Passing of a Matriarch, Persistence of a Mission
Passing of a Matriarch, Persistence of a Mission
Last week brought the passing of Tim’s grandmother Beverly, wife to the grandfather the firm is named in honor of. In touching on her legacy, he expounds on the firm’s mission of helping clients creating plans that empower their true purposes and help them live their best life.
FIVE THINGS YOU SHOULD KNOW
- Equity Markets – were higher this week with U.S. stocks (S&P 500) up 2.48% while international stocks (EAFE) rose 0.81%.
- Fixed Income Markets – were mixed with investment grade bonds (AGG) remained flat at 0.00% while high yield bonds (JNK) fell -0.02%.
- NYSE Blunder – On Tuesday, stock prices of some of the biggest companies on the NYSE whipsawed 25% in the early trading hours. Thousands of trades were canceled at an unknown cost, all thanks to human error 700 miles away in Chicago. A disaster-recovery system meant to safeguard U.S. markets was improperly shut off before trading hours which mislead the exchange’s computers. This process has now come under scrutiny as new measures may be considered to ensure human error does not interfere with trading operations, as companies like Charles Schwab voiced disappointment.
- Semiconductor Standoff – the U.S., Japan, and the Netherlands are hours away from reaching an agreement which will limit China’s access to ‘advanced semiconductor machinery’, according to Bloomberg. In October, President Biden unveiled said restrictions, but needed Japan and the Dutch to agree as they are home to some of the most important chip manufacturing companies in the world. China filed a dispute with the WTO in December, but all talks are ongoing and no decision there has been reached.
- Key Insight – [VIDEO] Last week brought the passing of Tim’s grandmother Beverly, wife to the grandfather the firm is named in honor of. In touching on her legacy, he expounds on the firm’s mission of helping clients creating plans that empower their true purposes and help them live their best life. [ARTICLE] We look at recent economic and earnings data to outline what likely lies ahead and highlight some interesting investing opportunities that have taken shape over the last year.
INSIGHTS for INVESTORS
I. Inflation Update – The Data Continues to Improve
A. Headline Data
While “bears” have expressed concerns of “sticky inflation” repeatedly of late to bolster their case, the reality is inflation data continues to rollover hard. Given the historic lag in which inflation responds to hikes, as well as the historic level of hikes in 2022, there is little reason their fear will actually occur.
As JP Morgan stated, “While the story last year was about inflation peaking, the 2023 narrative is shifting toward how quickly inflation can cool, and furthermore, how much cooling will be sufficient to get the Fed to pause its rate-hiking campaign. Last week, December’s CPI came close to expectations, and marked the sixth consecutive decline in the headline CPI on a year- over-year basis and the first monthly decline since June 2020. Core CPI on the other hand, which peaked three months after the headline figure, registered an increase of 0.3% m/m … The Fed is likely to welcome this much-awaited progress on inflation by slowing the pace of rate hikes in February … Looking further out, this report confirms that the inflation surge is ebbing; barring any shock, this cooling inflation environment should lead to a more symmetric approach to monetary policy as the year progresses, which will likely be positive for both stocks and bonds.” (See accompanying chart)
Producer Prices dropped in the most recent report as well, with headline prices falling by 5.79%. This price drop is the biggest such decline since the onset of the pandemic with only late 2014 coming close to 2009. As Bespoke further noted, “…core goods prices also have rolled over falling at a 1.05% MoM annualized pace as services inflation has fallen to a 1.25% rate.”
B. M2 Monetary Supply & Inflation
As we’ve noted in prior commentaries, the other key factor in bringing inflation under control was a decline in monetary supply after the “epic” surge during the pandemic.
As pointed out by former fund manager Scott Grannis, the recent decline in M2 monetary supply, “…suggests that the significant decline in M2 over the past 9 months means that consumer price inflation is likely to continue to fall for the balance of this year and possibly well into next year, thus meeting the Fed's objective.” (See accompanying chart)
This view is shared by Apollo economist Torston Slok who recently stated, “…with inflation back at 2% within a few months, the Fed will soon stop being so hawkish. In other words, the market is telling us that the soft landing will be accomplished over the coming six months. And, if inflation is six months is no longer a problem, then the Fed put is coming back. Because then the Fed will again have the flexibility to focus on unemployment, growth, and earnings instead of focusing entirely on too high inflation.”
C. The Fed’s Response
While we will get further clarity next week at the Fed’s next announcement, recent comments from various Fed governors strongly suggest they recognize the new trend in data and will be both reducing the size of, and remaining number of, interest rate hikes.
As noted by the Wall Street Journal, “In recent public statements and interviews, Fed officials have said slowing the pace of rate increases to a more traditional quarter percentage point would give them more time to assess the impact of their increases so far as they determine where to stop.”
II. What does this mean for the Economy and Markets?
The relative resiliency of the current earnings season, overall global growth, and new inflation forecasts are rapidly increasing the odds of a “soft landing.”
Commentator Lawrence Fuller noted, “According to JPMorgan’s trading model, seven of nine asset classes now show less than a 50% chance of recession. The odds were closer to 100% last fall. As it relates to the bond market, US high-yield bonds have realized the sharpest decline, based on market prices, to just an 18% chance of recession. Morgan Stanley economists are now calling for a “softish” landing this year and suggest that even if we do have a recession it will be mild at worst.”
What could this mean, that once again the economy is on its way out of recession, just as everyone is anticipating its arrival? This is often the case, and a big reason why people trying to trade markets based on backward looking economic data get whipped around to their own detriment.
Another view shared by Torsten Slok in his most recent commentary where he noted improving inflation data (see above) as well as improving growth estimates is, “This is all good news for credit, equity and capital markets.”
Alpine Macro opined on the current state of markets saying, “Why re-risk now, before recession hits? The BAML survey of professional fund managers shows that 87% of respondents expect a recession. 83% expect EPS to decline. Many are underweight equity exposure relative to their strategic normal allocations. But, 87% also expect Treasury yields to settle between 3-4% over the next 12 months. This is inconsistent: if we have a recession, bond yields will be much lower! EPS is already down 8%. If the coming, highly anticipated recession follows the early 2000’s pattern (the last tech bust), nominal earnings may have another 10% downside in the next 12 months. One cannot assume a very bad economic outcome with a contraction in EPS without adjusting bond yields too. If you adjust the expectation for the discount rate lower, per a weaker economy, the market is not expensive. Moreover, ex the FAANGM mega-tech stocks, the S&P ‘494’ trades at 16x P/E.”
III. Fundamentals and Current Opportunities
A. Earnings
While notable names such as Microsoft or Tesla make for great headlines, they alone do not define the overall market – much as that is often implied by the press. A broader look at corporate earnings, not just today but even more importantly 6-9 months out, shows an improving picture.
Analyst Brian Gilmartin, who does deep dives on S&P earnings regularly, recently stated, “What’s really interesting from an S&P 500 earnings perspective is what’s happening with quarterly EPS and revenue estimates in the back half of 2023. [Notably] the persistent strength in Q4 ’23 “expected” S&P 500 EPS. While it will be more telling when 2023 guidance is heard and we see the changes to the numbers over the next two weeks, take this as an early tell that “consensus” is expecting the back half of 2023 to be stronger than the first half of 2023. Note too how Q3 ’23 expected EPS growth are seeing far less severe revisions downward than the first two quarters of 2023.Rate of change matters.”
B. Investing Is More than Just Stocks
And while the improving economic and earnings picture will certainly impact equities, our main focus at the moment is making sure clients don’t overlook “boring” bond opportunities, both as to how they relate to their overall allocation as well as for all the outsized cash positions we see with far too much frequency.
After being quite bearish on corporate fixed income for some time (see here), the selloff amongst most fixed income sectors in 2022 has created an opportunity we believe many investors should consider moving forward. Of course, exactly where one should invest and how is very dependent on one’s circumstances and should be discussed with a professional.
Without recommending any particular type of bond, we share the chart below just to illustrate how the upside/downside potential for many types of bonds have radically changed for the better, as opposed to the setup that existed in 2020 when we were quite bearish on investment grade corporate bonds and U.S. Treasuries.
Our constructive outlook on fixed income is apparently shared by others. As noted by Goldman Sachs, “At our 2023 Global Strategy Conference, we surveyed ~400 portfolio managers (PM) on their opinion of the best performing asset class in the year ahead. Relative to 2022, PM confidence in fixed income has risen the most, particularly for corporate bonds. Higher yields, more attractive coupons, and our expectation for less interest rate volatility may continue to support portfolio asset rotations back into bonds in 2023.” (See accompanying chart)
After a year like 2022 with volatility seemingly everywhere, it is perfectly natural and quite common for many investors to “turtle up” and hide inside of large cash positions. However, it is also almost always a horrible investment decision, both in terms of lost opportunities in other asset classes or just on an absolute basis when one considers the eroding impact to purchasing power of inflation. Furthermore, when many great options now present within some special fixed income sectors with little credit or interest rate risk and very attractive yields, holding too much cash is an especially poor decision.
A quick look at the chart below shows that a) cash has never been in the top half of best options back-to-back years and in fact usually heads to the bottom of the chart, and b) over time it is consistently the worst option. Yes, you need to be prepared for the unexpected, but there are better ways to do that then hoarding cash.
As always, if you want to discuss how this info may apply to you and how to maximize your plan, we are here. If you want to discuss the cash alternatives we are using, we’d be happy to do that too. For those of you who are clients, you can trust your portfolio already do, or in short order will, reflect these outlooks.
Have a wonderful weekend,
Tim and the team at TEN Capital
DATA, JUST THE DATA
Data points this week included:
- U.S. Jobless Claims – dipped by 6K to a reading of 186K for the week ending January 21st. Week by week claims drop to their lowest since April and were well below expectations of 205K. Despite tech layoffs, the labor market remains tight. The four-week moving average has fallen by 9.25K to 197.5K which is the lowest since May.
- U.S. GDP – expanded 2.9% annually during Q4, beating forecasts of a 2.6% growth rate. Consumer spending bumped up 2.1% and spending on goods rose 1.1%. Spending on services rose 2.6% but was lower than the 3.7% in Q3. Private inventories bumped up 1.46 pp to growth. Contribution from net trade declined from 2.86 to 0.56 pp with exports falling (1.3%). Fixed investment fell (6.7%), and residential investment contracted (26.7%). Overall, in 2022 the GDP grew 2.1%.
- U.S. Balance of Trade Adv. – the trade deficit expanded to ($90.3B) in December, higher than the previous two-year low of ($82.9B) in November. Imports rose 1.9%, thanks to vehicle purchases and consumer goods. Exports fell once again by (1.6%), while sales of food, beverages, and vehicles rose 2.2%. Overall, in 2022 the trade deficit bumped up from $1.08T to $1.19T.
- U.S. Durable Goods Orders – expanded 5.6% MoM in December which is the sharpest gain since July 2020 and was far above expectations of a 2.5% increase thanks to a 16.7% increase in transportation equipment. Excluding transportation, new orders rose 0.1% and orders for non-defense capital goods edged down (0.2%).
- U.S. New Home Sales – expanded 2.3% MoM to an annualized rate of 616K in December. This is the highest value in four months and was slightly below forecasts of 617K. The median price for a new home was $442.1K and the average sales price as $528.4K. Nine months of supply exists in the current market and overall, in 2022, around 644K new homes were sold – 16.4% below 2021.
- U.S. PMI Composite Flash – improved to 46.6 in January after a reading of 45 for the previous month. This still marks the seventh consecutive month of contraction (below 50) in private sector activity. New orders dropped the least in three months amid high inflation and rising interest rates and on the price front, input cost inflation rose from December. Business confidence strengthened to a four-month high.
- U.S. Personal Income – increased 0.2% from the previous month in December and followed a 0.3% rise in November. This marked the smallest gain since April thanks to a small increase in compensation and proprietors’ income. PCE rose 0.1 MoM with core rising 0.3% MoM. For the year of 2022, PCE rose 5%.