There’s an old country song titled “Looking for Love in all the Wrong Places,” which tells the sad tale of a love starved fellow (it’s country after all) who struggles to find the lady of his dreams and how he remained patient and eventually things worked out. Sometimes investing is a similar game, as market volatility and other crosscurrents can make for difficult trading. But just as this poor guy eventually finally found his soulmate, patient investors who follow sound trading principles eventually hit paydirt.

Yes, it’s that time of year again where the weather turns cooler, the days get shorter, and the stock market tends to rally. It’s also a time when investors evaluate their performance for the past three quarters-plus and look to the next year.

More to the point, it’s that time of year when value investors (guys with bow ties and horned rimmed glasses) sharpen their pencils (Yes! Value guys still use pencils) and go to work. So, with five weeks left in 2023, here are a few things to consider, especially when it comes to looking for value – in all the right places.

The Fed Is Likely Done Raising Rates

First things first. According to the Fed’s calendar, when the Federal Reserve’s Open Market Committee (FOMC) meets on December 13-14, they will be tasked with delivering a Summary of Economic projections. That means that the central bank will be trying to forecast the future of the economy, and will do their best to ignore the elephant in the room (themselves). Ugh!

With all due respect, the Fed’s record on this is not any better than yours or mine. Maybe you and I do a little better since we live in the real world, which entails buying our own groceries, filling up the gas tank, and dealing with the reality of the world’s financial system – including the daily volatility in the markets when somebody from the Fed says something which spooks Wall Street’s algos.

Nevertheless, barring negative surprises in the payroll or inflation data (CPI/PPI) or some other unpleasant surprise, the odds favor no rate hikes in December to go along with the usual, “data dependent/inflation isn’t dead yet,” stuff from Mr. Powell at the post meeting press conference.

Bond Yields Are Likely to Remain Stable

The action in the Fed’s partner in setting interest rates, the U.S. Treasury bond market, agrees with the notion that the central bank is done raising rates. This is evident in the nifty retracement of the U.S. Ten Year Note yield (TNX) since it rose well beyond normalcy starting in April with the top finally arriving in early October, as I suggested here.

The prelude to the decline is worth reviewing as bond traders became so bearish that they pushed TNX well above what is considered a statistically normal trading pattern. Specifically, focus on the blue and red lines at the top of the price chart. The blue line marks three standard deviations above the 200-day moving average (the long term mean), the dotted line in the middle of the chart. Meanwhile, the red line marks two standard deviations above the mean.

A normal trading pattern occurs when the yield stays inside of the red line. Thus, when TNX hit the 5% yield on 10/20/23, it was well above three standard deviations above the mean. In other words, it was so far out of the norm that it had to reverse to the mean, which it has.

More important is what happens next. The best scenario is one in which TNX moves sideways, trading between 4.3% and 4.5%. The second best scenario is one in which TNX falls below 4.3%, but does so in a slow steady manner. Of course, an upward reversal, starting with a solid move above 4.5% would be very bearish.

What’s Worked so Far

The stock market is likely to follow the action in bonds, which means that steady to lower yields, especially if the Fed remains on hold, will likely favor stocks. On the other hand, higher interest rates will almost certainly kill any rally.

The big winners in 2023 have been technology stocks. And after a pause in the early part of the year, the bullish reversal in treasury bonds lit a fire under the homebuilder stocks. The poster child for the tech sector has been Microsoft (NSDQ: MSFT), while the bellwether for homebuilders has been D.R. Horton (NYSE: DHI). Both price charts speak for themselves.

Certainly, investors who have missed the rally in homebuilders and technology, especially hedge funds which have lost money due to misplaced short sales (bearish bets) will play catchup. Most of the time, they will play catchup by buying stocks in strong groups. That’s called window dressing, and it’s the practice of buying stocks which are moving higher to show clients that the fund is investing in bullish areas of the market.

That means that technology and homebuilders are likely to move higher, albeit perhaps at a slower pace, in the short term.

What Lies Ahead

And while the crowd who guessed wrong and missed the homebuilder and technology rallies chase these winning sectors higher, those of us who have benefitted from owning homebuilder and technology stocks will be looking for new areas in which to deploy money.

In the short term, one sector which usually benefits from the bullish late year seasonality is retail. As I wrote last week, one way to enter this sector is via the VanEck Vectors Retail ETF (RTH). This is a thinly traded ETF, which can be volatile. Yet, it captures the general trend of the sector and does offer some protection via its diversification among a wide variety of retail stocks.

Patience is Value Spelled Sideways

On the other hand, for those with a longer term time frame, it’s often worth looking at well out of favor sectors which may offer value. It’s important to recognize that value investing requires patience. Here’s an example. In April 2022, I recommended a uranium mining stock in my premium service, Profit Catalyst Alert, stressing that patience would be required when owning the shares. As of this writing, the stock is up 54%.

You can appreciate the general trajectory of that pick in the price chart for the Global X Uranium ETF (URA), which is up a nearly identical 53% since then. My main reason for recommending this sector was my expectation that global trends toward renewable energies would eventually favor the nuclear sector, and that the low prices in the sector were storehouses of value. And even though it took some time for my expectations to be fulfilled, I was correct.

Now, I’m seeing a similar pattern developing in the rare earth minerals, which is highlighted in the shares of the VanEck Vectors Rare Earth/Strategic Minerals ETF (REMX). That’s because the geopolitical situation, especially the relationship between the U.S. and China, is likely to remain volatile over the next few years.

Moreover, as technology evolves over the next few years, access to rare earth minerals will only increase. That means that new sources of these important materials will be required. And that means that a similar situation such as that which developed in the uranium market is well worth considering.

Now, in all fairness, REMX is barely starting what may be a lengthy bottoming out trading pattern. It may even go lower from its current levels. Certainly, mining is a controversial sector given the environmental and regulatory considerations involved and the rising costs involved in production of crucial minerals.

But, when I wrote my bullish take on uranium in April 2022, there were few takers. And of course, I could be wrong about the potential in rare earth minerals. But given the value in this sector of the market, this ETF is at least worth monitoring.

Bottom Line

The Federal Reserve is likely on hold on its interest rate increases barring major negative surprises. That sets up the potential for a continuation of the ongoing year end rally. Investors who missed the rally will be playing catchup. In the short term, this will favor groups which have already delivered big returns as money managers resort to window dressing to impress their clients.

Retailing stocks offer a short term seasonal opportunity to participate in the year end rally. Yet, their longer term prospects are uncertain given the potential for a sluggish economy.

During this time of the year, value investors often encounter excellent long term opportunities to buy into beaten up areas of the market before the crowd. Currently, one of those sectors is the rare earth minerals.

I own shares in URA and DHI in my private investment account.

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