The past week in markets summarized in three short headlines.
1. Back on Track
The Dow Jones and S&P 500 fought back after last week to post small gains, while the NASDAQ continued its surge for its fourth positive week in a row to start the year. The Dow Jones and S&P 500 modestly rose 1.8% and 2.5% weekly, while the NASDAQ stunned investors as it gained 4.3%. As we near the end of earnings season, it appears that a smaller proportion of S&P 500 companies have beaten analysts’ earnings expectations than usual.
According to FactSet, 69% of companies have exceeded net income expectations, which trails the five-year average of 77%. Earnings are expected to decline by 5% compared to the previous year. On the other hand, the U.S. economy has remained in positive territory during the fourth quarter of 2022, with GDP growing at an annualized rate of 2.9%. This exceeded most economists’ expectations and for the full year of 2022, GDP rose 2.1%, which helped ease concerns about the possibility of a prolonged recession.
Additionally, the Federal Reserve’s preferred gauge for tracking inflation showed a further cooling of price increases, with the Personal Consumption Expenditures Price Index rising at an annual 5.0% rate in December, down from 5.5% in November. Overall, investors planning for the long-term were pleasantly surprised this week as many metrics fell in their favor.
2. Eighth Wonder of the World
The power of compounding is an often-understood concept in investing, but it is one that can have a significant impact on your portfolio if used correctly. Compounding is the process of earning returns on your returns, which can lead to exponential growth over time. Albert Einstein once referred to compound interest as the eighth wonder of the world, and Benjamin Franklin stated that “money makes money, and the money that money makes money.”
To get a rough estimate of how fast compounding will grow your money, you can use the Rule of 72. The rule states that if you divide 72 by the return you hope to earn, that number will give you the approximate number of years it will take for your investment to double. For example, earning a 6% annual return will double your money in about 12 years (72 divided by 6). If you earn a 12% annual return, you will double your money in just six years.
The key to successful compounding is to think of your portfolio of stocks as a single asset. Your portfolio is the equivalent of Buffett’s investment in a single stock. The aggregate of all your stocks and trading activity can be viewed as the equivalent of simply holding one stock, such as Apple (AAPL). This change in focus requires some hard work. It requires you to manage that asset via active trading and to make sure that drawdowns stay small and your capital produces good returns. Overall, the amount of time your money spends in the market is the biggest factor in compounding.
3. Debate over Monetary Policy
The Federal Reserve’s policy-setting panel, the Federal Open Market Committee (FOMC), is set to announce the results of its two-day meeting on Wednesday afternoon. It is all but certain that the FOMC will raise its federal-funds target range to 4.50%-4.75%. This move represents a downshift to a 25-basis-point increase, which is the usual rate move for the FOMC until last year when it was playing catch-up in normalizing its monetary policy. In 2022, the FOMC imposed four supersize 75-basis-point hikes and then added a 50-basis-point increase in December.
The big question many investors are asking is if the word “ongoing” will be released in the Fed’s minutes. They know that this implies continuing rate-hikes that will likely depend on future economic releases including jobs reports and payroll growth. Investors across the board will pay close attention to Powell’s post meeting press conference as he is likely to address the major jobs cuts by tech companies amidst this uncertain financial time.
The market continued to take steps forward as all three major US indexes experienced growth, with the NASDAQ continuing its rapid growth. Though investors portfolio’s might’ve taken hits last year, the power of compound growth will allow them to prevail in the end. This coming Wednesday, the Fed will meet and determine the course of the US monetary policy going forward.