Date: May 8, 2023

***Q1 Client Update***

What a difference the turning of the calendar makes. Stocks and bonds both fell moderately in December to end the single worst year in diversified investing of the modern era. Coming into 2023, my thesis was that the bear market in stocks and bonds had ended in October 2022 and that 2023 was going to be the front-loaded year of the bull.

It only took the bulls a few days to get their legs underneath before they exerted their pressure on the bears. January turned out to be a strong month for the bulls in stocks, bonds, gold and crypto which was what I was looking for. February almost undid all of the good work done in January while March almost undid all of the downside from February. In the end the January rally in stocks and bonds turned out to be all of the gains for the quarter and that was nicely in the black.

Although 2023 began with my forecast as positive as anyone in the industry, I did not have my head in the sand, nor did I believe I had to be right, and the market could be wrong. On the contrary, several times I offered the path that would tell me I was flat out wrong. Specifically, I expected companies, especially in technology, to either pre-announce bad news or offer future earnings guidance that was below expectations. The key to my bullish front-loaded forecast was that these companies would not see their stock prices pounded like we saw at times in 2022. I threw out a somewhat arbitrary number of 5% or less on the downside when bad news hit. And the easy part about that scenario was that we would know in the second or third week of January if I was totally off base.

We already know how that story ended. Q4 2022 earnings which were largely reported in January 2023 came in better than expected with very few companies pre-announcing or guiding lower. And the ones that did were not overly punished. In fact, a good number of companies with bad news actually closed higher the day of the announcement. What does that indicate and why am I sharing it?

As I have written for literally decades, it’s not what the news is, but how markets react. In other words, we often see markets do the opposite of what we would expect based on the headlines. That is because markets often discount future events. The most bullish thing a market, a sector or a stock can do is go up on bad news.

The greatest example of that was in 2020 after Q1. The COVID news got worse and worse and worse, yet risk assets went up, up and up, almost in a straight line to 2022. The most bearish thing a market, a sector or a stock can do is go down on good news. The greatest example of that was in March 2000 at the height of the Dotcom Bubble. Technology stocks had soared parabolically like a rocket ship off the launch pad. Starting on March 10, 2000 each successive piece of good sector news was met with massive selling, almost straight down to mid-April.

In January 2023 we watched companies announce bad news, but investors either yawned or pushed the stocks higher. The broad stock market barely paused. That was a classic sign that bad news was already priced in or baked in the cake. It was also another confirming sign that the bear market of 2022 ended in October 2022.

Q1 2023 was not overwhelming on the news front. The KC Chiefs won Super Bowl LVII in what was one of the most exciting games in Super Bowl history. Russia and China seemingly strengthened their alliance, at least on the surface. China brokered a groundbreaking deal between Saudi Arabia and Iran, paving the way for others in the Arab world to follow. While none of these have an economic nor market impact, you can certainly make the case that global security concerns have increased.

The biggest domestic news of Q1 occurred in the banking sector as Silicon Valley Bank and Signature Bank both became insolvent and taken over by the FDIC. Credit Suisse was forced to sell to rival UBS by the government of Switzerland. This all invoked fears of 2008. I wrote extensively about the banking troubles on the blog so I won’t rehash everything I have said. The key takeaways are as follows. First, the U.S. banking system is structurally very sound, and I have no concerns about its solvency. 15 months ago, the banking system was overcapitalized in contrast to 2008 when banks had woefully low capital levels.

Second, the two banks that fell may be followed by a few more who do not operate like normal banks. In the old days, consumers stood in long lines outside of the banks to pull their money. It could take days. Today, everything is electronic and instantaneous. A bank run can happen in hours with social media feeding the frenzy. It has been said that the Silicon Valley Bank run took only a few hours and billions and billions of dollars exited before lunch was ever served.

Whether through arrogance or ignorance or a combination, these banks simply did not understand risk nor how to model it, especially in a sharply rising interest rate environment. In the case of Signature, it also trafficked in the crypto space where regulations are scarce, and volatility is historic.

Finally, one of the reasons why these two banks went under is because of stronger laws and regulations. I know that sounds very counterintuitive. Specifically, Dodd Frank was passed in 2010 to head off future crisis’ and prevent government bailouts with taxpayer funds. One of the unintended consequences was that the FDIC and Treasury were not permitted to help save an ailing institution, especially one that wasn’t systematically important. In other words, post-Dodd Frank neither the FDIC nor the Treasury could aid or rescue a bank until it was insolvent, leading to an ultimately higher cost in the end.

Turning to the economy, U.S. GDP growth was finalized at 2.7% for Q4 2022 with roughly 2% forecast for Q1. Inflation went from 6.4% to 6% to 5% in Q1, more than following my scenario. The economy created almost 500,000 new jobs in January, followed by more than 300,000 in February and more than 200,000 in March. While still very impressive, this does continue one of my themes that the economy slowly weakens or decelerates throughout 2023.

It wasn’t long ago when people turned GDP growth into a political debate because Q1 and Q2 2022 were negative. Those who screamed recession were easily proven wrong. My thesis has been that a mild recession is coming, but it wasn’t in 2022. Given the trend in the data, it is much more likely to begin later in 2023 or during the first half of 2024.

With a weakening economy, inflation almost cut in half and a stock market in the early stages of a new bull market, you think the Federal Reserve would be neutral to dovish. But that’s not the case at all. In Q1 Jay Powell & Co. raised rates in February and March by ¼% with at least one more coming in May. The biggest problem is that with all that’s going on, the four ¾% rate hikes from 2022 are just now impacting the economy.

Longtime clients already know my criticism, dislike and disdain for the Fed, regardless of who the Chair has been. For what are supposedly the most brilliant economists and bankers on earth, I think they do a poor job. They are usually late to the party to the detriment of investors and consumers. I did give them very high praise at the beginning of COVID so it’s not just me perennially bashing them.

At this point in the report, I usually write about my barbell strategy for investing. If you picture a barbell from the gym, there is a long, thin bar with big weights on both ends. Think of those weights as our conservative strategies and aggressive ones, the exact proportions do not matter yet. In theory, your money would have higher weights to conservative and aggressive strategies, especially if you are in or very close to retirement, and lower allocations to the middle of the road strategies. This barbell approach has also worked very well with monies being transferred in from 401K and 403b plans as those pre-packaged plans rely heavily on bonds for the more conservative approach and do not account for interest rates rising. Additionally, their aggressive choices do not usually reward the risk taken. If you would like to learn more about the barbell approach, we can set up a meeting, call, Skype or Zoom.

During my almost 34-year career I have successfully navigated many challenging periods where we were also always able to add value. Iraq invading Kuwait in 1990 and that bear market. The Fed running amuck with rate hikes in 1994. Russia’s default and Long-Term Capital with the bear market in 1998. The Dotcom Bubble imploding, 9-11, Enron, Worldcom and the 2 ½ year bear market from 2000-2002. The Great Financial Crisis, Madoff, AIG, Fannie Mae, Freddie Mac and another two-year bear market of greater than 50% from 2007-2009. Debt ceiling and European sovereign debt crisis of 2011 and that bear market. The COVID Crash in 2020. And last but anything but least, 2022, the single worst year in diversified investing history.

In hindsight, none of those difficult periods seem as bad as living through them in real time. When you are actually in the middle, it is more difficult to see how far off that light at the end of the tunnel is. That’s why I always try to provide different scenarios and paths forward. Over the years the worst thing about getting through various bear markets is the scars left on investors.

People suffer from recency, the notion that what recently happened will either continue to happen, be repeated or become the norm. It often prevents investors from taking advantage of opportunities. I have seen this in every single bear market. People tell me they want to wait “until the dust clears” or “until volatility settles down” or until they “feel more comfortable”. And that’s what separates the most successful investors from everyone else.

By the time these things happen, we have often seen 50% of the move have already taken place. I am not saying it is easy to take action when headlines are grim, or markets are plunging. You have to have confidence in the process advice. And I do tend to be on the early side in my views of markets turning.

2022 was very challenging, but it’s over. And I do not believe we will see another bond market collapse like that in the next 20 years. The great interest rate and balance sheet experiment by the Fed has ended. And you already know that I called 2023 The Year of the Bull because I thought that stocks, bonds, gold and Bitcoin would all be higher at the end of the year. I am sticking with it although I must admit that I thought markets would be even stronger by now.

2023 remains the third year of President Biden’s first term and no third years have been down since Germany invaded Poland in 1939. And the year is typically frontloaded with most of the gains coming by July 4th. I am still looking for a 15-20% gain in stocks. On a risk/reward basis, I like bonds even more as the economy continues to decelerate and weaken quarter by quarter. A double-digit year in bonds is doable. $2500 was a lofty target for gold, but now it seems achievable if the Fed stops hiking rates in May. Bitcoin already hit my $25,000 to $30,000 target in Q1. Frankly, I am not sure what to say now and I need to do some more work on it.

The U.S. economy should continue to weaken and dip into a mild recession. Housing is already very weak from the surge in mortgage rates. Manufacturing has rolled over to recessionary levels. The Conference Board’s Leading Economic Indicators have rolled over. Layoffs in tech land continue. Perhaps most importantly, the various yield curves have been inverted for a long time and to a deep level. They have a 100% accuracy rate. However, if I am wrong and the Fed does engineer the elusive “soft landing” like 1995, I will point to the resilience in the very lagging employment market as the key while stocks soar 30%+.

Fed Chair Jay Powell & Co. are close to ending one of the most vicious rate hike cycles in history. That should end in May. People championing interest rates should be very careful what they wish for. “Don’t Fight the Fed” may be the single worst investing adage in history. Look no further than Q1 2001 and Q3 2007. Risk assets unraveled and collapsed after those two rate cut cycles began. It is not a one way street.

In Q2, I look for stocks to continue to rally, but we will likely see a post-earnings season pause to refresh or mild to modest pullback. Buying weakness remains the strategy to employ and there should be another run to the upside at least into July. Bonds and gold both like the continued deceleration and weakness in the economy. The U.S. dollar does not. Those trends should also continue for most of 2023. The big outstanding question remains if 2022 already priced a coming mild recession. While the early read is yes, I do not have high conviction and it will take another few quarters to add to the weight of evidence.

Please continue to share your feedback, positive and negative. Investing is a marathon not a sprint and the long-term future continues to look very, very bright. We look forward to sharing that with you over the coming years. And I am always interested in meeting, whether it is to create or update retirement projections on your financial situation, review the strategies in your portfolio, run social security analysis’ on when and how to file for the best benefit, discuss your estate or even smaller transactional-type issues like securing a mortgage or weighing insurance. Again, here is the link to my calendar to schedule a meeting in the office, call, Zoom meeting or Skype.

Thank you for the privilege of serving as your investment adviser!


Heritage Capital, LLC

Paul Schatz AIF

Here is the link to our disclosure documents including our privacy policy as well as our ADV Part 2A & 2B.

According to SEC and state regulations Heritage Capital, LLC will deliver Form ADV Part 2 to all clients within 60 days of its annual amendment filing date. Here is the link to our disclosure documents including our privacy policy as well as our ADV Part 2A & 2B. Additionally, we may engage unaffiliated investment advisers as sub advisers to assist us with management of client assets. Our services under the investment advisory contract do not include financial planning.

Past performance may not be indicative of future results. The above individual account performance information reflects the reinvestment of dividends, and is net of applicable transaction fees, Heritage Capital’s investment management fee (if debited directly from the account), and any other related account expenses. Account information has been compiled solely by Heritage Capital, has not been independently verified, and does not reflect the impact of taxes on non-qualified accounts. In preparing this report, Heritage Capital has relied upon information provided by the account custodian. Please refer to formal tax documents received from the account custodian for cost basis and tax reporting purposes. Please remember to contact Heritage Capital, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you want to impose, add, or modify any reasonable restrictions to our investment advisory services. Please Note: Unless you advise, in writing, to the contrary, we will assume that there are no restrictions on our services, other than to manage the account in accordance with your designated investment objective. Please Also Note: Please compare this statement with account statements received from the account custodian. The account custodian does not verify the accuracy of the advisory fee calculation. A copy of our current written disclosure statement discussing our advisory services and fees continues to remain available upon request.


Paul Schatz, President, Heritage Capital