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It may be Cold Outside, but the Markets are Heating Up

We hope that everyone has a Merry Christmas and Happy Holidays!

Temperatures in the Midwest continue to fall. It should be a very cold Christmas, with the temperatures expected to be well into the negatives this weekend with frigid wind chill. Stay warm this weekend!

Markets, on the other hand, are more difficult to predict. What we do know for sure, is that volatility has been hot! The S&P 500 has seen 76 outlier days (a trading day beyond +/-1.50%) in 2022. To put it into perspective, a normal “rational” market environment would only experience about 13 outlier days per year.

Typically, this week (the week leading up to Christmas), will likely see a decline in stock prices because of last minute tax-loss selling. If there is a “Santa Claus rally” this year, that would occur in the week between Christmas and the new year. The probability of a Santa Clause rally next week is higher, given that the markets are oversold in the short-term.

With volatility heating up, it is no surprise that several defensive-related sectors such as Industrials, Consumer Staples, and Health Care are currently our highest rated/ranked sectors. On the other hand, Technology, Real Estate, Discretionary, and Communications are at the bottom of our risk-adjusted rankings. We keep seeing news of a disappointing holiday shopping season. The Consumer Discretionary sector already told us that retail sales would be weak. The sector has been underperforming the broader market since September and has just put in a new low for the year.

As the weather cools to extreme lows, we want to highlight the Energy sector. Energy has been the best performing US sector, by a wide margin, this year. More importantly, it has maintained a relatively random correlation to the rest of the stock market. While at times it has also been highly volatile, it has made for a good tool to diversify an investment portfolio to reduce volatility. Looking at a daily chart of the sector ETF (XLE), Energy is currently sitting on some short-term support. While its relative strength to the broad market had been falling for the last month, it has started to outperform the S&P 500 in the last week. These two factors could align positively for the sector.

Source: Canterbury Investment Management. Chart created using Optuma Technical Analysis Software

Bottom Line

There is plenty of negative news out there regarding the economy. The Fed is raising rates to curb inflation, fourth quarter GDP is expected to be negative, and credit card expenditures are at high while household savings are at a low. On top of that, the news has done a good job of letting everyone know that holiday expenditures are expected to be disappointing. On the bright side, fueling up your vehicle has been a little cheaper in recent weeks.

When it comes to markets, you have to separate the news and economy from decisions that are made in a portfolio of traded securities. Securities fluctuate based on supply and demand. Most news is already reflected in the current price. Markets will bottom out long before the news is at its worst. As an example, during COVID, markets bottomed at the same time that schools had just began to shut down. All of the negative news reported previously is already known to the market and is reflected in the price. That does not mean that things won’t continue to get worse, but you should avoid making reactionary decisions based on information that the market has already discounted.

It is cold outside. Luckily, you have a home thermostat to keep your indoor temperature comfortable. Market volatility is hot. We created the Portfolio Thermostat to keep your portfolio volatility comfortable during volatile environments. The goal is to maintain low volatility and efficient diversification during all market environments- bull or bear.


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