Beware of a Potential Stock Market Bear Trap
Major stock indexes turned a corner at the start of 2023.
After losing about 18% in 2022, the S&P 500 is up more than 7% so far in 2023. The Nasdaq 100 went from a 32.58% loss in 2022 to about a 14.01% gain this year.
Several factors are behind the rally.
Some technical market timing measures triggered buy signals. Most prominently, the market indexes moved above their 50-day and 200-day moving averages.
As for fundamental factors, investors are convinced the Federal Reserve is almost done raising interest rates and soon will decrease rates and stimulate the money supply. Central bank leaders anticipate that inflation will fall to the Fed’s target rate without triggering a recession or significant earnings declines.
Investors need to decide if this is the beginning of a new bull market or a bear market rally similar to the two we saw in 2022.
While inflation clearly has peaked and some of the supply problems of the last few years are resolved, there still are factors keeping inflation elevated.
The labor market remains strong, and wage increases support inflation above 2%.
China relaxed the Covid restrictions that restrained economic growth the last few years and is seeking to increase its growth rate. Higher growth in China should increase commodity prices.
Falling energy prices also helped bring inflation down from its peak. But faster growth in China and other factors are likely to keep energy prices steady or push them up.
The stock market probably needs an easier monetary policy from the Fed to continue rising.
Stock valuations remain high. The economy and corporate earnings still don’t reflect the full effects of the Fed’s tight monetary policies of 2022. That’s not unusual. There are lags between Fed policy changes and their effects. Those lags often trap investors who heard the “all clear” signal too soon.
Bear markets typically don’t end until the Fed starts to ease monetary policy. While it’s possible this time will be an exception, I don’t think the odds favor that. The Fed leaders say they will keep monetary policy tight until inflation is back to target, and they predict that won’t be for a while.
Facts About Digital Currency Investments
The digital currency markets are far from transparent, so it’s taken a while for researchers to develop some interesting data.
One recent study found that fiscal stimulus had a major effect on cryptocurrency trading. The researchers found that government lending to small businesses through the Paycheck Protection Program (PPP) was followed by an increase in internet searches for crypto-related investments.
That was followed by an increase in several measures of cryptocurrency trading and investing. The study concluded that fiscal stimulus increased demand for digital currency investments, especially among new investors. It also found that up to 14% of the PPP loans were diverted to digital currency investments instead of being used to maintain employment.
Another study looked for fake transactions on the digital currency exchanges. The researchers first developed a list of market patterns that usually indicate fake transactions are being engaged in to manipulate prices.
After examining transactions on 29 cryptocurrency exchanges, they concluded that an average of over 70% of the reported volume on the exchanges consisted of fake transactions, or what they called wash trading. The fake transactions increased reported trading by trillions of dollars annually, which made the exchanges appear to have larger investor bases and also distorted prices.
A third report, regarding the Greyscale Bitcoin Trust (GBTC), was widely reported. GBTC is an investment trust that buys and owns bitcoin, but it is not an ETF or similar investment, because the Securities and Exchange Commission prohibits it.
So, the GBTC shares aren’t traded on an exchange. Instead, they are traded on the over-the-counter markets.
GBTC also can’t create and redeem shares according to demand as ETFs and open-end mutual funds can. A fixed number of shares trade, and the share price can differ greatly from the value of the bitcoin held by the trust.
One thing that makes GBTC unique is that a number of retirement account custodians made it eligible to be purchased in their retirement accounts. Vanguard initially allowed it to be purchased in its IRAs, but suspended that privilege in April 2022.
The problem for those who own GBTC in their retirement accounts (or other accounts) is the wide changes in how the share price trades relative to the value of the bitcoin in the trust.
Initially, the shares traded at a premium of 15% to 20% in 2019, meaning the shares were worth more than the bitcoin held in the trust. But it began trading at a discount in February 2021.
With the failure of FTX, allegations of fraud, and other events in the digital currency world, GBTC isn’t popular now. Recently, its shares traded at about a 40% discount to the value of the bitcoin held by the trust. That assumes a seller can find a buyer for all of his or her shares. Meanwhile, GBTC charges annual expenses of 2%.
It’s a lesson in the risks of chasing an investment fad and purchasing illiquid investments.
You Can Lose Money in Flexible Spending Accounts
Taxpayers lose quite a bit of money in flexible spending accounts (FSAs) each year while trying to save a few tax dollars.
FSAs are fairly simple. Before the start of the year, an employee elects to defer part of his or her compensation into an FSA. The deferral is excluded from gross income for the year, avoiding income taxes.
During the year the employee can be reimbursed from the FSA for qualified medical expenses. The employee has to submit receipts and complete a reimbursement form. The reimbursements are tax free, so using an FSA allows an employee to earn some tax-free income.
But if the employee’s expenditures aren’t qualified medical expenses, the FSA won’t reimburse them. In addition, if the account has a balance after the end of the year, the balance reverts to the employer. With few exceptions, the employee loses the money.
The government doesn’t compile much data on FSAs and how much money is forfeited to employers.
But the Employee Benefit Research Institute (EBRI) says it has been able to obtain a lot of data on FSAs.
EBRI found that in 2019, 44% of workers with FSAs forfeited at least some of their money. On average, the workers lost $339. In 2020, 48% of workers forfeited some money, with the average forfeit being $408.
Money.com did the arithmetic using an estimate of the number of FSAs in existence and concluded workers in aggregate forfeited $3 billion in 2019 and $4.2 billion in 2020.
The Data
The ISM Non-Manufacturing Index jumped higher to 55.2 in January from 49.2 in December. That indicates the services sector had a solid expansion in January. December’s level was a two and one-half year low.
The PMI Services Index improved to 46.8 in January from 44.7 in December.
The PMI Composite Index for the economy was 46.8 in January, up from 45.0 in December. But all readings below 50.0 indicate a contraction.
Factory orders increased 1.8% in December after declining 1.9% in November.
But after excluding the volatile transportation sector, orders declined 1.2% in December, the same percentage as in November.
Productivity increased 3.0% in the fourth quarter of 2022, and the third quarter’s productivity was revised higher to 1.4%. Productivity declined 1.3% in 2022, the largest dip since 1974.
Unit labor costs increased only 1.0% in the fourth quarter, the lowest quarterly rise since the first quarter of 2021. In all of 2022, unit labor costs increased 5.7%, following a 2.4% increase in 2021.
Consumer credit balances increased at an annualized rate of 2.9% in December after jumping 7.1% in November. Revolving credit (mostly credit cards) increased 7.3% in December and 16.9% in November. Nonrevolving credit (mostly vehicle and student loans) increased 1.5% in December and 3.9% in November. All the percentages are annualized.
Last week’s employment situation reports stunned many on Wall Street. There were 517,000 new jobs created in January, following a 260,000 increase in December. The unemployment rate declined to 3.4%, the lowest level since May 1969.
The number of new jobs might be overstated because of adjustments the Department of Labor makes to the data each January.
Average hourly earnings increased 0.3% in January, following a 0.4% climb in December. Over 12 months, earnings increased 4.4% as of January, down from 4.9% at the end of December.
Average weekly hours worked also jumped in January to 34.7 hours from 34.4 hours in December.
New unemployment claims declined another 3,000 to 183,000 in the latest week. That’s the lowest level in nine months.
Continuing claims, which lag a week behind new claims, declined to 1.655 million from 1.666 million.
The Markets
The S&P 500 rose 2.14% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.20%. The Russell 2000 increased 2.14%. The All-Country World Index (excluding U.S. stocks) lost 0.87%. Emerging market equities fell 2.22%.
Long-term treasuries lost 1.72% for the week. Investment-grade bonds fell 1.09%. Treasury Inflation-Protected Securities (TIPS) declined 0.54%. High-yield bonds gained 0.27%.
On the currency front, the U.S. dollar rose 1.42%.
Energy-based commodities lost 2.92%. Broader-based commodities fell 3.40%. Gold declined 3.03%.
Bob’s News & Update
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