Paralyzed by the Puzzle, or Propelled by the Path

Paralyzed, by the Puzzle, or Propelled by the Path

The common things that drive investors and much of the investment industry stand in stark contrast to what drives markets and what investors need to do in order to find successful outcomes. We cover this, where we see opportunities today and our track record of being advisors of conviction in this week’s messages.

Five Things You Should Know

1. Equity Markets – were lower this week with U.S. stocks (S&P 500) down -3.21% while international stocks (EAFE) fell -3.55%.
2. Fixed Income Markets – were lower with investment grade bonds (AGG) down -1.02% while high yield bonds (JNK) fell -1.60%.
3. Global Inflation Climbs – elevated gas prices have created another monthly all-time high (+9.1%) for Euro-area inflation, almost assuring a massive interest-rate hike from the ECB when they convene next week. Investors are now pricing in a 75-basis point hike as economists warn households are set to face large hikes in energy costs. Meanwhile recent reports out of the U.K. suggest inflation could reach upwards of 22% next year if gas prices remain elevated.
4. Job Market Update – the economy added 315K non-farm payrolls for the month of August, which is well below July’s payroll report of a staggering 526K jobs added. This is a healthy (cooling) reading and hiring is happening across all sectors, most notably in professional business services and healthcare at 68K and 48K, respectively. To date, employment is now 240K above pre-pandemic levels noted in February of 2020. The unemployment rate slightly rose 0.2% to 3.7%.
5. Key Insight – The common things that drive investors and much of the investment industry stand in stark contrast to what drives markets and what investors need to do in order to find successful outcomes. We cover this, where we see opportunities today and our track record of being advisors of conviction in this week’s messages.

Insights for Investors

Intro – The Participant (Actors)

The journey of an investor can certainly rival some of the best dramas ever written with plenty of fear, greed, successes, and failures. While the markets, like life, often get blamed for this drama the “participants” certainly play their part in it as well.

How so?

When it comes to investors one of the issues that exacerbates poor decision making, which leads to more “drama”, is the strong desire to view things in a binary fashion as being good or bad. There are many times, such as now, when things are very gray and the best advice I can give is “when in doubt … don’t.”

That isn’t to say changes in one’s plan or portfolio should never occur, in fact they must which brings us to the issue with much of the investment industry. Coming to the point where you are confident in the need to make changes takes a) a lot of homework, b) no conflicts of interest so you can make those decisions with only the client in mind, and c) courage to perhaps look foolish for a time. The issue is that many brokers/advisors want an easy workload and/or easily defensible path forward and right decisions as we discussed before usually are “hard” to make.

Finally, is Mr. Market. If you wonder why investors and advisors struggle so much it’s that the traits that often defined them outlined above are the antithesis of how Mr. Market acts. Mr. Market (and the economy) is anything but easily definable as good or bad, and in fact almost always has good reasons for investors to embrace hope or fear – realizing this and letting them “balance” your emotions is the key. Furthermore, unlike those in the industry hiding behind scripts and cliches the market is anything but static. The market, as the old saying goes, is most likely to do whatever will surprise the most people.

The Path Forward

With so much potential peril, why even invest (e.g., leave the shore)?

To be frank because life demands it for most all of us.

To reach the goals we have for our families, whether those are exciting things such as family vacation, higher education or a vacation home or simply to safely provide for basic needs, we need to save and have that money earn us a return/income.

For those of you that worry a bit more than some, it is critical to remember the damaging effects of inflation over time. A mere 3% inflation rate over 10 years destroys over 25% of your purchasing power.

Doing nothing and “staying on the shore” is simply not an option for most.

The good news is that while yes there will be “waves of volatility, successfully reaching your goals on the other side is not dependent on your ability to predict the market’s “weather.”

The Problem (& the Solution)

To reiterate the problem, or challenge, for investors is to let go of the pressure to predict, to be perfect, and/or to define with exactitude a market whose nature will only frustrate such efforts to the point of countless failures.

That said, staying with an approach or advisor that never adapts may be “easy” in the short run, but result in a much “harder” reality down the road.

The good news is this isn’t mission impossible. Discipline, doing the hard thing (e.g., taking time to plan and “buying” low) and diligently monitoring for opportunities can result in investors making amazing progress over time.

The Puzzle – What to do with today’s market?

Is inflation abating or going to stay stubbornly high? Are we in a technical recession today or perhaps headed towards a severe one tomorrow? There are as many questions today as I can recall in quite some time. Questions with answers that only time will unveil.

This all results in an environment that challenges the issues raised above as much as any investing environment would.

To those investors looking to define the current outlook as good/improving or bad, an honest look at the data will only frustrate and result in more confusion. Growth is moderating but it’s still there, so too with inflation.

As the next two charts show there is reason from supply chains (chart 1) to monetary supply stabilizing to believe inflation will cool sooner than many fear, but how fast and how the Fed respond remain unknowns. Panicking at this point after a fair amount of market damage among stocks and bonds could prove foolish, but so too could be the presumption of a return to what has worked over the last few years.

To those advisors that fall within the definition above of those that have failed to adjust and evolve over the last few years, they are being exposed this year. As the following chart below shows, the basic 60/40 has failed to live up to its past performance or protect investors in a way they’d expect.

So, what is approach we’d have investors consider at this time?

Well, after two years of general skepticism or dislike of many parts of the multi-faceted fixed income universe, there are a number of opportunities that are emerging from this year’s sell off.

For those investors paralyzed by today’s market, consider that bonds may be set up quite well regardless of what path unfolds:

• Stagflation – defined by moderate to weak growth and higher than normal inflation where markets are usually range bound but volatile. While stocks may not produce returns in such times, the income from bonds enables investors to get some return.
  
• Recession – at today’s valuations bonds have likely recovered much of their ability to be a hedge against equity risk. If the economy was to weaken further, many types of bonds could actually respond well.
  
• Inflation Clouds Dissipate – if conditions were to improve and the Fed was able to slow or abate their rate hikes, bonds would likely respond well both in terms of income generation, and with capital appreciation as the result of eventual rate cuts.

For those of you out there saying, “but isn’t the Fed going to continue to raise rates and wouldn’t that hurt bonds as it has?” Possibly, but you need to keep in mind that it isn’t just the Fed’s actual hikes to date but the pricing in of future hikes. After last week’s hawkish comments those expectations are quite high, and our position is most of the damage is likely already priced in.

As to our record on managing fixed income for clients? Well thankfully, there is a published public record and unlike the advisors admonished above, we’ve been anything but static.

You are welcome to go back and read our thoughts in more details in the links below but here is the short history of us “walking the talk” of this week’s message.

1. On November 18, 2016, in the midst of a sell-off in fixed income and countless headlines about the impending reflation that would take down bonds, we published Lions and Tigers and Bonds, Oh My! encouraging investors to tune out the noise and hold tight. From that date until our next commentary on the topic (see #2) the Barclay’s Aggregate bond index gained 21.28%.
   
2. Then in midst of the pandemic after the brutal sell-off in equities and simultaneous run up in bonds, we urged investors to reconsider their allocation and lessen their fixed income exposure in a piece we put called How to Invest in a Post 60/40 Era on August 8^th, 2020, and to date the same index is down over 12%.
   
3. Which bring us to today, and this piece, Paralyzed by the Puzzle or Propelled by the Path. While any investor should of course consult with a credible professional as well keep in mind their own plan and risk tolerance, the purposes of our messages today are, a) to keep one’s focus on constructive actions, b) work with solid partners and c) keep in mind that there are always opportunities somewhere. Today for those with new funds to invest parts of the fixed income market may be just what they are looking for, but again not all bonds are the same which is why you or a good partner needs to really understand the pro/cons of any possible investments.

We mentioned courage above and that is because it often is the key to maintaining the discipline and patience required to achieve success. As you can see from the chart below, people “feel” pretty scared right now. As Bespoke commented, “While readings above 50% have been more common this year, in the history of the survey since 1987, less than 4% of weekly readings have been higher than this week's level of bearish sentiment.” For those of you that regularly follow these commentaries you know that such sentiment usually means we are closer to the end than the beginning of tough times.

In closing, don’t be “perma” when it comes to investing whether perma…bullish, bearish or static in your approach. The only “perma” that should define your approach is perma- process-oriented. Keep an open mind, keep calm, and keep an eye out for opportunities – just remember they are usually disguised as recent disappointments.


Have a wonderful Labor Day weekend,

Tim and the team at TEN Capital

Data, Just the Data

Data points this week included:

• U.S. Jobless Claims – dipped by 5K to a claimant count of 232K for the week ending August 27^th. The reading was far below the market estimate of 248K. This is the lowest level since June 25^th as the labor market remains tight. The four-week moving average fell to 241.5K, the lowest since July 9^th.
• U.S. Consumer Confidence – the Univ. of Michigan consumer sentiment reading came in at 58.2 for the month of August, which is far above the July reading of 51.5. Inflation expectations within the index fell to 4.8%, and the 5-year outlook came in at 2.95%.
• U.S. ISM PMI – remained steady at 52.8 in August, which is the same reading as the month previous. Factory growth stayed lower, but new orders hit the expansion mark again at 51.3. Employment rebounded as layoffs slowed and hiring freezes eased off. Conversely, production slowed from 53.5 to 50.4.
• U.K. PMI Manufacturing Final – came in at 47.3 for August, which is slightly higher than estimates of 46, but marks the first contraction (sub-50) in factory activity since 2020. Job growth has essentially stalled, orders have dropped, and new business levels have declined leading to lowered optimism.
• Eurozone Economic Sentiment – the ESI has fallen to 97.6 for the month of August, which was slightly below July’s reading of 98.9. Confidence in industry and services both fell to 1.2 and 8.7, respectively. Confidence amongst constructors bumped up to 3.9 and employment expectation also slightly rose.