Date: February 12, 2024

***Q4 Client Update***

2023 ended much the way it began, with the bulls firmly in charge, our strategies locked and loaded long and me continuing to pound the table for higher prices. However, the financial market landscape could not have been more different. 12 months ago, it was difficult to find a positive forecast. I was almost all alone on the bullish island for 2023.

Wall Street, the pundits and the media were firmly negative. Recession was coming. Inflation was out of control. Interest rates were soaring. And corporate America’s earnings were about to plunge. Market sentiment was full of fear, terror and despondency.

Fast forward to the end of Q4 and 2023. Recession fears were overblown. Inflation fell all year. Interest rates peaked and declined. Earnings accelerated. Market sentiment was confident, complacent, giddy and greedy. My oh my what a turn. With so many investors hating and disavowing the young bull market, it was no surprise that the major stock market indices soared 18%, 25% and higher as people were slow and reticent to jump on board. Each time the “risk on” markets declined, the masses quickly shifted back to their financial Armageddon posture, only to be run over by the freight train that was the Super 7 or Elite 8. That was until Q4.

Throughout 2023 I offered that a very routine, healthy and expected pullback in the mid-single digits should occur in Q3 with bottoms in August, September and October with September being the lowest low. While the decline came in on schedule it ended up being a few percent deeper than I thought with the final bottom in late October.

Let me add that even though I was keenly watching for that final sell off for several weeks, almost frothing to put money to work, the day of the low was atypical and had me scratching my head for several sessions before I began accepting what was happening. And I am glad I did. For the quarter, the S&P 500 soared 12% and bonds saw a very atypical return of 7%. Bitcoin skyrocketed 50%! That’s how the bulls finish a good year very well.

Once stocks hit their nadir, it was fascinating to watch sentiment change. Over the first two weeks, the masses did not believe a low of significance was reached. Consensus was to sell the rally and hunker down for more selling. By Thanksgiving there was a small wave of growing acceptance to buy the next dip, which never came.

December was all about the great chase. The masses collectively threw in the towel and started buying anything and everything in what became a buying stampede and melt up to year-end. Portfolio managers panicked and began worrying about their jobs as the stock market was about to print a huge year and many were left holding the bag.

While Q2 and Q3 were relatively quiet, Q4 was full of activity and newsworthy events. The quarter began with one of the most horrific events in modern history with terrorist group Hamas invading Israel to commit atrocities not seen since Hitler and the Third Reich during WWII. Unlike the U.S.’s 9-11, Israel’s was streamed on social media until many of the outlets pulled the videos down. I wish I could unsee some of the gruesome and unspeakable acts that were on Twitter.

Other global events that also did not impact the markets and economy saw beloved statesman, Henry Kissinger, pass away at age 100. India became the populous country on earth. President Biden and Chinese President Xi finally had their long-awaited face to face meeting with little progress on the major issues. And the Texas Rangers won the World Series in what was one of the least watched championships in baseball history.

Turning to events with economic or financial market impact, the labor strikes at GM and Hollywood came to an end which likely resulted in stronger labor markets. Iranian-backed Houthi rebels in Yemen began a string of terrorist attacks on western ships in the Red Sea, forcing many commercial vessels to change course and go around the southern tip of Africa. While the Houthis are not well organized and have little in the way of infrastructure, similar to the Taliban in Afghanistan, their continued attacks did and will have an impact on the price of goods. Shipping prices have soared and cargo company after company has altered routes to avoid putting ships and crews in harm’s way. Should these assaults expand or even continue, it is likely that U.S. consumers will see and feel the results in the inflation data.

Pivoting to the markets, in my 35-year career, I haven’t seen many or really any easier two-month periods than I saw in November and December as the “risk on” markets like stocks, gold and Bitcoin soared straight to year-end. It was one of those few times where we were fully prepared to sit on our hands and try not to screw it up.

The keys to the massive Q4 rally were known long before. I have referred to them as the Three Musketeers of inflation, meaning oil, interest rates and the dollar. In Q4 crude oil fell from $90 to $70 or 22%. The 10-Year Treasury Note yield fell from 4.60% to 3.80% although it briefly hit 5% first. The U.S. Dollar Index fell from 106 to 101 which is an enormous move for currencies.

Aside from the Three Musketeers, the markets breathed a sigh of relief when the anticipated massive quarterly treasury refunding announcement at the end of October showed fewer 10 and 30-year bonds coming to auction. With less supply than expected, upward pressure on long-term interest rates eased which can be seen as a tailwind for “risk on” assets. In all my years in the business I don’t ever recall the markets fretting so much about the quarterly refunding, but then again, the government hasn’t run trillion-dollar budget deficits that needed funding until the last few years. This story is long from over and I fully expect it to periodically rear itself when long-term interest rates are rising.

The nation’s debt and deficits are not new news. It has been building this entire century with nary a whiff of a long-term solution. And let’s be clear. Both political parties are to blame. They both overspend. It’s just on what programs that are debated. Raising income taxes is not the answer unless you are in favor of middle-class tax hikes which are politically untenable. And the government cannot cut enough discretionary spending unless you favor major cuts to the military budget. The long-term solution may lie in a compromise that includes small spending cuts, holding future spending without cost-of-living adjustments and the biggest tax overhaul in history that would include some type of European-style Value Added Tax, otherwise known as VAT. Please don’t shoot the messenger if you disagree.

The U.S. economy continues to survive and thrive on its ability to borrow money and finance its deficits. We enjoy the ultimate privilege of being the world’s reserve currency which means the world basically transacts in dollars. Items like oil, gold and other global commodities. Emerging countries also have some or much of their own debt tied to the greenback. Since Russia’s unprovoked invasion of Ukraine, some countries like Russia, China and India have transacted business in other currencies or a basket of currencies, but there is no evidence that the west is anywhere close to abandoning the dollar. One day that will come and it will not be pretty, but it’s not close at hand, at least not this decade.

Speaking of the economy, in Q4 we learned that Q3 GDP soared by a much better than expected 4.9%. That is serious growth so far into a recovery. I try not to qualify economic, nor market data and I certainly do not align with the conspiracy crowd. When I look under the hood, I see a big portion of the growth came from the “G” word, government. Don’t forget that Congress passed trillions in spending in 2021 and some or really much of that money had yet to be spent, especially on infrastructure. And that river of money is likely to continue for most of 2024 as it is a presidential election year with the party in power always trying to juice the economy before November.

While GDP growth surged, inflation ticked lower to the delight of everyone. Unemployment remained at or close to 50-year lows at 3.4%. Do either of these sound recessionary? This has been a huge problem for the bears and Doomsday crowd. The Chicken Littles have been screaming about the sky falling since 2021. The economic data do not support their narrative. The economy created 2.7M jobs in 2023 or roughly 225,000 jobs per month. 500,000 came in Q4 and accelerated higher from October’s low of 105,000 new jobs. That may not be the gangbuster numbers we saw in 2020, 2021 and 2022, but it’s still nothing to sneeze at.

Real recession is more than just earnings declining in a few sectors. Real recession sees job losses, lower prices, lower revenue, lower earnings and higher inventories. It also means the Fed reverses course and cuts interest rates with speed and magnitude. Given the challenges and peculiarities in the economy since COVID began, the next recession will be a giant reset on the economy. Inflation should return to a more stable and lower level along with mortgage rates. The employment picture will normalize so there are no longer two job openings for every one person to fill. In fact, depending on the depth of the recession, that ratio could very well completely reverse.

I never root for recession. It is difficult on the majority of Americans, even though life is not easy right now for so many. Unemployment obviously rises, wages decline, and people struggle. The “risk on” financial markets are rarely a picnic either. But recession is a necessity of capitalism and the somewhat free market economy. The reset of recession sets the stage for the next economic boom and surge in innovation and productivity. And it also sets the course for unthinkable levels on the major stock market indices.

With all that said, here’s the challenge I face in my analysis which may be a little wonky. The Conference Board’s Leading Economic Indicators (LEI) has a perfect track record of calling recessions. It peaked almost two years ago, and it has been down for 18 straight months. The longest downward streak before recession was 20 months in 2008 with the average being 10 months. A 0.50% increase in the unemployment rate has always forecast recession within 1-16 months except for 1986 with the average being 6 months.

My personal favorite economic indicator is the yield curve which is just the difference between a longer interest rate and a shorter one. I like to use three months and two years for the shorter ones and 10 and 30 years for the longer ones. When the shorter-term rates exceed the longer ones it’s called an inverted yield curve, something I have written about many times before and especially over the last two years. The inverted curve is an amazing predictor of recession 1-24 months out. The yield curve continues to be inverted to the deepest and longest amount of the modern era.

Here’s the challenge. Most indicators that forecast recession within a specific time period have already expired or are at the end of their historic norms. In other words, the window of opportunity for recession is quickly closing. That doesn’t mean there can’t be one or won’t be one in the future. I guarantee there will be another recession. It just means that many of our tried and true warning tools may not be working this time.

I have long posited that COVID may have structurally changed the economy to a degree that few will comprehend for years to come. The whole work from home economy for millions of Americans doesn’t have data before 2020. Sure, plenty of people had remote jobs before COVID, but nowhere near to the degree we see today. And then there’s the glut of commercial office space waiting for a leases to expire and prices to reset. How will borrowers and lenders make it all work? My sense is that they won’t and there will be some dislocations. Surely, millions of square feet of space can’t all be converted to Pickleball courts! These are fascinating times and history books are being written in real time. We will just have to be patient and see how it all unfolds.

Economically, Artificial Intelligence (AI) is now part three of the technological revolution that began with the Internet in the 1990s. I guess you could argue that it’s part four and call the invention of the personal computer in the 1970s as Ground Zero. We do know that AI will revolutionize the global economy. Short-sighted people bemoan the loss of millions of jobs without fully understanding how many new jobs will be created because of AI. It will just be different.

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.

Turning to our strategies, it was arguably the strongest quarter of my 35-year career, something I don’t say lightly. However, to be fair, for at least half that time, we only managed a few strategies at most so it’s not exactly apples to apples. Nevertheless, it was a great quarter across the board without exception and words like “unusual”, “atypical” and “rare” certainly apply.

One year ago, I forecast 2023 as The of The Bull. I quoted a number of historical studies, but none better than since Hitler invaded Poland in 1939, there has not been a down pre-election year for stocks. Adding a few more filters got me to see that even 30% was possible. While 2024 will not be as easy nor as fun, that doesn’t mean it has to be a bad year. I have already shared my 2024 Fearless Forecast so I won’t rehash it all again, but I will share some highlights.

First, my favorite study for 2024 is that not since Herbert Hoover in 1932 has there been a down year for stocks with an incumbent running for reelection. Some argue that President Biden will not be on the ticket. While that may ultimately be the case, right now he is.

Three other studies also point to an up year for stocks in the range of 11-15%, so that helps strengthen my conviction. And speaking of that election in November, it will dominate the media to the point of being an obsession. However, and this is a big one, elections absolutely do not impact the financial markets until Halloween, regardless of what you hear from the press. As I always do, when the time is optimal, I will run my presidential election forecasting algorithm and offer a quantitative prediction on who will win. For the record, it has accurately forecast the winner more than 80% of the time including the last two elections.

Three months ago, I called for an October low with stocks rallying strongly right into 2024 and the potential for November and December being large up months. I do not have the same positivity and confidence for Q1. Rather, the odds favor a peak coming in Q1 with some bumpy air and turbulence developing. While I do not see a major decline on the horizon, we certainly could see a 10% correction by Memorial Day. For the first five months, I think deeper weakness can be bought and strength sold. Technology, like those handful of high profile stocks, should be the last man standing, but eventually succumb to the decline.

Bonds are due to rally, but I do not believe they will get very far. I also don’t think they will get too far on the downside either. Gold still looks attractive and weakness should be bought until proven otherwise. $2500 remains on target in 2024 with much higher prices after that. Crude oil just cannot seem to get any love. I continue to view the low $60s and low $90s as the floor and ceiling.

The U.S. economy continues to defy gravity. It reminds me of The Little Engine That Could. Remember? “I know I can. I know I can.” While many studies have pointed to recession, it certainly will not begin in Q1 2024. When unemployment hits 4%, we can reassess. The pundits have now revised history to say we had an “earnings recession” without any overall weakness. Comments like that just make me shake my head.

Jay Powell and his friends at the Federal Reserve have concluded their interest rate hikes for this cycle. Talk of 6-7 rate cuts in 2024 without an exogenous event is absurd. My favorite indicator of future rates, the 2-Year Treasury Note, says that the Fed will cut by 1%, but certainly not in Q1. Q2 isn’t even guaranteed. Given how wrong they were about inflation, I continue to believe they will err towards standing pat rather than cutting too soon and risking an uptick in inflation.

Finally, as always, we will do our best to harvest as many tax losses as possible during Q1 and throughout the year. And we can always inform you, in real time, where your taxable accounts stand. Just ask.

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


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On Friday we bought levered, inverse S&P 500. We sold FENY and some levered NDX.


Paul Schatz, President, Heritage Capital