The capital markets posted mixed results in the second quarter of 2023. The broad fixed income market (BB US Agg) returned -0.8% in the quarter as rates increased across the maturity spectrum. The index is down 0.9% for the year. The US large cap market (S&P 500) continued its rally and finished the quarter up 8.7%, with the one-year return now up 19.6%. Growth stocks outperformed value stocks in the quarter (returning 12.8% versus 4.1%) and are now ahead by 15.6% over the last year. US small- and mid-cap stocks continued to underperform, returning 3.4% and 4.9%, respectively. International developed underperformed their US counterparts over the trailing three months and are in line over the trailing year. Emerging market stocks were barely positive for the quarter and year and significantly underperformed all other asset classes. Mainland Chinese stocks returned -10.7% in the quarter, while Latin American stocks returned 14.0%. The US dollar (US Dollar Index) was flat against most other currencies in the quarter and is now down 2.2% over the previous twelve months.
Given the surprisingly strong equity returns in the quarter, all of the Core Satellite portfolios posted positive returns. On a relative basis, both the Global and Select strategies underperformed their benchmarks, with the Global strategies underperforming by wider margins. For the trailing year, the Global strategies underperformed, while the Select strategies performed in line with their benchmarks.
The “Core” portion of the Global strategies underperformed the MSCI World Index in the quarter due to weak relative performance coming from BLES (3.0%), WWJD (1.7%), BIBL (4.9%), and ISMD (3.7%) versus 6.8% for the MSCI World. BIBL and BLES were negatively impacted as they didn’t own the high-flying, mega-cap tech stocks that drove most of the market performance due to Inspire’s screening. The weak performance was partially offset by the strong relative performance from FDLS (8.4%). The “Core” portion of the Select strategies performed in line with the MSCI World Index for the quarter; however, not owning the mega-cap tech stocks in our large cap sleeve also hurt performance. The “Satellite” portion of the strategies underperformed as two sectors we held over the course of the quarter (healthcare and consumer staples) underperformed the MSCI World Index. Healthcare was up 3.9% and consumer staples was down 2.4%. On the fixed income side, the bond portion of the 70/30 strategies outperformed the BC US Agg in the quarter by 0.7% given IBD’s shorter duration (4.1 versus 6.8 years) as interest rates rose. For the year, IBD outperformed the BB US Agg by nearly 2.0% as rates increased significantly.
As the stock market works through what seems to be an increasingly important inflection point, patience and objectivity are critical. Our analysis of the market sectors shows concerning weakness in the current leaders – technology, consumer discretionary and other “risk on” sectors. As Core Satellite operates and trades with an intermediate-term outlook rather than a short-term outlook, we have kept our overweight positions in Consumer Staples and Healthcare, despite their relative underperformance the past few months.
The technical structure, momentum, and relative strength indicators that inform Core Satellite portfolio decisions all point to a strong likelihood of a potentially large downturn in stocks once the current corrective rally is complete, which seems to be at or near completion right now. Prudent investing necessitates resisting the urge to chase rising prices and instead stick with a disciplined approach, in season and out of season, which generates a consistent investment methodology that is more likely to outperform over a market cycle than a haphazard, undisciplined, ‘chase-prices-wherever-they-go’ approach. We believe that our current sector overweights to more defensively natured sectors are the appropriate footing to position investors ahead of an expected slide in stock prices. That said, we continue to monitor sector data for changes in the big picture and seek to adjust portfolio allocations as that picture evolves.
The stock market successfully continued its rally over the past quarter, suggesting to some that prices are headed to new all-time highs and the painful bear market of 2022 is firmly in the rearview. However, behind the simple price increases of the S&P 500 there are troubling signs that have not only persisted but have become even more troubling as prices moved higher.
The technical analysis we employ for the Tactical Risk Management (TRM) strategies indicates that market risk is highly elevated and there seems to be a high probability of a nascent collapse in stock prices which would likely erase all the gains of this year and more, taking stock prices back below the lowest point in the 2022 slide.
The bright spot is that Money Flow for S&P 500 corrected out of its bearish, non-confirmation position, catching up and making a short term high to match the short term high of prices, so that cannot be ignored…but just barely, and in such a small margin relative to the extreme price high that maybe it actually should be ignored. But the other major indices have not followed suit, with NASDAQ, Dow Jones Industrial Average and the NYSE Composite still struggling with low Money Flow relative to price action.
Additionally, while the more tech heavy NASDAQ and S&P 500 have had a great run, the much broader NYSE Composite index has failed to rally in equal fashion, suggesting that a few mega cap tech stocks are simply giving a “head fake” for investors through their outsized influence on the price of the NASDAQ and S&P 500. That situation is generally not tenable for a long period of time, and a sinking tide will eventually bring all ships lower, even the preponderance of big tech stocks. And as seen in the chart below, NYSE Comp is currently struggling against overhead resistance of a long-term trend line that has repelled prices no less than seven times since November of 2021.
And perhaps most compelling for the bearish outlook is the Elliott Wave structure of the market, which, somewhat ironically, has been strengthened by the rally of the past months. In every rise or decline of markets, they move in waves rather than a single straight line. These waves form a series of impulsive declines (in a bear market) or rallies (in a bull market) followed by a corrective rally (in a bear market) or decline (in a bull market). The impulsive moves are longer and stronger than the smaller corrective moves, and as such you get the typical zig zag patterns of the stock market. The rally of the past months has increasingly played along with path and pattern that would be expected of a normal corrective rally in the context of a broader, bigger downtrend. In short, this corrective rally (if it proves out as such) will soon come to an end and be followed by a longer and stronger downtrend. That is the real risk showing in the charts right now with multiple points of confirmation.
There is always the chance that the higher probability outcomes do not come to pass and that the underdogs pull through, but in investing we like to go with the more probable outcomes as they materialize more often than not. Right now, in our analysis a renewed downturn seems more likely than a continued rally.
At Inspire Advisors – The Chandler Team, we focus on three main strategies that are diversified and actively managed “in house” by The Chandler Team. Below is an overview of how the strategies performed, what changes were made during the quarter, and our expectations for the quarter ahead.
