2)

Despite several economic and geopolitical challenges during the year, the U.S. economy avoided a recession and continued to grow moderately.
We believe U.S. economic growth has persisted primarily because of the strength of the consumer’s overall financial situation and ability to maintain spending levels.
Given the resilience of the consumer, declining inflation, and the Federal Reserve’s monetary policy now on hold, we see recession as less likely for the U.S. economy this year.
Since peaking at around 9% in June 2022, the Consumer Price Index (CPI) has fallen consistently to where it now stands at just above 3% on a trailing 12-month basis, per the latest government inflation report for November.
After pausing its rate-hike program last fall, we believe the Federal Reserve may begin cutting rates sometime in 2024.

Equities (Page 3)

The global equity markets performed well in 2023 with the benchmark S&P 500 Index posting a total return 26% for the year while the average stock returned 10% as measured by the S&P 500 Equal Weighted Index.¹
We see more favorable Fed monetary policy and a rebound in corporate earnings as the key drivers of the equity markets in 2024, potentially leading to positive performance for stocks.
Currently, we believe the technical picture for the stock market is very positive. However, we expect a mild correction in the equity markets sometime in the first quarter after the strong run-up in stocks in the last two months of 2023.

Fixed Income (Page 4)

2023 was a volatile year for the fixed-income markets as interest rates for most bonds rose during the first half of the year and then fell back down in the fourth quarter nearly to the levels where they started the year.

We see good value for investors in the fixed-income markets for the first time in several years.

Interest rates for high-quality fixed income instruments are now available that provide historically attractive risk-adjusted returns for conservative investors, in our view.

Commodities (Page 4)

We have a positive outlook for energy, copper, and agricultural commodities for 2024.
We continue to favor energy equities, especially companies involved in both the production and transportation of oil and gas products.

Equity Strategy – (Page 5)

Growth stocks outperformed value stocks in 2023, the reverse of what happened in 2022.
We currently favor value stocks over growth stocks for conservative investors seeking both dividend yield and lower volatility that is typically associated with value stocks.
We believe there is opportunity in certain high-quality growth stocks, especially those involved in the development of artificial intelligence (AI) technologies.
Small-cap stocks look attractive to us on a valuation basis but we feel this sector will continue to underperform large and mid-cap stocks in the first half of the year.
We see a muted economic outlook for most international economies in 2024 and remain invested below our normal allocations for this asset class.

Introduction

We begin 2024 with a cautiously optimistic outlook for the U.S. economy and financial markets. Supporting our optimism, are more favorable monetary conditions to begin the year, declining inflation rates, a resilient U.S. consumer, and a U.S. economy that refuses to fall into the much-anticipated recession. Our caution comes from concerns about the lag effect of the Federal Reserve’s 18-month monetary tightening, the 2024 elections and global geopolitical concerns. We will discuss our reasons for optimism as well as our concerns in more detail in our letter.

2023 was filled with market moving events and developments. Three regional banks failed in March, the war in Ukraine raged on for the second year, conflict in the Middle East escalated, the U.S. manufacturing sector deteriorated, and both consumer and business and confidence fell during the year to levels normally associated with a recession. Yet the resilient U.S. economy continued to grow modestly and the major U.S. stock markets approached new all-time highs at year-end. The old adage, “climbing the wall of worry” comes to mind.

As for the financial markets, 2022 and 2023 was very much a tale of two markets. Coming off a very strong 2021, the U.S. stock market entered “bear” market territory in early January 2022 that lasted nearly 10 months and took the major stock averages down over 20%. The broad-based, cap-weighted S&P 500 Index bottomed in October with a peak to trough decline of 28% and ended the year with a negative return including dividends of -19.8%.¹ 2023 was the opposite story with the S&P 500 Index staging a strong recovery culminating in a robust 26% total return for the year.¹

It was a similar case for the bond market as most major bond averages fell 8-12% in 2022 while rebounding somewhat in 2023.¹ Most major bond market indices posted modest gains for 2023, especially in the fourth quarter when it became apparent to investors that the U.S. Federal Reserve (Fed) might be at or near the end of its 18-month rate hiking program. Most intermediate high-grade corporate bonds, government agency mortgage instruments, and high-grade municipal bonds on average returned 4-6% to investors depending on maturities.¹ Short-term treasury instruments, money funds, and Certificates of Deposit produced similar returns in the 5-5.5% range for the year.¹

2024 presents new challenges and opportunities. Below are our views on what we believe is in store for investors this year.

U.S. Economy

Coming into 2023, the biggest fear facing investors was the prospect of a global recession developing as result of aggressive monetary tightening by most central banks around the world. The U.S. Federal Reserve (Fed) raised the benchmark Fed funds rate from the .25% level at the beginning of 2022, to 4.5% by the end of the year.² The Fed’s monetary tightening was one of the fastest, most aggressive rate-hike tightening cycles in the Federal Reserve’s history. Historically, when the Fed has embarked on aggressively raising interest rates it has often led to an economic recession. The Fed tightening led to what is known as an inverted yield curve where short-term interest rates are higher than longer term interest rates, a condition that has often signaled a looming recession. Many economists and investment strategists were calling for a mild-to-moderate recession in 2023 for the U.S. economy. However, the U.S. economy failed to get the memo. Economic growth persisted throughout 2023 despite the Fed raising the Fed funds rate four more times by a total of a 1% before pausing rates hikes in September.² Those rate hikes took the Fed funds rate to 5.5%, a level we have not seen since 2006 and considered restrictive enough by economists to significantly slow economic activity and bring down inflation.

So, why has the U.S. economy defied history and remained so resilient? In short, we believe U.S. economic growth has persisted primarily because of the strength of the U.S. consumer. As we have cited numerous times in our client letters, the financial health of consumers has remained very strong since recovering from the 2008-09 financial crisis and the deep economic recession that followed. Household finances improved substantially over the years following the 2008-09 economic crisis with household debt falling as a percentage of household assets, as indicated in the accompanying table on the next page.³ Total consumer debt rose from $14.7 trillion at the beginning of 2009 to $20.3 trillion in 3Q 2023 for a total increase of 38%, while consumer assets rose from $79.1 trillion to $171 trillion for a total increase of 116% over the same time period putting U.S. consumers in a much stronger financial position. We believe this bolstering of household balance sheets has allowed consumers to continue spending over the last couple of years despite the higher interest rate environment brought on by the Fed’s monetary tightening program. Since consumer spending accounts for two-thirds of U.S. Gross Domestic Product (GDP), the U.S. economy has been able to avoid falling into a recession thus far in our view.⁴ The employment picture has also remained positive as companies continue to add jobs, further supporting consumer finances and spending activity. Wage growth has also been supportive of consumer spending as the medium average wage growth has remained above 5% since the beginning of 2022.⁵

Investors are now asking themselves if there will actually be a recession or if a so called “soft landing” is in store for the U.S. economy, a term used figuratively to describe a scenario where the economy slows but avoids falling into a recession. The debate rages on but in our view, given the resilience of the consumer and the potential that the Fed will be able to cut rates in 2024, we are now leaning more toward the “soft-landing” scenario or, no worse, a very mild two-to-three quarter recession for the U.S. economy. We could see the U.S. unemployment rate rising from its current level of 3.7% per the latest jobs reportto above 4% but not much higher than that.⁶

Another key economic driver is inflation. Since peaking at around 9% in June 2022, the Consumer Price Index (CPI) has fallen consistently to where it now stands at just above 3% on a trailing 12-month basis, according to the latest report from the U.S. Bureau of Labor Statistics for November. The high inflationary environment was the driver for the Fed’s aggressive monetary tightening program implemented in March 2022. By raising the Fed funds rate and tightening monetary conditions, the Fed hoped to bring inflation back down toward its long-term 2% inflation target. Although the Fed cannot yet declare “mission accomplished,” it is well on the way to achieving its desired goal. We see inflation continuing to decline in 2024 with the possibility the CPI hitting the Fed’s 2% mark by 2025. This should allow the Fed to begin cutting the Fed funds rate sometime in 2024, possibly in either its March or May meetings. The Fed has not raised rates since July 2023 and signaled in its latest meeting in December, the possibility of easing monetary conditions in 2024 if the inflation numbers continue to improve.

Overall, we are optimistic about the prospects for the U.S. economy for 2024 with the Fed on hold and economic conditions remaining positive. However, we feel there is a delicate balance in the economy and there are several issues that could negatively upset the balance. Potential headwinds include deteriorating credit conditions for both consumers and small businesses from the lagged effect of higher interest rates and Fed monetary policy. It generally takes 18 months for Fed rate hikes to show the full impact on the economy. The Fed’s last Fed funds rate increase was July 2023 so the full impact of Fed tightening may not be felt until the latter half of 2024. Another potential headwind is the uncertainty surrounding the 2024 presidential election which could dampen both consumer and business spending until it becomes clear who will be running the country beginning in 2025. There are also a few geopolitical hotspots including, Ukraine, the Middle East and growing tensions with China, that could trigger negative economic effects is any of those situations were to escalate.

Despite these potential headwinds, we believe the resiliency of the U.S. economy will continue and economic growth will be sustained for 2024. If the economy weakens and the danger of a recession increases, the Fed now has room to aggressively cut interest rates to help offset the downward economic momentum.

Equities

As we closed books on 2022, the so-called “Santa Clause rally” for equities in December never materialized. In fact, over the last two weeks of December 2022, stocks fell 4% as measured by the S&P 500 Index.¹ This past December, the stock market, using the same index, treated investors with a very nice gain of 4.4%.¹ Apparently, Santa Clause is real after all! The December 2023 rally capped off a strong fourth quarter for the stock market and an impressive 26% total return for the S&P 500 Index for year.¹

However, this does not tell the entire story for the stock market for 2023. The majority of the gains for the market cap-weighted S&P 500 Index can be attributed to a few mega-cap large company growth stocks. The way the S&P 500 Index is calculated, a greater weighting is given to those stocks that have a higher market capitalization. In 2023, as you can see on the chart below, the top 10 stocks by market capitalization increased 62% in value while the remaining 490 stocks rose 8%. The S&P Equal Weighted Index, which assigns the same percentage weighting to each of the 500 stocks in the S&P 500 Index regardless of market cap, increased 10% for the year.¹We believe the equal weighted index is more representative of the performance of the overall stock market in 2023.

While receding inflation and more favorable monetary policy on the Fed’s part will be important influences on stock prices, we believe that greatest influence on equity markets in 2024 will be corporate earnings. According to Factset, the “bottom-up” consensus estimate for 2024 S&P 500 earnings is $246, roughly 10% higher than the 2023 earnings estimates.⁷ Using the December 31, 2023 closing level for the S&P 500 Index of 4770, the current price-to-earnings ratio (P/E ratio) is 19.5. We believe the P/E ratio is an excellent indication of the market’s valuation. The current P/E ratio of the S&P 500 is lower than the P/E ratio of 24.8 at the beginning of the bear market in January 2022, but above the 25-year average P/E ratio of 16.76 as of September 30, 2023. However, if you extract out the top 10 stocks in the S&P 500 Index from the calculation, the P/E ratio for the remaining 490 stocks falls to approximately 17.1 times earnings and much closer to the 25-year average.⁸

In addition, we believe corporate earnings growth has the potential to surprise on the upside in 2024 and which could be a positive catalyst for stock prices. But even if earnings come in closer to the consensus estimate, we believe stocks can make further progress in 2024. Of course, 2024 is an election year which will certainly factor into the stock market’s performance. Typically, stocks rise until the March Presidential election primaries, tread water until the November election, and then rally into the end of the year once the election is over. We think this scenario may play out in 2024.

Currently, the technical picture for the stock market is very positive. However, we expect a mild correction in the equity markets sometime in the first quarter after the strong run-up in stocks in the last two months of 2023. However, we feel any correction will be short-lived and will give investors an opportunity to put cash to work in equities, where appropriate. In addition, various investor sentiment indicators show a high level of optimism which we view as a contra-indicator of market performance and supportive of our view of a market correction in the first quarter.

Although the stock market finished the year with the major averages approaching all-time highs, we see more gains for stocks in 2024. The key drivers in our view will be a more accommodating Fed that may start cutting interest rates in the first half of the year, a continuation of declining inflation, sustained economic growth, or no worse than a very mild recession, and, most importantly, improving corporate earnings.

Fixed Income

2023 was a volatile year for the fixed-income markets as interest rates rose across the maturity spectrum for U.S Treasury securities, corporate bonds, and short-term money market instruments during the first half of the year as the Federal Reserve continued to raising interest rates through its July meeting. Bond prices, after initially rising in the first half of the year, fell significantly in September and October before staging a strong rally to close the year. The closely watched 10-year U.S. Treasury Note yield, which serves as a benchmark for other bond markets, started 2023 with a yield of 3.9%, rose to nearly 5% in October before declining back down to its year-end closing yield of 3.85%.¹ Essentially, the total return for the 10-year T-note was its average yield for the year of approximately 4.25%.¹

We begin 2024 with interest rates still above 5% for money funds and shorter-term securities, and yields on intermediate-to-long-term bonds in the 4-5% range.¹ We see good value for investors in the fixed-income markets for the first time in several years. Interest rates for high-quality fixed income instruments are now available that provide historically attractive risk-adjusted returns for conservative investors in our view. For investors seeking to generate income as well as for portfolio diversification purposes, we continue to favor U.S. Treasuries, high-grade corporate bonds, mortgage-backed securities, prime money market funds, and tax-free municipal bonds. We view tax-free municipal bonds, with current yields ranging from 3% to 4% for intermediate and longer-term maturities, as very attractive for investors in higher tax brackets. Those tax-free yields calculate to a taxable equivalent yield for investors in a 40% tax bracket of 5% to 6.6%. Investors who are holding significant cash in money funds may want to consider locking in the current yields on intermediate and longer term fixed-income instruments in the event the Fed begins lowering the Fed funds rate in 2024.

Commodities:

The commodity market struggled overall in 2023 after a strong 2022 performance. Most commodities had been on a tear since May of 2020 as demand exploded for various commodities like copper, steel, aluminum, energy, and agricultural products. Using the S&P GSCI Commodity Index (GSCI) as a basis for performance, commodities increased in value by about 137% since May 1, 2020 through the end of 2022.⁹ We believe that strong demand coupled with supply constraints and inflationary pressures pushed most commodity prices higher in 2020 and 2021. However, the commodity bull market took a breather in 2023, falling 1.3% based on the GSCI.⁹ Crude oil prices, which are a major component of most commodity tracking funds, were a big contributor in the 2020-21 bull run nearly doubling in price as measured by West Texas Intermediate (WTI) futures contract.¹ Coming into 2023, many analysts were predicting crude prices to reach the $100 level. WTI traded as high as $88 in November before falling back to the year-end closing price of $72, a decline of about 5% for the year. Natural gas prices fell much harder during 2023 on weaker than expected demand and rising inventories. The natural gas front month futures contract fell nearly 50% for the year, reaching levels not since the Covid shutdown in the Spring of 2020. We see prices of most commodities stabilizing at current levels in the first half of 2024 but resuming the upward trend that began in 2020 in the second half of the year.

We favor energy, copper, and agricultural commodities. We see upside opportunity in both crude oil and natural gas. Supplies of both commodities were higher than expected in the second half of 2023, especially natural gas which we feel is the primary reason for the price decline in 2023. In addition, demand for natural gas has been below forecast in the fourth quarter of last year due to a milder than expected fall/winter season. We believe supplies of both commodities will remain strong for the first half of 2024 and demand could weaken with a slowdown in global GDP growth. However, once we get into the second half of the year, we believe demand will begin to strengthen and excess supplies will be worked off, putting upward price pressure on both crude oil and natural gas. We continue to favor energy equities especially companies involved in both the production and transportation of oil and gas products. Dividend yields for many companies in these two sectors are well above the dividend rate for the S&P 500 which currently stands at 1.4%.¹ (Dividends are not guaranteed and are subject to change or elimination.) We see upside potential for many energy related stocks in 2024 and beyond.

Equity Strategy

Growth stocks outperformed value stocks in 2023, the reverse of what happened in 2022. The Russell 1000 Growth Index rose 42.5% in 2023 after declining -29.1% in 2022 while the Russell 1000 Value Index fell -7.7% in 2022 and posted a gain of 11.3% in 2023. It has been a wild ride for growth stock investors over the past two years while value stock investors have enjoyed smoother sailing. We currently favor value stocks over growth stocks for conservative investors seeking both dividend yield and lower volatility. The chart below shows the relative valuations for value vs growth stocks. The green dotted line shows the average relative value over the past 25 years. When the solid black line is above the green dotted line growth stocks are cheap relative to value stocks. When the black line is below the green dotted line value stocks are cheap relative to growth stocks. We believe that over the next several years, value stocks will outperform growth stocks.

We continue to favor companies that have a history of raising their dividends each year as well as high dividend yielding stocks. (Dividends are not guaranteed and are subject to change or elimination.) We also believe there is opportunity in certain high-quality growth stocks, especially those involved in the development of artificial intelligence (AI) technologies. We view AI as a major technological breakthrough that will have a significant impact on productivity in the future much the way the development of the internet has had over the past 30 years.

Small-cap stocks look attractive to us on a valuation basis but we feel this sector will continue to underperform large and mid-cap stocks in the first half of the year. Higher interest rates and a potential economic slowdown or recession could negatively impact small companies since they tend to borrow more to finance their businesses and typically don’t have the cash reserves to weather a recession. We have been bearish on this area for a couple of years and will remain bearish until we can get a clearer picture on the direction of interest rates and the economy.

International stocks are starting to look more attractive on a valuation basis as well however we are still invested below our normal allocation to this equity class. We see a muted economic outlook for most international economies in 2024 although there are pockets of growth that are starting to emerge. At some point, we feel both developed country and emerging market country stocks will be attractive for investment however, we believe that now is not the time to add exposure to these asset classes. A small exposure to international stocks may be appropriate for those investors seeking more portfolio diversification. However, we would wait to add additional exposure to this area until we get closer to the middle of 2024.

The Bottom Line

The biggest obstacle facing investors this time last year was the U.S. Federal Reserve’s restrictive monetary policy begun in March of 2022 to combat inflationary pressures in the economy, in our view. For that reason, as we wrote in our January 2023 TCM Investment Outlook & Strategy letter, we entered 2023 maintaining a cautious stance with respect to both stocks and bonds.¹⁰ Our concerns were primarily focused on the uncertainty surrounding the impact of the Fed’s restrictive policy on the U.S. economic growth as the higher interest rates filtered through the economy and potentially dampened both consumer and business spending. We expected, like many economists and market strategists, that the U.S. economy would experience a mild-to-moderate recession in 2023 lasting two to three quarters.

It was also our view that the Fed would pause its rate hiking strategy sometime during 2023 as inflation continued to decline and move toward its target level of 2%. Our forecast for the Fed funds rate was for the rate to reach the 5-5.25% range, which we believed was sufficiently restrictive to slow economic activity and bring inflation down significantly.⁹ As we discussed earlier, the Fed hiked the Fed funds rate by .25% to the 5.50% in July of last year and has been on hold ever since. As we observed the resiliency of the U.S. economy in the second half of the year, we became more optimistic that the Fed’s restrictive policy may not in fact, push the economy into a recession.

Thus far, there has been no recession nor does it appear like one is looming. With inflation falling significantly throughout 2023 and the Fed putting its rate-hiking strategy on hold, we enter this year more optimistic that the U.S. economy will continue to grow and the financial markets can make meaningful progress for 2024. We see the U.S. economy maintaining an inflation-adjusted growth rate of 1-2% for the entire year with the low probability of a mild recession in the second half of the year. We see annual inflation rate, as measured by the CPI, breaking below 3% and the unemployment rate rising to the 4-4.25% level, up from its current level of 3.7%.⁶ We believe equity markets can post high single digit and possibly low double digit returns for the year.

We will inevitably see more volatility in the financial markets once again in 2024. Corrections in both the stock and bond markets, after a strong fourth quarter rally last year, are certainly a possibility. The U.S. elections will likely be a major factor in financial market activity once the primaries crank up in February. We would use any corrections to add to both stocks and bonds, where appropriate.

We believe now is a very good time to review your long-term investment goals and to evaluate your current asset allocation strategy to help ensure your portfolio is in line with your long-term goals and objectives. This could also be a good time to rebalance portfolios back to long-term asset allocation targets.

As we begin the new year, we are very grateful for all of our client relationships and for the confidence and trust you place in us. We are honored and blessed to serve you and your families and look forward to our continued relationship.

May you and your families have a very Happy and Prosperous New Year!

Your Trinity Capital Management Team

Footnotes

¹Thompson charts

^{2 https://www.forbes.com/advisor/investing/fed-funds-rate-history/}

^{3 https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/chart/}

^{4 https://fred.stlouisfed.org/series/DPCERE1Q156NBEA}

^{5 https://www.atlantafed.org/chcs/wage-growth-tracker}

^{6 https://tradingeconomics.com/united-states/unemployment-rate}

^{7 https://insight.factset.com/have-industry-analysts-overestimated-sp-500-eps-for-2024}

^{8 Jeremy Siegel’s 2024 Economic and Market Outlook, CNBC interview December 27, 2024}

^{9 Trading Economics, https://tradingeconomics.com/commodity/gsci}

^{10 TCM 2023 Investment Outlook & Strategy, January 2023. https://www.tcmtx.com/blog/post/tcm-2023-investment-outlook-strategy-january-11-2023}

To view the above links, press and hold the Ctrl key on your keyboard, hover over the link and left click your mouse.

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns nor can diversification guarantee profits in a declining market.

The Consumer Price Index (CPI) is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics.

P/E Ratio is a valuation of a company or an index’s current value compared to its earnings per share. It is calculated by dividing the market value per share by earnings per share.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

P/M Tracking Number: 07042025-6196678.1.1

TCM 2024 Investment Outlook Strategy - January 2024.pdf

TCM Market Outlook and Strategy - October 6, 2023

Tue, 10 Oct 2023 05:00:00 +0000

Stephen M. Mills, CIMA_® Partner

Chief Investment Strategist

Brad Bays, CIMA_®

Partner

PIM Portfolio Manager

Highlights:

The stock market rebounded from prior year losses in the first 3 quarters of 2023.
The U.S. economy continues to show moderate but slowing growth led by consumer spending and a strong labor market.
The rate of inflation in the U.S. continues to recede.
The U.S. Federal Reserve has raised the fed funds rate three times in 2023.

We believe there are three primary factors currently influencing the financial markets and will likely drive both stock and bond prices over the next 6-12 months: 1) the direction of the economy, 2) inflation expectations, and 3) the Federal Reserve’s monetary policy. There are certainly specific issues, like the UAW strike, rising oil prices, the war in Ukraine, next year’s presidential election, and the employment picture that will influence what happens with the markets in the near term but we feel the three factors mentioned above will be the key variables to watch moving forward. We will address each one of these factors in the following commentary.

U.S. Economy

First, let’s address the current state of the U.S. economy and our forecast for economic growth over the next year. Currently, U.S. economic growth, while slowing, remains solid according to recent positive data. Through the first half of the year, inflation adjusted U.S. GDP (Gross Domestic Product), often referred to as “real” GDP, grew by an inflation adjusted rate of 2%.¹In our view, that is remarkable considering the degree in which the U.S. Federal Reserve (Fed) has increased interest rates significantly since beginning their rate-hike cycle in March, 2022. The Fed has taken the fed funds rate from nearly 0% to 5.5% through a series of rate-hikes over the past 18 months. Such an increase in rates would typically slow the economy and possibly even cause a recession. That has not happened, yet. Real inflation adjusted GDP is expected to grow by an annual rate of 1.9% in the third quarter, according to the Federal Reserve Bank of Philadelphia’s survey of professional forecasters.²The forecasters expect real GDP to grow at an annual rate of 2.1% in 2023 and 1.3% in 2024.²

Coming into 2023, most economic forecasters were calling for a mild-to-moderate recession beginning sometime in 2023, however, perhaps the most anticipated recession in history for the U.S. economy has yet to materialize. Although we still have a quarter remaining in the year, recent economic data suggests continued growth for the rest of the year.

The U.S. consumer remains primarily responsible for the growth in the economy this year, in our view. Consumers continue to spend money on travel, entertainment, and dining. Recent data also shows good demand for durable goods like homes, automobiles and household items as well. This is all in spite of higher interest rates. Although mortgage loan rates moved above 7% this year, both housing demand and prices have remained resilient. In addition, retail sales rose by .6% in August for the fifth consecutive month of increases.³ Some of this increase was due to rising gasoline costs, however overall, consumer demand remains moderately strong.

One of the main drivers of consumer spending is consumer finances. The chart below breaks down the U.S. consumers overall balance sheet. Consumer assets remain at a historically high level at $168.5 billion while consumer liabilities are low by comparison at $19.6 billion, most of which is made up of mortgage loans. Debt payments as a percentage of consumer disposable income is currently 9.7%. Although the percentage has increased from 8.2% at the end of 2021, it is still much lower than the 13.2% level reached in 2009. We believe this is one of the reasons consumer spending remains resilient in spite of higher interest rates. Something to watch moving forward is the impact of the resumption of student loan debt payments. Student loan debt, which is currently at $1.76 trillion, represents 9% of the total debt. The Biden administration froze student loan debt payments in 2020 during the pandemic. On June 30, 2023, the Supreme Court blocked President Biden’s student debt cancelation plan. As a result, interest began to accrue on all student loan debt September 1^st and payments will resume in October of this year.⁴ It remains to be seen how this will impact overall consumer spending.

On the industrial side of the economy, manufacturing output has continued to grow modestly in 2023. Industrial production increased by .4% in August and has increased by 1.9% year-to-date as of August 31.⁵ In addition, the labor market continues to be strong although we are starting to finally see some weakening in the monthly job gains per the U.S. Bureau of Labor Statistics August jobs report. Although the economy added 187,000 jobs for the month of August, the unemployment rate jumped to 3.8% from the previous months rate of 3.5%.⁶ The report indicates that labor supply is increasing as more workers enter the workforce for the first time since the pandemic. It appears that the labor supply/demand picture may be coming back into balance after several years of supply shortages.

Overall, we believe that the U.S. economy has largely shrugged off the effects of rising interest rates so far this year. While the economy remains on solid footing so far, we are starting to see some cracks in the growth narrative and indications that there is at least a potential for an economic slowdown and possibly a mild recession in the next in the next 12-18 months. We believe the lag effect of higher interest rates will begin to take a toll on both business and consumer spending. We are already seeing signs of a spending slowdown in the business sector as business confidence in the economy continues to wain due to concerns about the impact of inflation and increased borrowing costs. Higher inflation and borrowing costs cut into profits and curtail business spending which is starting to show up in the monthly data.

Inflation

Since the middle of 2022, there has been significant progress made on the inflation front. The chart below shows historical data for “headline CPI” (Consumer Price Index) as reported each month by the Bureau of Labor Statistics (BLS) as well as “core CPI” which excludes food and energy costs. Headline CPI peaked in June of 2022 at an annualized rate of 9.1% while core CPI peaked at 6.3%. Since then, there has been a sharp reduction in the headline CPI to 3.7% on a year-over-year basis, as of the August BLS inflation report.⁷ The BLS also reported that Core CPI has fallen from its June 2022 peak but still remains at a historical high level of 4.3% on a year-over-year basis. We anticipate more downward movement for inflation over the next 12 months although the pace of the decline will likely slow somewhat. We see core CPI staying in the 3-4% range for the foreseeable future while headline CPI remains somewhat volatile due to energy prices.

Federal Reserve Monetary Policy

If both the U.S. economy slows in the second half of the year as we expect and inflation continues to fall, the Fed may be able to end the rate-hike program they began in March of 2022. The Fed did not raise the Fed funds rate at their June Federal Open Markets Committee (FOMC) meeting but came back in July and raised the rate by .25% to 5.5%, a 22-year high.⁸ The Fed paused their rate hike strategy again at the September FOMC meeting. Most economists expect the Fed to raise rates one more time before the end of the year in either their November or December meeting, before pausing for a more extended time period to assess the economic impact of the higher rates.

The Fed tends to pay more attention to core CPI as well as core PCE (Personal Consumption Expenditure Price Index), which is calculated differently than the CPI. On a 12-month basis, according to the August U.S. Commerce Department report, core PCE rose 3.9% which was down from its peak of 5.2% in September 2022.⁹ Both the core CPI and the PCE inflation measures have improved significantly since peaking in 2022.

Chairman Jerome Powell and other Federal Reserve board members have continued to emphasize their determination to get inflation back down to its 2% target rate and have made significant progress toward reaching that goal. We expect the Fed to remain diligent in their effort to bring inflation back down to their target. If the economy slows as we expect and perhaps falls into a mild recession, then the Fed may start lowering rates sometime next year. However, our mindset remains that the Fed will keep rates higher for longer.

Equities

September was a rough month for the equity markets as the S&P 500 Index fell 4.8% while the Nasdaq-100 Index lost 5%.¹⁰However, year-to-date through September 30, both indices recorded gains of 13% and 27%, respectively (including dividends).¹⁰ The majority of the gains in both of these indices can be attributed to a few large company growth stocks. In fact, just seven mega-cap stocks are driving the majority of the equity returns this year. As of September 27, these seven stocks have risen on average 80.1% and have accounted for the majority of the gains of the market-cap-weighted S&P 500 Index.¹¹ The S&P Equal Weighted Index, which assigns the same percentage weighting to each of the 500 stocks, is essentially flat, down .1% for the same time period.¹¹While the stock market has been very narrow so far this year, we expect the market to broaden out as we move forward.

We continue to be encouraged by the resilience of the U.S. economy. We feel this resilience will translate into better corporate earnings as we move into next year. We believe the biggest determining factor of the performance of stocks is investor expectations of future corporate earnings growth. As we sited above, we see the direction of the economy, inflation, and interest rates having the most impact on financial markets over the next 6-12 months. Corporate earnings are certainly impacted by each of these factors. However, we believe that company managements will be able to navigate through these challenges and continue to grow earnings.

We see earnings growth for the S&P 500 Index re-accelerating in 2024 as year-over-year earnings comparisons become very favorable after several quarters of contracting earnings in 2022. The adjacent chart shows S&P 500 annual earnings going back to 1988. The green bars represent what is referred to as an “earnings recession,” which is when the year following an earnings cycle peak fails to exceed the previous peak year. You will notice that 2022 was an earnings recession year as the S&P 500 earnings declined from 2021. The chart shows that 2023, 2024 and 2025 will be positive growth years for S&P 500 earnings, according the consensus analyst estimates. If these estimates are realized, we believe they will provide a positive catalyst for stock prices in the fourth quarter of this year and in 2024.

We believe the risks to stocks include a possible economic recession in 2024 and continued rising interest rates. While we don’t feel that a mild recession would have a major negative impact on stock prices, if the economy experiences a more significant downturn, stocks would likely fall and possibly even give back most if not all of their gains this year. In addition, if interest rates continue to rise, we believe stocks would have a difficult time making much progress. Negative geopolitical events, continued rising energy prices and election year politics could also have a depressing effect on stock prices.

Despite these risks, we remain constructive on the stock market for 2024. We would use any further near-term weakness in stock prices to put cash to work in selective areas of the market. As we have recommended for the past two years, we continue to favor high-quality, dividend-paying U.S. mid and large company stocks. These stocks have on average underperformed the growth stock sector of the market so far in 2023 as investors have allocated cash to the growth areas of the economy like technology and consumer discretionary. However, we believe as the economy weakens, investors will migrate more toward stocks with consistent earnings and dividend growth. (Dividends are not guaranteed and are subject to change or elimination)

High dividend sectors like utilities, REITs, and certain consumer staples and healthcare stocks have been under pressure this year with rising interest rates. We see value in these sectors but caution that investing in these stocks may demand patience if interest rates continue to rise. We would continue to avoid adding cash to small cap and international stocks at this time, but would hold existing allocations in these asset classes.

We also continue to be positive on the energy sector. We believe energy stocks present an excellent long-term buying opportunity as the supply-demand picture remains favorable for both oil and natural gas, in our view. With oil prices now in the $80-90 range,¹⁰ we believe the cash flows for energy producers should be very strong for the foreseeable future. We believe these rising cash flows will allow producers to increase capital spending on oil and gas production activities as well as potentially raise dividend payouts to investors.

Fixed Income

The bond market continues to struggle this year after recording one of the worst years on record in 2022. Prices of high-quality securities like Treasury instruments, high-grade corporate bonds and municipal bonds, which in the first half of the year posted modest gains, have recently fallen into negative territory for the year. Rising yields are the culprit. The 10-year U.S. Treasury Note, which began the year with an interest yield of 3.9%, ended the third quarter yielding 4.6%.¹⁰ Yields for other fixed instruments have risen as well over the past several weeks.

Bond yields have broken out to the upside recently for both short-term and longer-term U.S. Treasury securities, according to our technical indicators. We use these as benchmark securities to assess the overall condition of the bond market. These rising yields have caused interest sensitive investments like bond funds, utilities and REITs, precious metals, and small cap stocks to hit fresh lows for the year.

We believe yields are rising because investors appear to be anticipating a period of stagflation reminiscent of the 70’s when inflation remained above 5% for most of the decade and economic growth was below average. We don’t expect inflation rates to stay as persistently high this time around nor interest rates to reach the same levels as they did in the late 1970s and early 1980s. Looking back, most economists believe the Fed did a very poor job of combating inflation during those years. Today’s Fed seems determined to bring inflation rates down by aggressively raising interest rates and keeping monetary policy tight until they reach their 2% target rate.

Continued issuance of Treasury securities to fund U.S. Federal government deficit spending is also putting upward pressure on interest rates, in our view. Based on the technical charts we follow, we believe the 10-yr Treasury Note could reach a 5% yield soon. However, if recession fears begin to creep into the markets, yields could move back down until there was further clarity on the economy. On a positive note, most high-quality money market funds are now yielding over 5% and we do not expect this changing in the near future.

The Bottom Line

There are many uncertainties facing investors in the near term. The UAW strikes, the risk of a government shutdown, the war in Ukraine, rising interest rates, inflation, and the potential of a recession are all issues that will impact financial markets for the foreseeable future. These risks can make it very difficult to invest and can lead to investment paralysis. While we believe these conditions could create more volatility in financial markets in the near-term, they can also create opportunity to put cash to work in high-quality investments, where appropriate.

Equities is one area we would consider adding cash to between now and the end of the year for investors seeking additional equity exposure. With the improvement in the overall stock market this year, we believe we are no longer in a bear market. In our view, the bear market ended in mid-October, 2022, when the S&P 500 hit 3500, down 27% from its January 3^rd 2022 high. From that bear market low, the S&P 500, even with the 8% correction we have experienced recently, is up nearly 20%. However, we are not yet ready to declare a new bull market. That may come when the S&P 500 takes out its January 2022 highs. We believe those highs may be topped sometime in the next 12-18 months, based on improving corporate earnings and a stabilization of the Fed’s interest rate policy.

In the meantime, we will continue to evaluate market conditions and keep you informed of the latest economic and market developments. As always, we greatly appreciate your continued trust and confidence in us.

Your Trinity Capital Management Team

Tyler TX Location
821 ESE Loop 323, Suite 100
Tyler, Texas 75701
903-747-3960

Webite:www.tcmtx.com

Footnotes

¹ https://www.bea.gov/news/2023/gross-domestic-product-second-quarter-2023-second-estimate-and-corporate-profits

² https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q3-2023

³ https://www.cnn.com/2023/09/14/economy/retail-sales-august/index.html

⁴ https://money.com/when-do-student-loan-payments-resume/

⁵https://www.federalreserve.gov/releases/g17/current/default.htm

⁶ https://www.bls.gov/news.release/empsit.nr0.htm

⁷ https://www.bls.gov/news.release/cpi.nr0.htm

⁸https://www.wsj.com/livecoverage/fed-meeting-interest-rate-decision-today-july-2023

⁹ https://www.cnbc.com/2023/09/29/pce-inflation-august-2023-good-news-for-inflation-hawks.html

¹⁰ Thompson charts

¹¹ Wells Fargo Investment Institute, Chart of the Week, October 3, 2023

The indices presented in this material are to provide you with an understanding of their historic performance and are not presented to illustrate the performance of any security. Investors cannot directly purchase any index.

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns nor can diversification guarantee profits in a declining market.

Diversification does not guarantee profit or protect against loss in declining markets.

Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

Dow Jones Industrial Average: The Dow Jones Industrial Average is an unweighted index of 30 "blue-chip" industrial U.S. stocks.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility.

The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions.
Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks smaller, less-seasoned companies, tend to be more volatile than the overall market.
Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues.

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

PM-04052025-6003545.1.1

TCM Market Update - July 14, 2023

Thu, 13 Jul 2023 05:00:00 +0000

Stephen M. Mills, CIMA®

Partner

Chief Investment Strategist

Brad Bays, CIMA®

Partner

PIM Portfolio Manager

Commentary

The new year brought a more positive tone to the global financial markets as major stock and bond markets recorded gains through the first half of 2023. The Dow Jones Industrial Average (DJIA) posted a year-to-date total return 4.8% through June 30, while the broader-based S&P 500 Index (S&P 500) rebounded from its 20% loss in 2022 to notch an impressive total return of 16.9% over the same time period. As we will discuss in the section on Equities, the strong performance of the S&P 500 was led primarily by a handful of large company growth stocks.

The bond market also bounced back from one of the worst years on record in 2022. High-grade fixed-income instruments posted modest returns for the first six months of the year with major high-grade bond indices registering total returns between 2-4%, depending on length of maturities.1 The positive returns came from mostly interest income pay outs from the bonds but the longer maturing portfolios generated modest capital gains due to declining bond yields.

We believe the performance of the financial markets so far this year has been driven by a combination of a better-than-expected economic environment in the U.S., declining inflation rates, and investor anticipation of a shift in U.S. Federal Reserve’s monetary policy.

U.S. Economy

Perhaps the most anticipated recession in history for the U.S. economy has yet to materialize in the first half of 2023. At the beginning of the year, many economists and market strategists were forecasting that the U.S. economy would slip into a recession by the second or third quarter of this year. Although certain components of the economy like manufacturing and housing have been in what some would describe as a recession since the third quarter of 2022, various broad-based economic indicators currently show that the overall U.S. economy grew in the first half of the year. It seems the weakness in the manufacturing and housing sectors has been offset with strong growth in the services sector, which is mostly driven by consumer spending. Despite higher interest rates and negative news headlines concerning the banking crisis in March, consumers have continued to spend on service areas like travel, hospitality, entertainment, and dining while pulling back on major purchases like homes, automobiles and household items.

One broad-based measure of U.S. economic output is the GDP (Gross Domestic Product) report issued by the U.S. Bureau of Economic Analysis (BEA). The BEA recently released their revised GDP estimate for the first quarter of 2023 which showed U.S. output grew by 2% during the quarter.2 The latest estimate for second quarter GDP from the BEA is for an increase of 1.3%.2 Although, GDP growth is definitely slowing from its 2.1% pace for 2022, we don’t feel it is near falling to a recessionary level at this time.

Consumer spending is mostly responsible for the economy’s growth in the first half of the year. Personal consumption expenditures accounted for 68% of U.S. GDP output as of March 31 while manufacturing only accounted for 10.9%.3/4 Government spending accounts for balance of GDP output at about 21%. One reason consumers continue to spend may be the continued strong labor market. Jobs growth has been robust so far in 2023 as the economy has added over 1.5 million jobs through May and employers have raised wages by 3.4% year-over-year, according to the Bureau of Labor Statistics May 2023 report.5 In the May labor report, the employment rate ticked up from 3.4% in April to 3.7% but still remains historically low. In addition, the overall financial health of consumers remains very strong. As you can see in the adjacent chart provided by the U.S. Federal Reserve, as of the first quarter 2023 household finances are in good shape with total liabilities at $19.6 trillion, as indicated by the red portion of the bar, while household net worth was $148 trillion as indicated by the green portion of the bar.6 It is evident from the chart that consumers have not overextended themselves with debt over the past two years. Household debt payments accounted for only 9.6% of disposable personal income, as of the end of the first quarter, below the lowest levels recorded between 1980 and the onset of the pandemic in March 2020.7

We believe the overall financial health of consumers could continue to spur demand, especially in the services sector. While there is evidence that higher interest rates are starting to crimp consumer demand, it doesn’t appear to us that the current level of interest rates for mortgages, car loans and other consumer credit sources will dampen demand enough to throw the economy into recession this year. While we still believe the U.S. economy will experience a mild recession at some point in the next 12-18 months, based on the strength of the labor market and the resilience of consumer spending, it looks like to us that a recession might not occur until sometime in 2024.

Another positive for the economy is the continued decline of inflation which has been on a downward path since peaking in June of 2022. Both the widely followed Consumer Price Index (CPI) and the lessor known Personal Consumption Expenditures Index (PCE) continue to fall. The PCE is closely watched by the Fed as an indication of overall inflation in the economy. The most recent report from the U.S. Commerce Department showed the PCE Index rose by .1% for the month of May and 3.8% for the previous 12 months.8 While Fed’s preferred “core” index, which excludes food and energy prices, was up .3% for May, this was a significant improvement from the April report and the lowest rate since April 2021.8

If inflation continues to subside, the Fed may be able to let off the monetary tightening gas pedal over the next few months. At the last Federal Open Markets Committee (FOMC) meeting in June, the Fed did not hike the Fed funds rate for the first time since beginning its monetary tightening strategy in March 2022. The Fed had increased rates ten times by a total of 5%, with the last rate-hike coming at the May 2023 FOMC meeting. Chairmen Powell indicated in the post meeting briefing that the pause would likely be temporary and suggested the possibility of more rate-hikes in the future. The closely followed Fed funds futures contracts, used to forecast future Fed rate hikes, is currently signaling an 87% probability of a rate-hike at the July Fed meeting. Many economists expect the Fed to raise rates one to two more times this year reaching a “terminal rate” of between 5.5% and 6% before pausing. Powell and other Federal Reserve board members, have continued to emphasize their desire to get inflation back down to its target rate of 2% which may mean a bit more monetary tightening this year. Regardless, it’s looking more like the Fed is nearing the end of its 15-month rate-hike cycle. We believe this is a major positive for the economy going forward.

Equities

At the beginning of 2023, few market strategists predicted a 16% plus total return for the S&P 500 Index this year, much less for the first six months. Even the most bullish strategists were forecasting returns for the entire year in the 10-12% range. However, when you drill down into the details of the S&P 500 performance, you find that the majority of the gains were driven by a few of the largest growth stocks. In fact, about 80% of the S&P 500’s return can be attributed to only seven of the largest S&P 500 stocks in the index as of June 30.9 Most of these stocks are large capitalization technology companies that are involved in artificial intelligence (AI) applications. Investors drove up the prices of these stocks in the first half of the year based on the sentiment that AI will bring transformational productivity growth for many businesses over the next several years. While we believe AI applications will continue to be implemented in many industries over the next several years, the euphoria that has driven up the stock prices of many AI related companies may be somewhat premature since much of the growth potential may be years down the road. If you take the performance of these seven companies out of the S&P 500 Index, the return for the quarter is approximately 5%. The equal-weighted return for the S&P 500 Index, which is a broader measure of performance, was 7% for the first six months.1 Although 7% is still a very nice six-month return for stocks, it pales by comparison to the cap-weighted return of the S&P 500 of 16.7%.

We are encouraged by the resilience of the U.S. economy and equity markets thus far this year. We believe this bodes well for the second half of the year particularly if corporate earnings can begin to rebound from two consecutive quarters of mild contraction. Investors seem to be ignoring the mild contraction in earnings perhaps due to expectations that earnings growth will resume sometime in the second half of the year and accelerate in 2024. Stock prices are typically forward-looking and tend to discount future economic activity. We believe the biggest determining factor of future corporate earnings will be the nature and extent of a potential recession for the U.S. economy. A so-called “hard landing” for the economy, entailing several quarters of negative GDP, would most likely send stocks prices lower, perhaps even testing the 2022 lows. On the other hand, if the economy avoids recession and experiences a “soft landing” as some suggest, then the all-time stock market highs reached at the beginning of 2022 may be in reach.

Consumer sentiment may be the key to future performance of equities as illustrated in the accompanying chart provided by Blackrock. Since 1978, whenever consumer confidence, as measured by the University of Michigan Sentiment Index, is low and at a turning point, stock prices have enjoyed a significant rally over the next several years. Historically, when consumers are feeling less confident about the economy and about where things are headed, that is often a great time to put money to work in stocks. Of course, past performance is not necessarily an indication of future performance, but it does give us some insight on where stock prices might be heading over the next few years. Consumer confidence has been improving since it reached a low point in June 2022. In June of this year, consumer confidence rose 9% to 64.4%, the highest level since the beginning of 2022 according the latest report from the Confidence Board.10 It should be noted, however, that this rebound still leaves consumer confidence well below levels associated with past market peaks.

The rebound in equity markets so far this year has spurred many market strategists to declare the bear market in stocks officially over as the S&P 500 recently hit a level where it was 20% higher than the October 2022 lows. Although this is a significant recovery that cannot be ignored, it still leaves the S&P 500 approximately 8% below its all-time high reached in January 2022. Until the S&P 500 can exceed its all-time high, we are not quite comfortable declaring the bear market dead. We are concerned with the narrowness of the market advance as we discussed earlier. With the majority of the gains coming from just a few of the largest stocks in the index, we are reluctant to declare the end of the bear market. However, recently we began to see the market broaden out as more stocks began to participate in the rally. This is a good sign that equities could be in the beginning stages of a bull market. But we will need to see more evidence of the broad-based strength in equities before climbing on board the bull train.

In the near-term, we believe the risk for stock prices at this point may be to the downside. Currently, technical indications suggest to us that stocks are over-bought and could be due for a correction in the range of 3-5% range. Anything much greater than that would potentially indicate that the performance of the S&P 500 since the October 2022 market low has just been a bear market rally. But if stocks can hold key technical support levels over the next few weeks, it could be a good sign the bear market is over and a more constructive environment for stocks lies ahead. For now, we recommend holding cash reserves until there is further evidence supporting the potential for higher stock prices this year.

Fixed Income

At the beginning of 2022, interest rates across the maturity spectrum for most fixed-income instruments were at historically low levels. Short-term instruments like U.S. Treasury securities, bank CD’s and prime money market funds offered yields below .5%. Intermediate and long-term yields weren’t much better on highly-rated fixed-income securities. The 10-Year U.S. Treasury Note yield started 2022 at a yield of 1.6%.1

That all changed when the Federal Reserve launched their monetary tightening campaign in March 2022 and raised the Fed funds rate from .25% to where it currently stands at 5%. The Fed’s actions forced interest rates higher for virtually every fixed-income instrument. That was bad news for bond investors as the rising rates pushed bond prices lower resulting in significant losses during 2022. Today, the higher yields are good news for fixed-income investors, as it gives them an opportunity to lock in what we believe are attractive interest rates and cash flows. With interest rates exceeding 4% across much of the yield curve, investors can potentially lock in interest income from newly purchased high-quality fixed-income instruments and potentially enjoy meaningful capital gains on their holdings. High-quality fixed-income instruments could also serve as a potential portfolio hedge if the U.S. economy falls into a recession in the second half of the year as some economists and market strategists forecast. We believe a weaker economy would potentially lead to falling interest rates and rising bond prices.

Strategy

We continue to favor high-quality, dividend-paying U.S. mid and large company stocks. These stocks have on average underperformed the growth stock sector of the market so far in 2023 but are starting to perform much better in June. We believe investors will migrate more toward these kinds of stocks as the economy slowly weakens for the rest of the year and dividend yields become more attractive. There are many high-quality dividend-paying stocks that now offer yields in excess of 3%. (Dividends are not guaranteed and are subject to change or elimination).

Small-capitalization (small-cap) stocks have also started to perform better recently and could present an excellent buying opportunity in the second half of the year. Small-caps have generally under-performed their large capitalization (large- cap) counterparts since 2020.1 However, the valuations of small-cap stocks relative to large-cap stocks look attractive and the technical picture is starting to improve, in our view. Historically, when small-cap stocks start to outperform large-cap stocks it lasts for several years. However, if the economy weakens in the second half of the year under the weight of higher interest rates, it may pay to wait before adding additional exposure to small-cap stocks.

Commodity stocks on average have performed poorly in 2023, particularly, stocks in the energy, materials, and metals sectors. We believe investor concerns about rising interest rates and the potential of a recession have weighed on stock prices in this area. We see this as a good area of opportunity in the second half of the year and into 2024. We believe energy stocks present an excellent buying opportunity as the supply-demand picture remains favorable and investors once again seek exposure to the energy sector after taking profits in the first half of the year. Many oil and gas stocks are now paying dividend yields in excess of 4%. Although, dividends are not guaranteed, we feel the strong cash flows of many high-quality energy stocks not only support current dividend payouts, but provide the potential for dividend rate-hikes in the future.

We continue to remain neutral toward foreign stocks. The Eurozone officially entered a mild recession in the first three months of the year with GDP falling .1% during the quarter following a .1% decline in the 4th quarter of 2022, according to Reuters.11 A recession is typically defined as two consecutive quarters of economic contraction. The good news is it appears the recession in the Eurozone will be mild and perhaps last only for a few quarters. At some point, we feel both developed country and emerging market country stocks will be attractive for investment however, we believe that now is not the time to add exposure to these asset classes.

For investors desiring fixed income exposure to generate cash flow as well as for portfolio diversification purposes, we continue to favor high-quality fixed-income instruments like U.S. Treasuries, high-grade corporate bond, bank CD’s, prime money market funds, and tax-free municipal bonds. We view tax-free municipal bonds, with current yields ranging from 3% to 4.5% for intermediate and longer-term maturities, as very attractive for investors in higher tax brackets. Those tax-free yields calculate to a taxable equivalent yield for investors in a 35% tax bracket of 5.4% to 6.9%. As we mentioned in our January 2023 client letter, we continue to favor using a “barbell” strategy for the fixed-income component of a portfolio. This strategy involves investing a portion of the fixed-income allocation in short-term instruments, with maturities of less than 2 years, while investing the remainder of the allocation in longer-term bonds with maturities ranging from 10-20 years. The percentage in each maturity category depends on individual risk tolerance and cash flow needs. We would avoid most international and emerging market fixed-income holdings for now as a potentially stronger U.S. dollar and weaker overseas economic conditions could negatively impact prices. We would also avoid so called “high-yield” bonds. These bonds, which have lower credit ratings than high-grade bonds, tend to underperform in a recession as default rates typically rise.

The Bottom Line

We approached 2023 with a cautious attitude toward the financial markets based on concerns about the impact of significantly higher interest rates on economic growth this year. Like many advisors, we have been surprised by the strength and resilience of both the economy and the equity markets. Although we are encouraged by the strength, we remain concerned that at some point the higher interest rates and tighter credit conditions could depress economic activity. We believe these conditions could create more volatility in financial markets in the near-term. However, it is our view, that investors should continue to hold equity allocations according to their long-term investment objectives and ride out the volatility because once we get to the end of the Fed tightening cycle, we could begin to see a more constructive economic and market environment. We see any potential near-term weakness in stock prices as a good opportunity to selectively add to high-quality equities, where appropriate.

As always, we greatly appreciate your continued trust and confidence in us and we will continue to work to keep you informed of economic and market developments.

Your Trinity Capital Management Team

Footnotes
1 Thompson charts
2 https://www.bea.gov/
3 https://fred.stlouisfed.org/series/DPCERE1Q156NBEA
4 https://fred.stlouisfed.org/series/VAPGDPMA
5 https://www.bls.gov/news.release/realer.nr0.htm#:~:text=Real%20average%20hourly%20earnings%20increased,weekly%20earnings%20over%20this%20period
6 https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/chart/
7 Wall Street Journal, “Why Economies Slowed More Since Central Banks Hit the Brakes,” June 26, 2023
8 CNN Business, “The Fed’s Favorite Inflation Gauge Show Prices Rose .1% Last Month, June 30, 2023
9 CNBC.com, “The Biggest Threat to a Major Pullback in Stocks is a Hard Landing for the Economy, June 20, 2023
10 https://www.conference-board.org/topics/consumer-confidence
11 Reuters, Euro Zone Saw Winter Recession, More Challenges Ahead, June 8, 2023.

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns nor can diversification guarantee profits in a declining market.

Diversification does not guarantee profit or protect against loss in declining markets.

S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.

Dow Jones Industrial Average: The Dow Jones Industrial Average is an unweighted index of 30 "blue-chip" industrial U.S. stocks.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

Index return information is provided for illustrative purposes only. Index returns do not represent investment performance or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions and do not reflect deduction for fees, expenses or taxes applicable to an actual investment. An index is unmanaged and not available for direct investment.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility.

• The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions.
• Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks smaller, less-seasoned companies, tend to be more volatile than the overall market.
• Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues.

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

CAR-0723-00729

TCM Economic & Market Update - July 13, 2023.pdf

TCM Market Update - April 21, 2023

Fri, 21 Apr 2023 05:00:00 +0000

Stephen M. Mills, CIMA_®

Partner

Chief Investment Strategist

Brad Bays, CIMA_®

Partner

PIM Portfolio Manager

Highlights:

Fears of a banking crisis in the U.S. economy led to higher-than-normal volatility in the financial markets in the first quarter.
The Federal Reserve may be soon approaching the point when they will pause interest rate hikes.
Inflation pressures in the economy continue to subside.
We continue to expect a mild-to-moderate recession for the U.S. economy in 2023.

Commentary

The stock and bond markets continued to experience higher than normal volatility during the first quarter of 2023. March was a particularly volatile month as a potential banking crisis unfolded with two large banking institutions forced to shut down operations by the FDIC (Federal Deposit Insurance Corporation) due to insufficient capital reserves to cover the deposit withdrawals.

Both the stock and bond markets reacted to the news, with stocks prices moving down sharply and bond prices for U.S. government-backed securities rising as investors flocked to the safest areas of the financial markets. The fear of contagion subsided quickly with the move by the FDIC to insure all deposits at the two failed banks. Investors reacted positively to the news driving stock prices back up. The broad-based S&P 500 Index ended the quarter with a gain of 7.5% including dividends.¹ Most of the major bond indices were slightly higher for the quarter as well.

Although the financial markets appear to have shaken off the banking concerns for the time being, we believe the aftershocks of the two bank failures will likely be felt for several months as lending institutions potentially tighten loan standards and reduce lending in order to protect their capital base in case the stress to the banking system increases. If access to credit becomes more difficult for consumers and businesses, we believe the economy could suffer. Small business lending is particularly important for the U.S. economy since almost half of all U.S. workers are employed by small businesses according to a recent Forbes study. Banks with less than $10 billion in assets accounted for 43% of small business loans outstanding at the end of 2022, according to Rebel Cole, a professor of finance at Florida Atlantic University.² By contrast, the 13 largest U.S. banks accounted for less than 23% of small business loans, much of which are credit card balances.² We see this potential tightening of credit as another headwind for the U.S. economy for the next few quarters increasing the probability of a recession this year. In our TCM 2023 Investment Outlook & Strategy letter sent out in January of this year, we stated that we expected the U.S. economy would experience a “mild-to-moderate recession in 2023 lasting two or three quarters.” (See footnote 3 for a link to this letter) This continues to be our view.

We see continued evidence in the data that U.S. economic growth is weakening. We believe the impact of the Federal Reserve’s (Fed) year-long monetary tightening strategy, initiated in March 2022, is beginning to negatively impact economic activity. Higher interest rates for both consumer and business loans tend to slow borrowing and curb spending. Although retail sales figures have been mostly positive for the past six months, we believe consumer spending will tail off over the next few quarters. Since consumer spending accounts for approximately 70% of U.S. output, weakness in retail sales could lead to a mild contraction in U.S. GDP in the second half of the year. Although the Fed believes it can bring down inflation without causing a recession, we have our doubts. From our viewpoint, the Fed’s aggressive monetary tightening strategy of rapidly raising interest rates along with reducing its balance sheet through quantitative tightening, will at the very least stall economic growth and at worst cause a moderate recession lasting a few quarters. We believe the odds of a so called “soft landing” for the U.S. economy have diminished with the latest Fed actions and the recent problems in the banking sector. The latest reading for the Index of Leading Economic Indicators (LEI), as reported by The Conference Board, fell for the 11^th straight month and has reached a level that is often associated with a recession, as reflected in the above chart.⁴

We believe the recession risks and the concerns in the banking sector may cause the Fed to pause interest rate hikes soon. The most recent .25% rate hike by the Fed at its March meeting, moved the Fed funds rate up to the 4.75%-5% range.⁵ Based on the Fed’s statements and Chairman Powell’s post-meeting comments at both the December ’22 and March ‘23 meetings, we feel the Fed may hit the pause button on future rate increases as soon as their next meeting in May and then monitor inflation and economic data for a few months to see what impact its’ monetary tightening policy will have on both inflation and economic growth. Fed funds futures are now estimating a little over a 60% chance that there will be no rate hike at the Fed’s May meeting and a better than 90% chance of at least one .25% rate cut by year end.⁶

Inflation is another risk factor for the economy as it continues to run higher than normal at an annualized rate above 6%, as measured by the Consumer Price Index (CPI). However, the CPI has been trending lower the past several months. The adjacent chart of the CPI and core CPI illustrates the decline in prices since peaking in June 2022. Another key inflation indicator, the core personal consumption expenditures price index (PCE), one of the Fed’s preferred proxies for inflation, continues to move lower on a month-over-month basis according to data released by the Commerce Department for February which showed inflation rising 4.6% from a year earlier.⁷ We see inflation continuing to fall over the next few months as economic activity slows and key elements of the CPI like wages, housing costs, and food and energy prices continue to decline. If inflation continues to trend lower, this should allow the Fed to pause rate hikes and focus more on preventing further damage to the banking sector.

Despite the economic headwinds and problems in the banking sector, the global equity markets have shown resilience so far this year. As mentioned earlier, the S&P 500 Index gained 7% in the first quarter while the technology heavy NASDAQ composite surged 16.8%.¹ The S&P 500 officially entered a bear market on June 16, 2022 went it fell 20% from its January 3, 2022 high. Since then, the S&P 500 has been in a trading range between the June ’22 lows of 3636 and the August ’22 highs of 4305. Currently, the S&P is trading nearer to the higher end of that range at 4129 as of April 21.¹ We believe the S&P 500 will remain in this trading range for the next few months as investors assess the impact of the Fed’s monetary tightening policy on the economy.

Personally, we still favor high-quality, U.S. large company dividend stocks and growth stocks. We feel quality is the key to navigating this uncertain environment. That means holding stocks in larger companies that have strong balance sheets, positive cash flows, and favorable earnings forecasts. If we do enter a recession this year, we believe you want to own companies that can weather the storm and have the resources to take advantage of business investment opportunities. We still view small cap stocks as unfavorable at this time given the potential recession risks for the economy. Small businesses tend to be more sensitive to economic downturns and have fewer capital resources to weather a difficult economic environment. We are starting to become more bullish on international stocks. With China reopening from its Covid lockdown and Europe showing economic strength after a year-long recession, we feel now may be the time to add some exposure to these areas. Both valuations and growth prospects look attractive, in our view.

If you are looking to add fixed income, we also favor having a very high-quality portfolio. In particular, we would consider U.S. Treasury instruments along with high-quality corporate and mortgage-backed securities. Instruments that offer daily liquidity, as well as one-to-two-year CDs, are now offering attractive yields . We continue to favor a “barbell” approach for the fixed income portion of a portfolio where appropriate. The barbell consists of having a portion of one’s fixed-income portfolio invested in the very short end of the maturing spectrum in money funds and short-term fixed-income instruments (less than 2 years maturity) and another portion in longer-term maturity fixed-income instruments going out 10 to 20 years where appropriate. Although longer-term bonds carry a higher risk of fluctuation of principal as interest rates rise and fall, we believe the higher yields make them attractive currently. We see interest rates on longer-term fixed-income instrument trending lower this year, particularly if the U.S. economy inters a recession. Currently, the 10-Year Treasury note is yielding 3.6%.¹Whether it stays that high remains to be seen.

Another issue that investors may have to deal with and that could impact the financial markets is the upcoming budget process in the U.S. Congress and the need to raise the debt ceiling in order to continue funding government spending. The U.S. Government ran up against the $31.4 trillion debt limit in January of this year.⁹ Since then, the U.S. Treasury Department has been using special accounting measures to continue paying the government’s bill. These stop-gap measures will likely run out by this summer, forcing Congress to pass legislation to raise the debt ceiling. Currently, Democrats and Republicans in both houses of Congress are far apart on a new budget. If negotiations fall apart and the debt ceiling is not raised in time, the U.S. government would default on debt payments and other government obligations. Although such a default is unlikely since both sides of the political aisle understand the disastrous effect a default would have on the U.S. economy, Congress may take the issue right up to the deadline like they did in July of 2011, potentially negatively impacting the financial markets.

In summary, we see continued volatility for the financial markets until the Federal Reserve pauses rate hikes and more is known about the impact of the Fed’s monetary policy measures on inflation and the economy. We recommend maintaining a high degree of portfolio diversification and would use corrections in the financial markets to add to high quality stocks and bonds. We believe once we get deeper into the economic cycle and get more clarity on Fed policy, the Federal budget debate and the fallout from the recent bank failures, the stock market will become much more constructive.

As always, we greatly appreciate your continued trust and confidence in us and we will continue to work to keep you informed of economic and market developments.

Your Trinity Capital Management Team

Website:https://www.tcmtx.com/

Tyler TX Location
821 ESE Loop 323, Suite 100
Tyler, Texas 75701
903-747-3960

Footnotes

Thompson Charts
Wall Street Journal, “Small Banks Are Losing to Big Banks,” March 31, 2023
https://www.tcmtx.com/blog/post/tcm-2023-investment-outlook-strategy-january-11-2023
U.S. News & World Report, “Leading Indicators Fall Again in February, Signaling Recession on the Horizon,” March 17, 2023
Wells Fargo Investment Institute Market, Federal Open Market Committee Meeting Key Takeaways, March 22,2023
Dorsey Wight Daily Equity & Market Analysis, March 29, 2023
Wall Street Journal, “Consumer Spending Growth Moderated in February and Core Inflation Eased,” March 31, 2023
https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312a.htm
Wall Street Journal article, “Republican Budget Still Months Away, Complicating Debt-Ceiling Talks,” March 30, 2023

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

The Consumer Price Index (CPI) is a measure of the cost of goods purchased by average U.S. household. It is calculated by the U.S. government's Bureau of Labor Statistics.

CAR-0423-00748

TCM 2023 Investment Outlook & Strategy - January 11, 2023

Thu, 12 Jan 2023 06:00:00 +0000

Stephen M. Mills, CIMA® Partner

Chief Investment Strategist

Brad Bays, CIMA® Partner

PIM Portfolio Manager

Executive Summary

Introduction (Page 2)

For the first time in over 50 years, both the stock and the bond market major averages experienced double-digit declines and officially entering a bear market.
We believe the carnage in the financial markets in 2022 was primarily caused by two underlying factors: high inflation and rising interest rates that were fueled by the U.S. Federal Reserve monetary tightening.

Global & U.S Economies – (Page 3)

The biggest fear facing investors currently is the prospect of a global recession developing during 2023.
We expect that the U.S. economy will experience a mild-to-moderate recession in 2023 lasting two or three quarters.
Economic conditions in Europe and Asia have continued to deteriorate. Recession looks likely for most European and Asian economies, in our view.

Equities/Commodities – (Pages 3-5)

Rising interest rates and inflation were the main drivers of the bear market in stocks in 2022, in our view.
We see the primary influence on stocks prices in 2023 will be corporate earnings.
We believe corporate earnings will weaken in the first half of 2023 but begin to recover in the second half of the year.
One of the few bright spots for investors in 2022 was the commodity market.

Fixed Income – (Page 5)

Interest rates on fixed-income instruments of all maturities increased significantly in 2022. This rise in rates caused major losses in most intermediate and longer-term securities and funds.
We believe 2023 will be a much better year for fixed-income investors. With interest rates exceeding 4% across much of the yield curve, investors can potentially enjoy meaningful cash flow from newly purchased high-quality fixed-income instruments.

Strategy – (Pages 5-6)

We are guardedly optimistic on equities and favor high-quality dividend paying stocks and certain growth stocks.
Small-cap stocks look attractive to us on a valuation basis but we feel this sector will continue to underperform large and mid-cap stocks in the first half of the year.
We remain bearish in foreign stocks based on our negative economic outlook for most international economies and the potential of continued U.S. dollar strength in 2023.
We remain very bullish on commodities in general, but in particular crude oil. We favor high-quality energy stocks in both the production and pipeline sectors that have attractive dividend yields.
We favor precious metals like gold and silver based on a positive fundamental and technical picture.
We continue to favor high-quality fixed-income instruments like U.S. Treasuries, bank CD’s, prime money market funds and high-grade corporate and municipal bonds.

The Bottom Line - (Page 7)

Looking out to the second half of 2023, we believe the Fed will have stopped its rate-hike strategy, inflation statistics will be moving closer to the Fed’s 2% target, and the economy will be in the later stages of a recession and perhaps beginning to recover by year-end.
In the meantime, we are encouraging our clients to stay the course, ride out the near-term market volatility and look for brighter skies to hopefully develop in the second have of 2023.

Introduction

2022 is perhaps a year most investors would like to forget. For the first time in over 50 years, both the stock and the bond market major averages experienced double-digit declines with stocks officially entering a bear market on June 17 when the broad-based S&P 500 Index (S&P 500) hit a level that was 24% lower than its January 4 all-time high.¹ A bear market is typically defined as a 20% decline from the previous high. The more value-oriented Dow Jones Industrial Average (DJIA) fared better but still recorded a loss of 8.8% for the year.¹ The NASDAQ Composite Index, which is dominated by growth stocks, suffered a decline of 33.1% for 2022.¹

High-grade fixed-income instruments, which typically insulate investors during stock bear markets, didn’t fare much better in 2022. Most major bond market indices ended the year with negative returns. The closely watched 10-year U.S. Treasury Note yield rose from 1.5% to 3.9% by year-end. This rise in yield translated into a 16.7% loss for those who held the 10-year T-Note for the year.¹ Intermediate to long-term municipal and corporate bonds experienced similar losses.

We believe the carnage in the financial markets in 2022 was primarily caused by two underlying factors. First, high and rising inflation and second, rising interest rates which were fueled by U.S. Federal Reserve monetary tightening implemented to combat the high inflation. Inflationary pressures in the economy began building in early 2021 as post pandemic spending began to heat up and supply chain problems reduced the availability of many goods. Entering 2022, the Consumer Price Index (CPI) was rising at an annual rate of 7%, according to the December 2021 CPI report issued by the U.S. Bureau of Labor Statistics.² The CPI continued to rise in January and February of 2022 prompting the Federal Reserve to begin raising the Fed funds interest rate in March by .25%.² As inflation continued to increase, reaching a peak level of 9.1% for the CPI in June, the Federal Reserve accelerated their rate-hike strategy with a .75% increase at the June FOMC (Federal Open Market Committee) meeting. This was followed by three more .75% rates-hikes over the next three FOMC meetings.³ It has been one of the fastest, most aggressive rate-high cycles in the Federal Reserve’s history.⁸A final rate-hike of .50% in December brought the Fed funds rate to 4.5%, up from just .25% at the beginning of the year.³

In addition, the Federal Reserve ended its quantitative easing program that it had begun in early 2020 to provide liquidity for the financial system that had been stressed by the coronavirus pandemic. This so-called “quantitative tightening,” removes liquidity from the financial system and tends to dampen economic growth. Both the stock and bond markets reacted negatively to the Federal Reserve’s monetary tightening strategy. Further deterioration in both markets followed the mid-December FOMC meeting when Chairman Jerome Powell indicated that the Federal Reserve will continue to increase the Fed funds rate.

Global & U.S. Economies

The biggest fear facing investors currently is the prospect of a global recession developing as result of the aggressive monetary tightening by most central banks around the world, in our view. Higher interest rates tend to depress economic activity as the cost of borrowing rises making it more expensive to purchase things like real estate and other goods with financing. As an example, mortgage loan rates in the U.S. have risen from a 3% average 30-year fixed mortgage rate in December 2021 to a 6.5% average rate as of the end of 2022.⁴ This over doubling of the mortgage loan rate has hurt housing market. The number of contracts to purchase a home fell for the sixth consecutive month as of November home sales data.⁵ Also, retail sales fell .6% during the traditionally strong month of November, another sign that higher interest rates may be impacting spending.⁶

Despite the tightening monetary conditions, the U.S. economy has remained resilient. Although certain pockets of the economy are experiencing weakness like housing, retail sales, and durable goods, there are other areas showing strength like automobiles, healthcare, and energy. The job market remains strong indicating that businesses are still hiring workers. According to the December jobs report issued by the U.S. Bureau of Labor Statistics, employers added 223,000 jobs and the unemployment rate was 3.5%.⁷ We feel the unemployment rate will rise as higher interest rates work their way through the economy. However, because of the persistent under-supply of workers, we don’t see the jobless rate going above 4.5% in 2023. Fed officials forecast the unemployment rate to rise to 4.6% by the fourth quarter of 2023, in economic projections released in December.

We expect that the U.S. economy will experience a mild-to-moderate recession in 2023 lasting two or three quarters. Wells Fargo Investment Institute (WFII) is projecting a moderate recession this year. They expect U.S. GDP (Gross Domestic Product) to decline by 1.3% in 2023.⁸ WFII is also projecting an unemployment rate of 5.2% and the CPI moving all the way down to an annualized rate of 2.2% by the end of 2023. We agree with their inflation forecast but do not believe the unemployment rate will reach that level in 2023. We feel that once the Federal Reserve is convinced inflation is moving persistently toward its target annual inflation rate of 2%, they will pause further rate-hikes. We see this happening sometime during the first half of 2023 after perhaps two or three more .25% rate-hikes. That would bring the Fed funds rate to 5-5.25% which we believe will be sufficiently restrictive to slow economic activity and bring inflation down significantly.

Economic conditions in Europe and Asia have continued to deteriorate. Recession looks likely for most European and Asian economies, in our view. The one bright spot may be China which is in the process of lifting its’ Covid restrictions that have been largely in place since the pandemic started in early 2020. If China can successfully reopen their economy in the first half of 2023, it could give a boost to other Asian economies as well as other major trading partners like the U.S and Europe.

Equities

As we closed books on 2022, the so-called “Santa Clause rally” for equities in December never materialized. In fact, over the last two weeks of December, when the stock market typically rallies, stocks fell 4% as measured by the S&P 500 Index.¹ For the entire month of December, the S&P 500 declined by 5.8%.¹ We believe that worries of a recession in 2023 as well as the likely continuation of Federal Reserve rates-hikes in the first quarter fueled the decline in stocks. This weakness in the stock market was in spite of positive news on inflation that was reported by the Bureau of Labor Statistics (BLS) on December 13.⁹ The BLS reported that CPI rose by only .01% in November and the 12-month inflation rate fell to 7.1.⁹Although that rate of inflation is still high by historical standards, it is a significant improvement from the June 12-month CPI level of 9.1%.⁹ Perhaps more importantly, it was the fifth consecutive month of declining CPI.

If this trend of declining inflation continues in the first quarter of 2023, we believe the Federal Reserve may pause their rate-hike strategy sometime in the first half of the year. We believe this would be a potential positive catalyst for both stocks and bonds. In the meantime, we expect the stock market to remain volatile. In 2022, the S&P 500 experienced a 2% daily move in either direction 46 times, the most since the 2008 financial crisis.¹⁰ While we don’t expect 2023 to experience this level of volatility, we feel the stock market will continue to be volatile for first quarter of the year.

While high inflation and rising interest rates have been the primary driver of financial market volatility in 2022 in our observation, we believe investors will shift their focus away from these two factors and toward corporate earnings in 2023. We have long believed that the two primary factors that determine stock prices are interest rates and company earnings. The level of interest rates influences investor preferences for various investments. The higher the level of interest rates, the more attractive are fixed-income type of investments. Currently, interest rates for short maturity U.S. Treasuries, bank CDs and prime money market funds are in the 4% to 4.5% range.⁸ These short-term fixed-income instruments now offer significant competition for stocks which currently have an average yield of 1.8% using the S&P 500.¹ We believe one of the primary reasons for the weakness in stocks in 2022 was a shift by investors from stocks to fixed income as interest rates rose. With the Federal Reserve possibly ending its current rate-hike program sometime in the first half of the year, we believe the downward pressure on stocks from rising rates will subside.

We believe that greatest influence on stock prices in 2023 will be corporate earnings. Currently, the consensus estimate for S&P 500 earnings is $230. Using the December 31, 2022 closing level of 3840 for the S&P 500 Index, that price gives us a Price-to-Earnings Ratio (P/E Ratio) of 16.6. This is compared to a P/E Ratio of 24.8 at the beginning of the bear market on January 4, 2022 as you can see in the accompanying chart. The average P/E Ratio at the S&P 500 lows for the last five bear markets was 15.6 as indicated in the chart. The S&P 500, at its year-end 2022 closing level of 3840, is only 6% away from that average bear market P/E Ratio low. That is not to say that the P/E Ratio for the S&P will not drop below that level. However, it does demonstrate that the S&P 500 is at a reasonable valuation level based in the consensus earnings forecast, in our view.

We feel the current level of the S&P 500 Index, after having fallen nearly 20% in 2022, mostly reflects the higher market interest rates and the possibility of a mild-to-moderate recession for the U.S. economy in 2023. We expect 2023 corporate earnings will decline from 2022 levels as the economy weakens and possibly falls into recession. Weaker earnings would most likely be negative for stock prices. We could even see a testing of the 2022 market lows in the first half of the year. The S&P 500 Index hit its lows for the year on October at 3491 as discussed earlier. We believe there is a possibility that the October low for the S&P 500 could be tested in the first half of 2023. That’s about 10% below the level where the S&P 500 started the year.

While we expect the October low to hold, if corporate earnings worsen more than expected in the first half of 2023, we could see the S&P 500 break below that level. If that happens, we believe the next level of support for the S&P 500 is the 3200-3300 range. While we don’t believe the S&P 500 will go down that much from here, it is a risk that should be considered by investors looking to put cash to work in equites. To be clear, we believe the October low for the S&P 500 will hold if tested. At that 3500 level for the S&P 500, we feel stocks would be very attractive on a valuation basis.

We see a more positive environment for stocks in the second half of 2023. We believe there are three potential catalysts for a recovery in stocks. First, the possibility that the Federal Reserve not only pauses its rate-hike strategy, but also begins to ease monetary policy in the second half of the year. Second, the continued decline in the inflation data as the impact of higher interest rates begins to dampen both consumer and business demand for product and services. Third, potential recovery in corporate earnings in the latter half of the year. We also expect investor sentiment toward stocks to become more positive by mid-year. Sentiment is also an important driver of stock prices, in our view.

Commodities:

One of the few bright spots for investors in 2022 was the commodity market. Most commodities have been on a tear since May of 2020 as demand exploded for various commodities like copper, steel, aluminum, energy and agricultural products. We believe that strong demand, supply constraints and inflationary pressures have pushed prices higher. Using the Invesco DB Commodity Tracking Index as a basis for performance, commodities have increased in value by about 130% since May 1, 2020.¹ Energy prices are a major component of most commodity tracking funds, typically making up over 50% of the benchmark weighting. Since May of 2020, crude oil prices, as measured by West Texas Intermediate (WTI) prices, have increased by almost 200%.¹ While there are various reasons for the rise in crude oil prices, we believe it all comes down to an insufficient supply of crude oil in order to cover ongoing demand. A similar story applies to many other commodities. Economics 101 teaches that when demand exceeds supply, prices must rise. We remain optimistic on most commodities sectors although we could see some weakness in the first half of the year due to slowing economic growth.

Fixed Income

At the beginning of 2022, interest rates across the maturity spectrum on most fixed-income instruments were at historically low levels. Short-term instruments like U.S. Treasuries, bank CD’s and prime money market funds offered yields below .5%.⁸ Intermediate and long-term yields weren’t much better on highly-rated fixed-income securities. The 10-Year U.S. Treasury Note yield started 2022 at a yield of 1.6%.¹ That all changed when the first quarter inflation data came in higher than expected and the Federal Reserve responded by raising interest rates in March. The increase in interest rates in 2022 hit bonds with maturities more than 10 years very hard as we previously discussed. 2022 was one of the few years in U.S. financial market history where many investors experienced losses on both stocks and fixed-income investments.

We believe 2023 will be a better year for fixed-income investors. With interest rates exceeding 4% across much of the yield curve, investors can potentially enjoy meaningful cash flow from newly purchased high-quality fixed-income instruments. With the potential of a pause in the Fed’s rate-hike strategy in the first half of the year, we see interest rates stabilizing near current levels. If a recession hits the U.S. economy in 2023 and inflation pressures continue to subside, the Fed may even begin cutting rates in the second half of the year. This would potentially lead to falling bond yields and rising bond prices which would give fixed-income investors an opportunity to recover some of their losses from 2022

Strategy

Equities/Commodities:

We continue to favor high-quality, U.S. mid and large company stocks over smaller company stocks. We especially like stocks that pay dividends and sell at reasonable valuation levels. There are many high-quality dividend paying stocks that now offer yields in excess of 3%. We also favor companies that have a history of raising their dividends each year. However, dividends are not guaranteed and are subject to change or elimination. While we are unable to mention specific securities in our letter, we would be happy to discuss our recommendations with you.
We believe there is also a potential opportunity in certain high-quality growth stocks now that prices of many of these stocks have come down significantly in 2022. The Russell 1000 Growth Index, which is made up of higher growth and higher P/E Ratio stocks, declined by 33% in 2022 after several years of double-digit positive returns.¹ Several high-quality growth stocks, in particular those in the technology sector, dropped in value by 50-70%. We believe many of these stocks are now very attractive for the long-term investor.
Small-cap stocks look attractive to us on a valuation basis but we feel this sector will continue to underperform large and mid-cap stocks in the first half of the year. Higher interest rates and recession could negatively impact small companies since they tend to borrow more to finance their businesses and typically don’t have the cash reserves to weather a recession. We have been bearish on this area for a couple of years and will remain bearish until we can get a clearer picture on the direction of interest rates and the economy. While waiting for this clearer picture may cause us to be a little late in participating in the recovery of this asset class, we want to maintain a more conservative outlook for the first half of the year for the reasons stated above.
We remain bearish on foreign stocks based on our negative economic outlook for most international economies and the potential of continued U.S. dollar strength in 2023. At some point, we feel both developed country and emerging market country stocks will be attractive for investment however, we believe that now is not the time to add exposure to these asset classes. A small exposure to international stocks may be appropriate for those investors seeking more portfolio diversification. However, we would wait to add to this area until we get closer to the middle of 2023.
We remain very bullish on commodities in general, but in particular crude oil. We believe the supply of crude oil will continue to be constrained for at least the next 12 to 18 months. Although we may see some drop-off in demand due to economic weakness in the first half of the year, we believe the supply/demand imbalance will remain and support crude oil prices near current prices. WTI is currently trading at about $76 per barrel. If demand softens as we expect in the first half of the year, we could see the price of WTI fall below $70 to the mid-60s. However, we feel the upside potential for WTI is significantly greater once the global economy begins to recover. We see prices possibly nearing the $110-120 level sometime in 2023.
We continue to favor equities in the commodity sector, in particular, energy stocks. Even if crude oil prices weaken this year, we believe energy companies involved in the oil and gas production area will continue to show strong positive cash flows as long as crude prices stay above $60 per barrel for WTI. Dividends for this sector are well above the dividend rate for the S&P 500 which currently stands at 1.8%.¹ In addition, several high-quality oil and gas pipelines stocks are paying dividend yields over 5%. Again, dividends are not guaranteed and are subject to change or elimination. We see upside potential for energy stock prices in 2023 if energy prices move higher as we expect.
At this time, we are cautious in the near-term on the basic metals sector of the commodity market based on our belief the global economy will be in recession this sometime this year and demand for many commodities like copper, steel, and aluminum may temporarily decline. We would wait until the middle part of year to add to this sector.
We favor precious metals like gold and silver which have been strengthening in price recently. We believe the fundamental and technical picture for gold and silver is very positive. These precious metals tend to perform well in recessionary environments, from our observation.

Fixed Income:

We continue to favor high-quality fixed-income instruments like U.S. Treasuries, bank CD’s, prime money market funds as well as high-grade corporate and municipal bonds. We view tax-free municipal bonds, with current yields ranging from 3% to 4.5% for intermediate and longer-term maturities, as very attractive for investors in higher tax brackets. Those tax-free yields calculate to a taxable equivalent yield for investors in a 35% tax bracket of 5.4% to 6.9%. In 2022, this sector experienced significant outflows as investors sought to protect principal from rising interest rates. We see cash flowing back into this sector in the first half of the year as investors seek lock in these yields.
Over the past two years, we have favored keeping average bond maturities under 10 years in order to help reduce downside risk if rates were to rise.¹¹ We are now favoring lengthening the average maturity for the fixed-income component of a portfolio in order to take advantage of the higher interest rates. In particular, we favor a barbell strategy for the fixed-income component. This strategy involves investing a portion of the fixed-income allocation in short-term instruments, with maturities of less than 2 years, while investing the remainder of the allocation in longer-term bonds with maturities ranging from 10-20 years.
We would avoid most international and emerging market fixed-income holdings for now as a potentially stronger U.S. dollar and weaker overseas economic conditions could negatively impact prices, in our view.
We would also avoid so called “high-yield” bonds. These bonds, which have lower credit ratings than high-grade bonds, tend to underperform in a recession as default rates typically rise.

The Bottom Line

We realize that our forecast for the first half of the year for the U.S. economy and stock market is cautious if not somewhat pessimistic. We have maintained this cautious position since June of last year when the Fed surprised investors with a .75% rate-hike and indicated further rate-hikes to follow. We believe these moves by the Federal Reserve changed the short-term outlook for stocks and increased the probability of a recession for the U.S. economy. This cloud of Fed monetary tightening still hangs over the stock market. We believe that until the Fed is finished increasing the Fed funds rate, it will be difficult for stocks to sustain an upward tread.

However, we see the proverbial light at the end of the tunnel. Looking out to the second half of 2023, we believe the Fed will have stopped its rate-hike strategy, inflation statistics will be moving closer to the Fed’s 2% target, and the economy will be in the later stages of a recession. On the basis of these forecasts, we believe the bear market in stocks will end by no later than early summer and the stock market will be in the early stages of a more durable recovery.

For this reason, we are encouraging our clients to stay the course and ride out the near-term market volatility. Since it is very difficult to time stock market movements in our experience, we believe investors should continue to hold equity allocations according to their long-term investment objectives. We believe any further downside in stocks would be a good time to selectively add to high-quality equities, where appropriate.

In addition, we believe the beginning of the year is a good time to evaluate your current asset allocation strategy to help ensure your portfolio is in line with your long-term goals and objectives. This could also be a good time to rebalance portfolios back to long-term asset allocation targets.

As we begin the new year, we are very grateful for your confidence and trust in us. We are honored to serve you and your families and look forward to our continued relationship.

May you and your families have a very Happy and Prosperous New Year!

Your Trinity Capital Management Team

Trinity Capital Management, 821 ESE Loop 323, Suite 100, Tyler, Texas 75701. 903-747-3960. www.tcmtx.com

Download the PDF version of this report by clicking here.

Footnotes

¹ Thompson charts

²https://www.bls.gov/regions/mid-atlantic/data/consumerpriceindexhistorical_us_table.htm

³ https://www.forbes.com/advisor/investing/fed-funds-rate-history

⁴https://fred.stlouisfed.org/series/MORTGAGE30US

⁵https://www.usnews.com/news/economy/articles/2022-12-28/home-sales-fall-4-in-november-way-below-forecasts-and-the-sixth-monthly-decline-in-a-row

⁶https://www.cnn.com/2022/12/15/economy/us-retail-sales-november/index.html

⁷Wall Street Journal article, “Hiring, Wage Gains Eased in December, Pointing to a Cooling Labor Market in 2023,” January 9, 2023

⁸ Wells Fargo Investment Institute, 2023 Outlook, December 2022.

⁹ Wall Street Journal, “Inflation Isn’t Vanquished Yet” December 13, 2022.

¹⁰ Barron’s, “What a Crazy Year: A Bear Market, Oil’s Pop, and Those Bond Yields” December 30, 2022

¹¹ TCM 2021 Investment Outlook & Strategy dated 1/11/21 and TCM 2022 Investment Outlook & Strategy dated 1/10/22.

See page 8 for notes and disclaimers

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns nor can diversification guarantee profits in a declining market.

Diversification does not guarantee profit or protect against loss in declining markets.

P/E Ratio is a valuation of a company or an index’s current value compared to its earnings per share. It is calculated by dividing the market value per share by earnings per share.

Dow Jones Industrial Average: The Dow Jones Industrial Average is an unweighted index of 30 "blue-chip" industrial U.S. stocks.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions.
Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks smaller, less-seasoned companies, tend to be more volatile than the overall market.
Materials industries can be significantly affected by the volatility of commodity prices, the exchange rate between foreign currency and the dollar, export/import concerns, worldwide competition, procurement and manufacturing and cost containment issues.

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

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