The Week Behind 

During the holiday trading week, indices put on some turkey weight as yields and the dollar continued to show weakness. In my view, Wednesday’s releases, on balance, justify the moves made across markets: stocks, bonds, currencies. Of those releases, the FOMC Minutes proved to be the most consequential. In line with prior prints, they reaffirmed the dominant trend and narrative: December’s meeting will result in a smaller-increase to the Fed Funds Rate. So long as this remains consensus, the emphasis will shift from the magnitude of hikes to the destination of Fed Funds. The Fed Funds Rate is an important variable in determining the appropriate market multiple to value stocks. Generally speaking, the higher the terminal rate, the lower the multiple. 

Highlights

• PMI for November came in below both forecast and the prior month, suggesting the economy is slowing.
• Continuing and Initial Jobless claims each came in above expectation, indicating unemployment may be increasing.
• Reacting to weak economic data, the US Dollar, US2YR, and US10YR all finished the week lower.
• The FOMC Minutes provided incremental evidence the committee is leaning toward 50bps in December. However, the committee has yet to reach a consensus regarding the terminal rate of Fed Funds. 

Opportunities Overseas

Now is the time to start looking at emerging market (EM) opportunities. EM investments tend to have a lower P/E and higher dividend yield than U.S. and Developed Market counterparts, which make them attractive places to diversify.

A strong US dollar is a headwind for EM because it devalues EM currencies, making it difficult to achieve the growth necessary to evolve into a Developed Market. The US Dollar, after failing to find support at its 50d and 90d SMA, is on course to meet its 200d SMA. A break below the 200d SMA indicates the US Dollar – the most substantial EM headwind this year – has entered a statistical downtrend. This would be a major buy-signal for institutional managers eyeing the space. 

Outside of Europe, I am bullish on EM over the next 6-18 months. In anticipation of the US Dollar eventually breaking down at its 200d SMA, I have already started dollar cost averaging into my favorite two plays, but my risk tolerance is higher than most. Be mindful, EM investments are harder to research and homework is not optional. However, there is still time to do it and make an informed investment before the alpha, or outperformance, is bought up.

The Week Ahead  

This week will be dominated by the macro. The first test for markets comes Wednesday: ADP Employment, Job Openings, Quits, and the Beige Book. Thursday offers no reprieve as PCE, the FED’s favorite inflation indicator, crosses the wire. Payrolls on Friday will give us an update on the unemployment rate, which the FED is closely monitoring to gauge policy.

To keep it brief, we will not get into the official forecasts, but we will remind ourselves that the bull-thesis is contingent on weaker economic numbers and cooler inflation prints. Finally, with the VIX near the bottom of its range and the S&P near the top of its range, it appears more “good” than “bad” is currently priced-in. Consequently, I do not expect the same resilience in the face of news that contradicts the bull-thesis surrounding a less-hawkish FED. 

2023, The Year of …

With the benefit of hindsight, we can say 2022 has been the year of the FED: interest rates, hikes, balance sheet reduction, etc… As a result, we have witnessed bonds return as an alternative as well as multiple compression. As we prepare to put a bow on 2022, it is a good time to think about what dynamics will drive 2023, what the results will be, and where capital will generate the best returns. 

Though my crystal ball is far from perfect, I think the dominant theme in 2023 will be the level of earnings in the aftermath of a record increase to the funds rate – 475 – 500 basis points – at a record pace – 12 months. As a result, I foresee higher unemployment and scarcer growth, which will catalyze a stabilization and/or cooling in the US Dollar and treasury yields. To avoid fallout from higher unemployment, I will avoid companies levered heavily to the consumer and look for companies that do not rely on the consumer to meet expectations, healthcare and biotech. To find growth when growth is scarce, I will look for companies where stimulus still provides a tailwind, infrastructure. To take advantage of a cooling US Dollar and yields, I look to mid-to-high quality multinationals, select-technology, EM equities, and short-duration treasuries. Concisely, I expect 2023 to be a complicated year for equities, but I believe a well-diversified portfolio crafted to take advantage of secular-growth stories and macro-tailwinds can outperform.