Market FIRE Review, Outlook, and Commentary: February 2023

Happy Presidents Day 2023! Since our year-beginning 2023 Review Outlook, and Commentary, the bull run in the stock market has largely continued into early-February, with only some mild signs of a pullback by mid-month. Technical indicators and economic developments support a continuation of this recent pull-back, though not to the degree that the gains since the start of the year will be reversed. Continued upside for the first half of the year appears to be in sight. The course for the rest of the year may well depend on the continuing direction of inflation and direction of interest rates as set by the Federal Reserve and the bond market.

I. Review of Recent Market and Economic Developments: Early 2023 Bull Run Continues, But With Recent Pullback Inspired by New Inflation, Spending, and Jobs Data

Both the S&P 500 and Nasdaq have reached a recent peak during approximately the first week of February, with that recent peak having exceeded the prior most recent relative peak reached at the very beginning of December. In the case of the S&P 500, the recent relative low towards the end of December 2022 also was higher than the prior recent relative low from early October 2022. (The Nasdaq’s recent relative low, on the other hand, was still somewhat lower in early December 2022 than the prior recent relative low from early October 2022.)

Since the start of the year 2023, the overall market rally has been characterized by impressive breadth, in that the number of advancing stocks has far exceeded the number of declining stocks, suggesting that we are in, or soon may be in, the early stages of a new bull market. This breadth is also supported by the high numbers of stocks with prices exceeding their 200-day moving averages. This state is in contrast to the state of the stock market towards the end of 2021, right before the recent 2022 bear market, when market gains were driven primarily by large cap tech stocks, even as many other sectors languished in rolling or sideways bear markets.

These developments that have marked early 2023 have occurred amid macroeconomic data suggesting that inflation will remain elevated for longer than desired, even as there have not been many signs of a slowing economy. In particular, the January 2023 Consumer Price Index (CPI) reading that was released this past week showed only a slight 0.1% decline in the yearly rate of inflation (from 6.5% down to 6.4%), which was significantly less substantial than the 0.5% decline that economists expected. The January 2023 CPI reading similarly showed a monthly rate of inflation that actually increased to 0.5% from the 0.1% monthly rate last December. The related January 2023 Producers Price Index (PPI) showed a slight 0.2% decline in the yearly rate of inflation for producers (from 6.2% to 6.0%), reflecting a monthly rate of inflation that increased to 0.7% after having declined by 0.2% during December 2022.

These inflation data releases occurred soon after the January 2023 jobs report showed approximately 500,000 new jobs created, which was much more than the approximately 100,000 jobs forecast by economists. The January retail spending report likewise showed an expectedly strong 0.5% monthly increase in seasonally adjusted total consumer spending. Together, these pieces of data mean in turn that not only inflation but also interest rates may also remain higher for longer, which will depress stock market valuations and ultimately stock market prices.

Towards the start of the month of February, the Federal Reserve again slowed the rate of its interest rate increases in the Federal Funds rate, increasing it by 0.25% after the prior 0.50% and earlier series of 0.75% increases. The slowed pace of increase, combined with Federal Reserve Chairman Jerome Powell’s perceived “dovish” comments at his post-release press conference, initially contributed to the continuation of the early-year rally. However, these developments pre-dated the release of January jobs and inflation readings. Since their release, several other Federal Reserve officials have signaled that they may increase rates by 0.50% in March. Economic and market analysts have also become convinced that the much hoped-for “Fed pivot” of slowing or even declining interest rates in the second half of 2023 may not materialize.

Additionally, continued quarterly earnings reports have been mixed, though generally favorable in many areas and at least not disastrous in relatively underperforming areas. Among major tech companies, “Mr. Market” has reacted favorably to earnings reports from Microsoft, Apple, Netflix, Meta (parent company of Facebook), and AMD, but unfavorably towards earnings reports from Amazon, Alphabet (parent company of Google), and Intel. Among industrials stocks, General Motors, Exxon Mobil, and John Deere fared well after their earnings reports, even as Ford and Caterpillar did less well. Among travel stocks, Airbnb and Marriott had very strong earnings reports, whereas Expedia Group’s was less than stellar. Among energy stocks, Exxon Mobil did very well after its earnings report, based on stellar cost and expense management, while Devon Energy did not do well, as declining natural gas prices lowered its cash position. Many other companies had reports that were given a mixed reception, even as those companies’ stocks have generally enjoyed the overall early year rally.

Among companies that still have yet to report their quarterly earnings results and that may influence the broader market, much of the retail sector remains, including Walmart, Home Depot, and Target during the upcoming holiday-shortened week. Smaller and mid-tech companies also still have yet to report.

II. Near-Term Outlook: Bull Run Expected to Continue, But Within Trading Ranges

The most recent economic data, likely future course for interest rates, and most recent quarterly earnings reports all combine to suggest that the stock market overall will be limited in the extent of its recent bull market run, but it also likely will not decline to the point of re-testing the prior lows from the end of 2022. The fact that a recession does not appear to be imminent, with continuing strong employment and moderate economic growth, makes a resumption of the terrible Bear Market of 2022 appear to be unlikely in the first half of 2021, even as upside potential remains muted until interest rates are set to decline. The slowing trajectory of interest rate increases, even as the rates increase, at least show that light may be at the of the tunnel and most of the multiple compression in stock valuation may have already taken place.

Indeed, the favorable technical indicators of market breadth and higher relative highs along with higher relative lows all suggest favorable market sentiment that may lead to further gains in the near future through the first quarter and possibly second quarter of 2023. The recent tendency of the market to rally in the closing hours of the trading day even after receiving negative economic news (such as release of CPI and PPI data for January) also suggests that market participants are motivated to again buy dips, which should allow the rally to continue.

Risks to this outlook include geopolitical conflict with Russia in connection with Ukraine and with China in connection with Taiwan or surveillance activity on the U.S., a protracted domestic political standoff over the federal debt ceiling (which remains unresolved and with no apparent progress), and a deterioration in corporate earnings or consumers’ financial well-being regarding employment or debt. Any increases in the rate of inflation to prior levels from 2022 may also pressure stocks if such increase were to occur over any three-month average.

III. Commentary on Near-Term Stock Investing and Options Trading

Given the above outlook, Market FIRE-oriented investors (those who use stock investing with options trading to provide for financial independence) should consider using the more recent pullback from the early year bull-run to buy-to-close profitable covered call options that are outstanding against current stock positions. Given the projection of a near-term resumption of this bull run, such investors should even consider closing these covered call options upon a 50% or greater gain, as opposed to greater 67% or more levels usually used as a metric for options trading. Also given this projection of more room to run in the early year market rally, investors should consider supplementing long stock positions with longer-dated long call options, especially for stocks against which deep in-the-money covered calls are outstanding, to essentially provide for a diagonal call spread.

As stock prices continue to be lower than the overall recent highs of August 2022, Market FIRE-oriented investors should also consider deploying excess cash (beyond cash for expected short-term living expenses and emergency needs) to purchase additional positions of long stock or expand existing positions. Given the relatively recent run-up in prices since January 2023, Market FIRE investors might also consider selling cash-secured put options for stocks that the investor seeks to add or expand in the portfolio. These cash-secured puts may be used as a means of hedging for future price fluctuations, using currently below-market prices for strike prices in order to set up the choice as between getting a “discount” from current stock price levels if the short put options are assigned or being able to close the short put options profitably based on receipt (and retention) of the options premium.

As for industry sectors for stock positions that may be acquired or added to during the upcoming period (through the first half of 2023), StockMarket-FIRE.com continues to favor GARP (“growth at a reasonable price”) technology stocks (those that are profitable and do not trade at triple digit P/E ratios), as well as energy, industrial, materials, travel-related discretionary, discount retail, and financial stocks. Given the expectation, but far from the certainty, that we are at the early stages of the next bull market, small-cap and mid-cap companies within these industries should also be considered, as those types of companies historically are more likely to attract interest from other investors and thus to thrive, relative to their larger cap and generally more established peers.

As always, any suggestions or recommendations regarding stock market investments and options trades are offered here for educational purposes and are meant to serve as commentary, not as investment advice. Individual circumstances may vary, and any investment or trading decision should be based on one’s individual circumstances and guided by individualized research and/or individualized investment advisors that are engaged by investors as their own fiduciaries.

Stay tuned, and stay engaged! With patience and fortitude, this is the time for stock pickers to shine over their passive index-investing peers.