Ugly Markets Can Turn Beautiful Quickly

Ugly Markets Can Turn Beautiful Quickly

Equities markets have been enduring history making levels of volatility of late, which always brings out the doomsayers and attention seeking pundits. What really matters is what likely lies ahead, and history tells us a much different story than the so-called experts.

Five Things You Should Know

1. Equity Markets – were lower this week with U.S. stocks (S&P 500) down -5.15% while international stocks (EAFE) fell -3.26%.
2. Fixed Income Markets – were lower with investment grade bonds (AGG) down -0.95% while high yield bonds (JNK) fell -2.18%.
3. Fed in Focus – with updated inflation data this week disappointing expectations, we have yet another month of impending Fed decision-making dominating the conversation. While some have suggested a historic 100 basis point rise next week could be necessary most investors, including JPMorgan Chief Economist Michael Feroli, are still pricing in expectations for a 75-basis point increase.
4. Rail Strike Averted – a last second agreement was made this week to avoid a U.S. railroad shutdown that would have seen more than 100,000 workers on strike and caused a massive disruption to already strained supply-chains. While still pending final approval, the tentative agreement should see wages immediately increased by over 10% and exempt time off for certain medical events.
5. Key Insight – Equities markets have been enduring history making levels of volatility of late, which always brings out the doomsayers and attention seeking pundits. What really matters is what likely lies ahead, and history tells us a much different story than the so-called experts.

Insights for Investors

“To everything there is a season…” Turn by The Birds


I. Is this week’s CPI data a signal of more doom and gloom?


The market’s historic streak of 1%+ weekly declines (see more on this below) continued again this week after a disappointing CPI report seemed to suggest that inflation may not be slowing as fast as hoped.

The report led many, such as Tom Essaye, to ask “Was the hot CPI report a bearish gamechanger?” Of course, there are any number of takes on that question (mostly emotional) but his was well reasoned and based in current facts. He stated,

“So, was the hot CPI report, which signaled inflation isn’t quickly receding, a bearish gamechanger? No, and here’s why. First, it didn’t materially alter rate hike expectations.
Yes, a 75-bps rate hike in September is now fully expected, and there’s a rising chance of a 100 bps (we don’t think that’s likely but, in the aftermath, we are seeing Fed funds futures price in that chance). Additionally, the market now is pricing in a greater chance of a 75-bps hike in November (as opposed to the previous 50 bps).

Most importantly, yesterday’s hot CPI didn’t materially alter the outlook for the “terminal rate” from the Fed. Prior to CPI, the terminal rate was between 3.875% and 4.125%. Following CPI, fed fund futures now has the terminal rate between 4.25% and 4.50%, which is essentially just a 25-bps hike higher than previous expectations.

Second, while it clearly showed inflation remains sticky, it didn’t invalidate the idea that inflation has also peaked, and that is an important positive compared to the depths of the June selloff (where there was no evidence that inflation had peaked).

As such, the August CPI report, while clearly disappointing vs. the hope of quickly declining inflation, didn’t materially dim the outlook for markets and as we stated in last week’s Market Multiple Table, we still think the S&P 500 “fair value” range remains between 3,680-ish and 3,910-ish.”

In other words, while volatility is likely here until there is a bit more clarity on the path of inflation and the Fed’s rate, such periods of weakness have usually been followed not by the doom and gloom of many pundits, but rather by strong returns for the patient investor once this range-bound market comes to a resolution.

Before we discuss that latter point, let’s dig a bit deeper than the headline on inflation. While CPI data disappointed this week what many missed was that the Producer Price Index dropped to 8.7%, below both expectations of 8.9% and from a peak of 9.8%. This is critical of course because the path of Producer Prices is a leading indicator for Consumer Prices (see accompanying chart).

Alpine Macro’s outlook is stated as, “Easing supply bottlenecks, waning goods demand, and fading commodity prices amid a hawkish Fed will bring U.S. inflation down faster than currently expected; disinflation will re-emerge as the prevailing macro tendency. disinflation globally. Bearish equity market sentiment is ubiquitous on fears of global recession and persistent inflationary pressure. If inflation declines more via supply recovery than demand destruction, bond yields will drop, putting a floor under equity valuation.”

And finally, a former manager/analyst I respect a great deal, Scott Grannis, is strongly in the camp that inflation will drop quickly beginning in the new year and the Fed will not have to raise rates beyond current expectations. He cites the following two charts as key evidence.

II. But it “feels” so bad!!

Volatility naturally frays investors nerves. And during such times of volatility, it is hard to be optimistic and “see” how things will get better…but history repeatedly has shown us they do.

If you are one of those investors struggling with your nerves, there is good reason. As Bespoke pointed out this week, last Friday’s close was, “just the eleventh period since 1952, the S&P 500 has closed out the week with a gain or loss of 1%+ for five straight weeks.” If you are familiar with some the dates below, you’ll see they too came during “dark times” such as after the severe recession of ‘73-‘74, 1990’s Savings and Loan Crisis, 2001’s dot.com crash, 2003 recession, 2008 Great Financial Crisis, and of course 2020’s global pandemic.

What has that historically meant for markets?

The narratives of despair were strong during most of the timeframes above, made all the more powerful by the numerous negative news stories dominating the headlines. However, what most often lie ahead was a much different picture. As Bespoke noted saying, that while “prior periods where the S&P 500 experienced similar streaks were generally weak in terms of performance, but forward returns tended to be better than average.”

As you can see from the following chart, after such weakness, odds of an improved market are solidly positive, “One and three months later, the S&P 500's median performance was gains of 4.43% and 5.51%, respectively. Over both time frames, those returns are well over twice the historical average for all periods since the early 1950s. Six and twelve months later, both the average and median performance was in the double-digit percentages with positive returns over 80% of the time.”

III. Fade the Crowd and the Attention Seeking Experts
As you know, we think history is strongly on the side of being a contrarian when it comes to investing and “fading” the sentiment of the “crowd.” During such periods as those outlined above, the average investor, and their frayed nerves, gets quite bearish – while institutional investors tend to look for opportunities.

History would seem to be repeating itself again. Bespoke recently highlighted, “…the most recent investor sentiment survey results from the Yale School of Management.” And found that the, “…‘one-year confidence’ reading shows that individual investors are now more bearish than they've ever been on the market in the survey's history dating back to 2001 (top left chart, orange line). Institutional investors, on the other hand, have actually been getting a lot more bullish lately. While still low relative to ‘history, the percentage of respondents who think the market is attractively valued has been increasing for both institutional and individual investors recently.” However, “(a)fter the sharp drop we've seen for the stock market this year, individual investor confidence in "buy the dip" is now at the bottom of its multi-decade range.”

The market is volatile, any normal person would be growing weary, and your neighbors and co-workers are likely very pessimistic. While it is easy to jump on the bearish wagon, history tells us such a set-up is more indicative of being closer to the end than the beginning, even if we may not be out of the woods just yet.

And as relates to the experts…

When we raised cash for clients in January, many of today’s prominent bears were nowhere to be found. Now that the market is mired in a bear market and investor sentiment is “fearful” (link), they come out to tell us about how bad things are and seek to outdo each other to grab attention.

Take for example this Bloomberg headline, “Treasuries also flash warning signs. A key part of the yield curve risks inverting to a level last seen in the early 1980s as the US inches closer to a recession, Allspring Global Investments said.”

Triggers such as “warning signs”, not seen in a long time and “recession” are there to grab your eyes and stoke your fears. Perhaps one should ask what happened over the next year and next decade? (See second Bespoke chart above for part of the answer).

In 2010, it was famed bond investor Bill Gross warning of the “new normal” of horrendous returns that lie ahead for investors. Of course, the market then proceeded to enter one of the biggest bullmarkets in history.

Today, it’s Stanley Drunkenmiller issuing a similar warning. (link)

The truth?

No one knows, period.

Furthermore, such dire outlooks ignore a lot of positive data too. Analyst Lawrence Fuller commented on this phenomenon stating, “Stocks struggled yesterday in the face of more dire forecasts from market pundits, despite economic reports that showed our economy is weathering the inflationary storm exceedingly well. Weekly unemployment claims fell 5,000 to 213,000 when they were expected to rise to 225,000. While industrial production slipped 0.2% in August, due to a weather-related decline in utility output, overall manufacturing activity expanded from strength in capital spending. Lastly, retail sales for August rose 0.3% when the consensus was expecting a decline of 0.1%, and the annualized gain of 9.1% exceeded the inflation rate of 8.3%.Yet, optimism can't seem to overcome the doom, gloom, and misery that a growing consensus wants to spread.”

In short, there is always more to the story and the evidence for the market and economies continued resilience is still present.

IV. Key Takeaways

1. Don’t let the daily scoreboard mess with your mind. There is a lot of game left.
2. It’s not just about what may lie ahead, but how that compares to current expectations. It won’t take much for things to exceed all the dire expectations.
3. We build portfolios not just for good times, but that can provide for our clients during the tough times via volatility protection and income production
4. Successfully investing over time is about shifting from a stacking cash mindset to one that focuses on building a durable cash flow throughout market cycles.
5. We don’t pretend to predict the weather. We are here to help you navigate the inevitable storms and get you safely to the other side with proper planning and portfolio construction.

As we are all experiencing now, seasons change and none of them last indefinitely – markets are no different. You don’t need to fear (market) winter, you just need to dress (portfolio) appropriately.

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 5K to a claimant count of 213K for the week ending September 10^th. The reading was far below the market estimate of 226K and puts a spotlight on a tight labor market. The four-week moving average fell by 8K to 224K.
• U.S. CPI – eased slightly to 8.3% in the month of August, which is only 0.2% lower than the previous reading and just above estimates of 8.1%. YoY increases can be found within energy up 23.8%, gas up 25.6%, food up 11.4% (highest increase since 1979), and shelter up 6.2% (highest increase since 1984). Core inflation increased from 5.9% to 6.3% this month, a number which the Fed will not be too pleased with, and one that markets responded poorly to.
• U.S. PPI – fell (0.1%) MoM in August and marks the second consecutive dip after a (0.4%) decline in July. Overall, prices of goods decreased (1.2%) including diesel fuel, eggs, and organic chemicals. Prices for services did rise 0.4%, marking the fourth month in a row with an increase. YoY, producer prices have increased 8.7%, with core prices moving up 0.4% MoM and 7.3% YoY.
• U.S. Manufacturing Index – the Philadelphia Fed Manufacturing Index fell to a reading of (9.9) for the month of September after a rise of 6.2 in August and missed the mark of a rise of 2.8. The current activity indicator moved into negative territory, with new orders also remaining negative, but the shipment index remaining positive.
• U.S. Retail Sales – rose 0.3% in August after falling (0.4%) the month previous. With gas prices falling nationwide, consumers have been able to increase spending on motor vehicles up 2.8%, restaurants up 1.1%, and building materials up 1.1%. Sales at gas stations contracted (4.2%), along with furniture stores down (1.3%) and non-store retailers down (0.7%).
• U.S. Industrial Production – contracted (0.2%) MoM in August, missing forecasts of a 0.1% rise, and below the previous month’s reading of a 0.5% rise. Manufacturing output rose 0.1%, while durable manufacturing remained unchanged. Nondurable manufacturing rose 0.2%, with machinery, computers, and aerospace leading the way.
• Eurozone Industrial Production – fell (2.3%) MoM in July which is a stark contrast to July’s reading of a 1.1% rise. This is the biggest decline since August 2021 as production for capital goods, intermediate goods, and durable consumer goods all fell (4.2%), (0.8%), and (1.6%), respectively. Amongst the bloc, the biggest declines were seen in Germany down (0.7%), France down (1.5%), and Span down (1%).