And We’re Off…
FIVE THINGS YOU SHOULD KNOW
INSIGHTS for INVESTORS
“May you live in interesting times…” – Ancient Chinese Curse
After a brutal 2022 across most asset
s classes many investors probably felt “cursed” and as we entered 2023 there were no shortages of doomsday scenarios being espoused. And yet, risk markets year-to-date have proven to be resilient despite a still hawkish Fed.
If you were to just read the headlines you might be surprised to know that the S&P 500 is up around 6.5% and the Barclay’s bond index up around 3% so far in 2023. Even more surprising to many is the performance of European stocks (FEZ) which are up over 15% just this year, and up 12% over the last year compared to negative overall returns for all the major domestic benchmarks.
All this has left investors feeling pretty polarized between extreme fear for some and renewed bullish sentiment for others.
Our advice to most investors at this time is to embrace the opportunity to be a diversified investor that exists today where many bonds are once again of value and many alternative asset classes are trading with very attractive yields. After a decade of S&P 500 centric returns, there are many other assets classes that should not only help you dampen volatility but actually have real return potential themselves.
With higher interest rates just settling in at elevated levels and beginning to really work through the economy it would not surprise us to see volatility pick up over the next couple of quarters.
That isn’t to say one should abandon equities, but we maintain our conviction that value and dividend-oriented sectors are likely the best place to be not only from a total return perspective, but also for their dollar-cost
s averaging capabilities until greater direction appears within the Fed’s future policy.
The battle between deteriorating economic conditions and the timing/scale of future monetary easing and/or rate cuts from the Fed will determine whether the bulls or bears “win” over the next few months.
As summarized by JPMorgan, “While the odds of a U.S. recession have increased … the risk outlook for
th e markets is becoming more balanced. Monetary policy should pose less of a headwind for stocks going forward. Economic data is moving in the right direction and the slowdown in inflation, wages and activity should become more pronounced in the coming months. Moreover, if the outlook worsens, the Fed could ease monetary policy, which could provide significant support to financial markets. Meanwhile, the investment landscape still presents opportunities. Bonds can provide portfolios with attractive income and some capital appreciation when the Fed eventually cuts rates. An emphasis on quality is important, but broadly speaking, equity markets tend to perform well in the 12 months following an end of a tightening cycle, as shown in the chart.”
Adding to the uncertainty within markets is this month’s banking concerns. Alpine Macro still feels that perhaps the greatest risk coming f
overactive governments themselves that upend banking norms and trigger a crisis. In any case, virtually everyone sees greater government regulation over the next couple of years and further consolidation within the sector. While many people are trying to “trade” these fears, our best advice would be to refrain from trading risk assets based on what are still guesses about banking’s future and remain mindful of your cash levels. Tom Essaye pointed out a very important data point(s) that between the Fed discount window and Bank Term Funding Program, both of which exist to help banks in need of cash, the Fed has had to lend $160 billion just since March 1st. He continues, “as the old saying goes, “Put your money where your mouth is.” So far, banks’ money, and their mouths, are telling us that the regional bank crisis is not over, and if anything may be getting worse.”
Goldman Sachs recent take on the financial crisis is a bit more benign. They pointed out that while “(r)ecent stress in the financial sector has raised concerns regarding the monetary health of banks. Relative to the Global Financial Crisis, many banks today hold more cash, fewer risky real estate loans, and have lower loan to deposit ratios. In addition, Tier 1 capital ratios, representing the first line of capital available to absorb losses, are at multidecade highs, providing capital buffers for these banks.” (see accompanying chart)
On the potentially bullish side is the 10-year Treasury having seemingly put in a top with the yield having declined below is 200 day moving average. As Bespoke notes, this has usually resulted in decent markets over the next year, if not right away. That point
out that historically after such drops below the 200-day moving average, “in terms of the individual periods, there were just two where forward returns over the next year were extremely weak (Oct 1973 and March 2000). These are also two prior periods that often get bandied about in comparison to the current period. However, you could also make comparisons between now and other periods above as well (extreme volatility of the treasury market in the early 1980s and Orange County bankruptcy’s impact on the Financials in late 1994), but it’s always easier to remember the bad experiences than the good ones. One thing to note about the 1973 and 2000 periods, though, is that the S&P 500 was pretty much weak right out of the gate once those streaks came to an end and never was even up 3%. It has only been two weeks since the most recent streak came to an end, but for now, the S&P 500 has been able to tread water. The longer that continues to be the case, the more comfortable investors will be thinking that a repeat of either of those two periods is less likely.” (see accompanying chart)
Another bullish quantitative indicator is the continuation of record dour sentiment with the latest AAII reading coming in at just 22.5% bullish. The historic average is 37.5% and the latest reading brings the consecutive week streak of below average sentiment to 71 weeks.
In summary, bullish investors need to see/believe the following:
While bearish investors will likely need to see some combination of the opposite of two or more of the above.
It’s a fair fight which is why we feel many income assets are such a great option. Many of them can “win” in either case, maintaining or increasing in value as safe havens in a recessionary risk-off event or possibly rallying alongside stocks in the event the Fed does engage in monetary easing sooner than is currently expected.
Have a wonderful weekend!
Tim and the team at TEN Capital
DATA, JUST THE DATA
Data points this week included: