Navigating the Squeeze

FIVE THINGS YOU SHOULD KNOW

1. Equity Markets – fell this week with U.S. stocks (S&P 500) down –0.70% and international stocks (EAFE) falling –1.37%  
2. Fixed Income Markets – finished lower with investment-grade bonds (AGG) down –1.09% while high yield bonds (JNK) fell –0.29%
3. Weekend Shutdown Likely – As of writing, Congress was unable to agree to a short-term spending measure this week, meaning the U.S. government will shut down on Oct. 1^st. While Senate leaders introduced a bill that would keep the government open through mid-November and provide an additional $6 billion in support to Ukraine, there was little chance that proposal would pass the House. Republic House Speaker Kevin McCarthy is planning to use a shutdown to secure more concessions and an opportunity to “sit down with the president to secure the border.” 
4. China Property Crisis – This week saw China’s property stocks fall the most in 9 months as China Evergrande Group failed to repay an onshore bond and scrapped a planned meeting with creditors. Many Evergrande executives, including their founder Hui Ka Yan, have been placed under police control while the government investigates potential mismanagement. The second largest property developer in China has now seen losses to its valuation of over $56 billion this year.
5. Key Insight – Successful investing is about navigating where things are headed, and not getting hung up on where they’ve been. This week we take a look at the latest, forward-looking, inflation, data, and what it means for both stocks and bonds.

INSIGHTS for INVESTORS  

Introduction

When most things aren’t working, or at least as an investor had hoped, many investors feel compelled to “do something.” And yet many studies have shown that those actions, more often than not, tend to be counterproductive, in large part because people abandon beat-up investments (sell low) to buy things that have done well (buy high), which is of course the opposite of the old adage buy low/sell high.

Like many adages or wisdom, easy to say/know much hard to actually do.

For investors today the common challenges come in the forms of a) not chasing a small basket of mostly tech stocks, and b) holding onto or buying many forms of fixed income.

This week we’ll share some more charts and info from a few of our partners to help put this in a better context and give you more knowledge and perspective that helps keep your decision-making on solid footing.

Storm Clouds Darken

As analyst Tom Essaye wrote this month, the two biggest risks to the current equity rally are 1) that inflation bounces back, and 2) growth slows too much – to which he points out that “the U.S. economy is losing momentum. If growth data starts to look more like last week’s flash PMIs, then concerns the Fed has gone too far will rise and that will pressure the market multiple. At that point, hope for rate cuts won’t help materially because even if the Fed starts cutting rates in early 2024, it’ll likely be too late to prevent a growth slowdown.”

On the growth front, the biggest concern surrounds the American consumer. A recent Bloomberg survey showed that the majority of respondents now believe consumption will shrink in early 2024, with another 21% saying it will happen in Q4. The bottom line is sentiment is strongly shifting.

Q3 data showed a strong consumer so why the change?

For one, “’ The big question is: Is this strength in consumption sustainable?” says Anna Wong, Bloomberg Economics’ chief US economist, who expects a recession to start by year-end. “It is not sustainable, because it’s driven by these one-off factors” – notably a summer splurge on blockbuster movies and concert tours.’”

Secondly, Bloomberg reports that “Researchers at the Federal Reserve Bank of San Francisco say the excess savings that have helped consumers get through the price spike will run out in the current quarter — a sentiment that three-quarters of the MLIV Pulse respondents agreed with.”

On the inflation front, the task of lower rates won’t be easier anytime soon. As noted by Daryl Jones of Hedgeye, “Oil is an important one. In December 2022, the monthly average for WTI was ~$78.00.  Assuming we stay near current prices, the Y/Y tailwind from oil prices on inflation becomes ~+18% Y/Y. This is in stark contrast to the most recent CPI report in which energy commodities were down -4.2% Y/Y and fuel oil was down -14.8% Y/Y.”

Add these up and you get the dreaded economic environment referred to as “stagflation.” Tom Essaye, highlighted above, pointed out this week in response to equity markets recent weakness, “The S&P 500 suffered its worst decline since March on Tuesday, and the reason for the decline was clear: Stagflation. The two economic reports on Tuesday, Case-Shiller Home Price Index and Consumer Confidence, pointed to 1) Higher inflation and 2) Slower growth, which is, by definition, stagflation.”

S&P 7 vs. the S&P 493

Such dour outlooks are at odds with a market that has been very much “risk-on” from a headline perspective this year. But as we often say, “headlines can be misleading” and we believe that is very much the case regarding equity market strength and what is reflects about the true state of the economy.

Much has been written or said about the bifurcated stock market in 2023 but the following graphic from the team at Apollo really highlights the starkness of the situation. As Torsten Slok summarized, “The seven biggest stocks in the S&P500 are up more than 50% in 2023, see chart below. The remaining 493 stocks are basically flat. The bottom line is that if you buy the S&P500 today, you are basically buying a handful of companies that make up 34% of the index and have an average P/E ratio around 50.” (emphasis added)

As of 9/23/23

What he’s really saying is that investors know to remain diversified and buy things at attractive valuations, chasing these hot stocks or even buying a basic index fund at this point would be just the opposite of those tenets – especially in light of the fact that overall earnings have declined this year making the market even more expensive.

Bonds: Broken or Beckoning?

Last week’s commentary discussed the inevitable reality of how many investors feel “squeezed” along their journey. This could come in the form of time (delayed results) or price (positions moving against you for a period of time).

While blue-chip stock investors are facing this squeeze in terms of time as they seek to outwait this period of flat performance, bond investors are facing the squeeze in terms of price as yields continue to bleed higher.

We wrote for many years about the unattractiveness of most fixed income given their exceptionally low yields, however after the current sell-off many investors should likely take a second look at the role this asset class could play for them in terms of both income as well as protection from an impending recession.

As we noted above, when investments/asset classes go down, so does investors’ feeling towards/about them. And yet, in order to “buy low” or miss not out on returns via rebounds one must fight these feelings.

So, what typically happens to bonds historically in such environments?

First, from Hartford Funds comes the great reminder that periods of weakness are hardly permanent and can lead to periods of solid returns for the patient.

And from AllianceBernstein came these great graphics showing 1) how investors in cash or money markets fair when the Fed begins to cut rates in terms of their yield, and 2) by contrast how other forms of fixed income respond to Fed rate-cuts historically.

Graphic 1

Graphic 2

Summary

Markets do not move in straight lines and thus investors must be prepared for periods of time when it feels as though progress isn’t being made. The patient investors are ultimately rewarded with time as asset classes eventually get their day in the sun.

You both that time with sufficient income whether from your portfolio or other source, and an unemotional and historically accurate perspective.

As the saying goes, “History may not repeat itself, but it often rhymes” and use this perspective to keep yourself prudently positioned. For more historical info/perspective, once again visit this great site that we shared a couple weeks ago called “Keep Calm and Remain Diversified.”

Have a great weekend!

Tim and the team at TEN Capital

DATA, JUST THE DATA

Data Points This Week Include:

U.S. Jobless Claims – edged higher by 2,000 to 204,000 on the week ending September 23^rd. This fell well below market expectations of 215,000 to remain close to the over-seven-month low in the earlier week.

U.S. Durable Goods Orders – unexpectedly rose 0.2% MoM in August 2023. This rebounded from a revised 5.6% slump in July, which beat market forecasts of 0.5%.

U.S. Consumer Confidence – is expected to hold nearly steady in September, at 105.8 versus August’s much lower 106.1. The assessment of the jobs market and expectations for higher interest rates were two factors driving August’s results.

U.S. MBA Mortgage Applications – declined 1.3% in the week ending September 22, 2023, following a 5.4% rise in the previous week. This was the largest increase since mid-June.

Eurozone M3 Money Supply – decreased 1.3% year-on-year to 15.93 trillion EUR in August 2023, following a 0.4% reduction in July which was worse than market forecasts of a 1% fall.