Perfect vs. Good
FIVE THINGS YOU SHOULD KNOW
- Equity Markets – rose this week with U.S. stocks (S&P 500) up 0.81% and international stocks (EAFE) up 1.79%
- Fixed Income Markets – were mixed this week with investment grade bonds (AGG) down -1.04% while high yield bonds (JNK) gained 0.52%
- Fed Minutes – The recap of the March Fed meeting suggests officials are still on track to continue with rate hikes when they meet next month. While the language suggests some officials are uncertain what the longer-term rate path looks like, currently economists are pricing in a quarter-point hike in May followed by an extended pause.
- Intelligence Leaks – The current administration faced some embarrassment this week after the biggest U.S. intelligence leak in a decade revealed the extent of U.S. agencies spying on both foes and diplomatic allies including South Korea, Israel, and Ukraine. After an investigation it was revealed a trove of classified documents were shared online by a 21-year low-level airman, raising questions on who all has access to sensitive information.
- Key Insight – [VIDEO & ARTICLE] Investors are almost always caught in a tug-of-war between two fears - the fear of loss and the fear of missing out. As they try to reconcile this struggle, they often feel compelled to make the “perfect” call, and in so doing abandon not only what is possible, but sound investment philosophy. We discuss in this week’s video the current headlines stoking each respective “fear” and remind people of three key principles to keep in mind.
INSIGHTS for INVESTORS
Intro
Predictions, perfections … traps. One of the first commentaries I wrote back in early 2016 was entitled “From Fear to Fear…The Life of Too Many Investors.” In short, I discussed the often-manic movements, or at the least impulses, that investors face as markets and headlines undulate between the fear of loss and the fear of missing out.
Truth is, there are always reasons to be fearful in either regard, but of late the clash between these fears seems to be reaching/returning to heightened levels.
Before we dig into the current setup facing markets, consider the lessons of 2022 and 2023 to date in terms of expectations and relative performance.
Just When You Think You Know…
As JPMorgan recaps below, just about the time investors thought they’d figured things out, markets reversed course sending last year’s leaders to the bottom of the pack while last year’s losers returned to prominence.
They stated, “Market volatility persisted during 1Q23, but several of 2022’s underperformers experienced a notable turnaround, highlighting investors’ willingness to look beyond near-term challenges and to front run a dovish shift in monetary policy.”
From a performance perspective, internationally developed market equities led the way, bolstered by cheaper relative valuations and surprisingly robust earnings. Well-capitalized European financials benefited from the return to a positive interest rate environment, while industrials were propped up by lower-than-feared energy costs. Emerging market equities also experienced gains, rising by 4%, as China’s reopening looks set to benefit from consumers tapping into excess savings amassed during the lockdown.
Turning to U.S. equities, large caps rose by 7.5% and small caps rose by 2.7%. This divergent performance can be attributed to the higher weight of financials and lower weight of technology in the small-cap index relative to the large-cap index. Amid the regional banking crisis, investors leaned into tech relative to financials, particularly as technology companies had already taken steps to optimize costs and defend margins. Turning to fixed income, the prospect of a dovish shift by the Fed in response to the banking crisis led yields to decline, with U.S. fixed income finishing the quarter up 3% and global high yield up 3.1%. Lastly, REITs edged up 1.5%, supported by a slight improvement in mortgage rates and modest declines in home prices; in contrast, commodities fell by 8%, primarily due to lower energy prices.”
Today’s Dilemma
With the S&P up year-to-date a solid 7.5% or so, and many international markets up double digits, bullish sentiment is returning driven in large part based on hopes that the Fed will ease their path of rate hikes soon and help engineer the much ballyhooed “soft-landing” for the economy.
This week brought plenty of info to try to decipher with both new CPI (consumer) and PPI (producer) inflation data, as well as the release of March’s Fed minutes reflecting their deliberations and outlooks.
As summarized by Bloomberg, “US equity futures and European stocks rose as investors weighed the path of Fed interest-rate increases for the rest of 2023. Minutes of the Fed’s March meeting signaled officials appear on track to extend their run of hikes when they meet next month, while staff advisers forecast a “mild recession” later this year. Economists see the most likely outcome as a quarter-point increase in May, followed by an extended pause. But the language in the minutes, coupled with some officials’ comments and a still-uncertain outlook for the impact of credit tightening on the economy, point to a rate path that may not be fully settled.”
And while both CPI data eased in March to 5% year-over-year (0.1% below expectations) and PPI even more so, falling 0.5% month-over-month for the fastest drop since March of 2020’s COVID-related drop, the path forward is less clear.
For one, as noted by Bespoke, “Longer-term, the weakness in PPI relative to CPI for goods only is less indicative of disinflation which tends to come with middling readings on the CPI-PPI spread.”
Furthermore, many argue that such declines are actually indicative of building recessionary pressures and pending deflation. Many analysts, including a group from UBS on Thursday, highlighted their growing concerns around slowing economic growth and the market's vulnerability at current levels without an “imminent pivot in Fed policy.”
Other headline-grabbing “fears” include recent currency pacts between China and other foreign countries (see Brian Wesbury’s great article on this topic below), damaging Pentagon leaks of sensitive information around the war in Ukraine, and a recent BBC report that China has been simulating strikes on six “key targets” with Taiwan stoking already significant geopolitical tensions between the U.S. and China.
What’s One to Do?
As the saying goes, perfection is often the enemy of good, and that is certainly true for investors trying to hold themselves to timing markets' future movements with supreme accuracy.
One must let that pressure go, and instead focus on:
a) What do they personally need to get through a variety of possible markets and economic conditions?
b) What can they emotionally withstand (how do they balance the above “fears” within their approach? and
c) Is their portfolio positioned to both survive and even thrive through diversification and re-positioning in various market conditions?
Such a plan and portfolio will never be perfect and no amount of study will reveal with enough certainty the future, but neither is necessary to be successful.
To paraphrase FDR, the only thing investors have to fear is fear itself.
Letting go of that fear is not just the path to a better portfolio, but a better journey as an investor altogether.
Have a wonderful weekend,
Tim and the team at TEN Capital
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How to Lose Reserve Currency Status
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 4/10/2023
History is full of economic and societal collapses. The Incan and Roman societies disappeared, the Ottoman Empire fell apart, the United Kingdom saw the pound lose its reserve currency status. So, anyone who says the US, and the dollar, couldn’t face the same fate doesn’t pay attention to history.
The question is: will it? Russia, China, Brazil, and others, including Saudi Arabia, all seem to think they can find a way to replace the dollar and undermine US dominance on the world economic stage.
They may try. And they may cause many to fret, but we highly doubt these countries will succeed. In order to understand why we think this, it is important to understand the ascendance of America. In the late 1700s, the US was a patchwork of colonies barely clinging to the Atlantic Seaboard.
But it wasn’t victory in the revolutionary war that made America strong, it was the writing of the Constitution and the culture that created that Constitution. The rule of law, private property rights (especially to inventors through patents), democracy (and free elections) made America different and ushered in two centuries of supercharged human progress.
While the US ran up large debts to fight wars, it managed to grow its way out. At the same time, our monetary system kept the value of the dollar fairly strong and stable relative to other currencies. The combination of all of this led to deep and robust capital markets, and a dominant 60% representation by the dollar in foreign currency reserves and nearly 90% of global financial transactions.
If the US reverses course, printing too many dollars, undermining entrepreneurship with high taxes and regulations and growing government too much, then the dollar’s standing will diminish. Clearly, we are on that path today. Federal government spending has reached an all-time high of 25% of GDP in the past three years, state and local spending is near 20%...so, combined, government controls 45% of US output.
As Milton Friedman said, the more the government is involved, the higher the price of things and the lower the quality. More importantly, for the dollar, the Federal Reserve has embarked on an experimental “abundant reserve” monetary policy that has flooded the financial system with more liquidity relative to GDP than at any time in US history. In 2007, the Fed’s balance sheet was 5% of GDP, today it is more than 30%.
Massive government involvement in the economy, combined with excessive money creation is a perfect recipe for the decline of a currency. But, before you become convinced that this will happen to the US anytime soon, think about what might replace the dollar. It would have to be a currency managed by a country that had better policies.
What made America strong is not its natural resources (which it definitely has), but its human resources and freedom. China, Saudi Arabia, and Russia may have resources, but they are not free. It will not be any these countries that replaces the dollar and it is highly unlikely to happen in our lifetimes. However, that’s not to say it won’t happen in our children’s lifetimes. Bad policies beget bad outcomes. King Dollar will only stay that way if the US keeps its fiscal and monetary house in order. Limiting government spending, keeping tax rates low, and returning to a “scarce reserve” monetary policy are our suggestions.
The problem we see is that politicians have used the last two “crisis” periods to expand the size and scope of government, not shrink it. With government so big, we are likely to face another crisis. It’s past due time to head that off.
DATA, JUST THE DATA
Data points this week included:
- U.S. Retail Sales – fell 1% in March and worse than expectations for a 0.4% decline. The largest drop came from gasoline sales, mostly driven by lower oil prices.
- U.S. Industrial Production – rose 0.5% year-over-year in March for the lowest pace of growth in over 2 years. The reading was mostly weighed down by a 1.1% drop in manufacturing output.
- U.S. Jobless Claims – saw an increase of 11,000 in initial claims last week for the first increase in 3 weeks. Continuing claims on the other hand saw a decrease to 1.81 million.
- U.K. Industrial Production – fell 0.2% month-over-month in March despite expectations for growth. This marks the second consecutive month of contraction.
- Eurozone Industrial Production – grew by 1.5% in February led by a rebound in energy production. The reading also beat expectations for a 1% improvement.
- Eurozone Retail Sales – fell 0.8% in February following an upwardly revised 0.8% gain in January. Year-over-year sales are down 3%.