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Without a Defined Why the "Watch Outs" Creep In

Without a Defined Why, the "Watch Outs" Creep In Market volatility doesn’t just dominate the headlines, it often dominates investor mindshare. With a well-defined “why” behind your plan, the deadly “watch-outs” that can derail your goals can be kept at bay.

Without a Defined Why, the "Watch Outs" Creep In

Market volatility doesn’t just dominate the headlines, it often dominates investor mindshare. With a well-defined “why” behind your plan, the deadly “watch-outs” that can derail your goals can be kept at bay.

Five Things You Should Know

  1. Equity Markets – were higher this week with U.S. stocks (S&P 500) up 2.58% while international stocks (EAFE) rose 3.25%.
  2. Fixed Income Markets – were higher with investment grade bonds (AGG) up 1.08% while high yield bonds (JNK) rose 2.02%.
  3. ECB Action – this week saw the European Central Bank agree to raise deposit rates by 0.50%, marking their first rate hike since 2011. The size of the increase came as a surprise and now brings the rate to 0%, the first time it hasn’t been in negative territory since 2014. When speaking on the hike ECB President Lagarde acknowledged that “inflation continues to be undesirably high and is expected to remain above the (bank’s) target” of 2%.
  4. Draghi Steps Down – despite comments earlier this week confirmed his willingness to rebuild the struggling government in Italy, Prime Minister Mario Draghi resigned from his position and subsequently leading to the dissolution of parliament and setting Italy up for a round of snap elections as early as October. While the former ECB president remained fairly popular with everyday Italians, he was unable to solidify his party coalition going forward.
  5. Key Insight – [VIDEO] With [ARTICLE] Feelings and cheap comparisons come easy (especially by the doomsayers these days). While no one can know the future, we explore some deeper points to if nothing else be better informed of what may lie ahead.

Insights for Investors

What Kind of Bear Market Do We Likely Have?

I’ve seen all sorts of lame attempts at forecasting, including one well-known figure that insinuated that since it’s been about twice as long as the historic average time between recessions, the next recession will be twice as deep/bad. Being funny, cute, provocative is one thing but, actually attempting to guide people with such drivel is a crime of sorts in my book.

All the work we put into these commentaries, and into curating the wonderful partners that supplement our process, is solely to be better informed, to be more balanced and, hopefully as a consequence make better long-term decisions on behalf of our clients.

If one is going to compare recessions to glean potential insights, then the circumstances and actual fundamentals that drove them must be properly understood. Goldmans Sachs put together some great thoughts and graphics on just this subject and we wanted to make sure to share them to provide a more positive take on what may lie ahead.

Please see below.

Are There Reasons to Believe Things Could get Better?

A. Fundamental Arguments
Alpine Macro’s Global Strategy team, a well-respected analytical shop, is now making the case that the recent bear market in equities is nearing an end, and consequently that investors should start buying on weakness rather than selling stocks on strength:
Their points include, and we quote:

  1. “The Fed is prioritizing relieving consumers’ inflation angst over sustaining robust economic growth. Many financial market metrics suggest that investors are now discounting a recession despite the labor market’s persistent strength.
  2. Core inflation is showing signs of rolling over; by year end, slowing growth could be good news for stocks, if it heralds a dovish Fed pivot.
  3. Current forward P/E multiples already discount the recent surge in interest rates, so the direction of stock prices going forward is likely to hinge more on the outlook for earnings. Corporate profit guidance is already dropping and given the large shakeout in stocks that has already occurred, the bear market may be largely over.
  4. Commodities will not be immune to a mild recession, while bond yields are poised to plummet as the economy cools and inflation drops. The scenario of inflation accelerating from current levels (requiring more tightening than is currently discounted) is a tail risk, not our base case. Investors should also add to bond allocations on price weakness.”

Another key fundamental point, that if nothing else strikes at the heart of those that want to liken our current circumstances to the great recession of 2008, is the present state of Corporate Balance Sheet Strength. A recent Fed/Duke CFO survey (cited by Apollo) asked, “Why does your company not need to borrow money in the next 12 months?” 80% of companies respond that they don’t need to borrow because they have enough cash on their balance sheets. Only 10% of companies think that interest rates are too high.

Refer to the Goldman recession comparison above and know financial imbalances (and that’s being kind to what existed heading into 2008) do not exist anywhere near the levels that we saw at that time. (See accompanying chart below)

Furthermore, the topic of the moment, inflation, is improving by any objective observation. JPMorgan noted, “On the bright side, we see promising signs of inflation coming off its highs in July. Oil and gas prices have dipped meaningfully (down 11% and 4% from June), as have airline fares (down 8%), and this should lead to a deceleration of price pressures in the coming months.” Bespoke commented in similar fashion pointing out that, “After briefly surging above $130 per barrel right after the invasion, crude oil has now declined nearly 28% from that peak. Look for these declines to start showing up in the monthly inflation numbers in the months ahead” (See chart below).

B. Quantitative Reasons

The reasons for embracing something other than the direst outlook are mounting from a quantitative perspective as well.

Fund manager Thomas Hayes pointed out two key points: “1) U of M Consumer Sentiment at 50. Since 1980, the last 3x it dropped below 58, it marked the lows in sentiment and peak in inflation. Avg S&P gains 12 months later were +20.87%. 2) “Fed does want to "reduce demand" but they don't want to destroy the economy. They promised $47.5B in Quantitative Tightening in June. They only did $7.5B (and were net buyers of Treasuries).”
Again, as to reading the proverbial tea leaves to try to understand the Fed’s likely thinking, consider Bloomberg stating, “Bullard, another policy hawk, began to cross the wires and he largely echoed Waller’s view that a 75-bps hike was appropriate, and the neutral rate is likely lower than previously thought.”
Similarly, "This softening of inflation expectations is one reason why we expect the FOMC will not accelerate the near-term hiking pace and will deliver a 75bp hike at the July FOMC meeting," per Goldman Sachs Chief Economist Jan Hatzius.

And from Torsten Slok the opinion that, “With reference to the dual mandate, the Fed will later this year begin to talk about how the downside risks to growth are intensifying, and those recession risks will ultimately outweigh the shrinking upside risks to inflation.”

Lastly, is the topic of investor sentiment which we brought up a couple months ago, and with all due respect to the struggles of mid-June, does appear to be indicating a floor near current market levels.

According to Bloomberg, “Investors are in "full capitulation" as outlooks for global growth and profits are at all-time lows, according to the BofA's latest fund manager survey. Cash levels are the highest since 9/11 and equity allocation the lowest since Lehman. BofA's Bull & Bear Indicator is "max bearish" and recession anticipation is the highest since May 2020.” (See following charts).

While poor sentiment does not guarantee an immediate market bottom, history has shown that the more extreme sentiment gets in either direction, the sooner and greater the market “surprise” has usually been.

C. Technical Arguments

Machines run a majority of daily trading activity and thus any fully informed take on market activity must have some understanding of each component influencing their movements.

And while there are many ways to spin “past performance” to scare investors of what may lie ahead, an honest historical evaluation unveils a different likelihood.
“Oversold? Yes, in a big way. Weekly MACD is now more oversold than both the 2008 and 2020 lows. Going back to 1994, the 2008 weekly MACD reading was a record low reading, until this week. To reach the 40W MAV the SPX will have to plunge even deeper into oversold territory.
MACD (Moving Average Convergence/Divergence explained: The MACD is an oversold/overbought indicator that looks at the relationship between a long term and a short term moving average.” - Source: “Weekly S&P 500 Index Chart, by Gary S. Morrow, July 14, 2022 (see accompanying chart)

In Closing: Mindset Matters

Consistency and an appropriate timeframe for your goals is key to one’s financial success as JPMorgan CEO Jamie Dimon alluded to last week when asked if the economic “hurricane” that he himself had coined/mentioned would make him change course regarding his plans.

He responded by saying, “We’ve always run the company consistently, investing and doing stuff, through storms. We don’t like to pull in and pull out, and go up and go down, and go into markets, out of markets through storms…We invest, we grow, we expand, we manage through the storm.”

Investors would do well to mimic his response with regards to their plans and portfolios.

His sentiment that, "We are prepared for whatever happens and will continue to serve clients even in the toughest of times", reflects the same mindset we bring to serving our clients.

Proper preparation is why during a manic bull run while times were still “good” we preached the importance of our L.I.V.E. philosophy, of not being captive to past returns when determining your allocation, and instead encouraged investors to pare down their exposure to then winners such as tech stocks and traditional fixed income.

And for those nearing or entering retirement we pounded the table on the importance of building a portfolio that would generate sufficient income to avoid forced selling during the inevitable rough times ahead, such as the current period.

We share all the above not because we are certain of what will happen, but to counter the chorus of doomsayers out there that pretend they do. And to remind investors again that successful investing is not about predicting markets but building a plan and portfolio that are ready to both survive and thrive through all the inevitable twists and turns.

Have a wonderful weekend!

Tim and the team at TEN Capital

Data, Just the Data

Data points this week included:

  • U.S. Jobless Claims – increased by 9K to a claimant count of 251K for the week ending July 16th. The increase makes last week’s reading the highest since November 2021 and above expectations of 240K claimants. The four-week moving average increase 4.5K to 240.5K.
  • U.S. Existing Home Sales – dipped (5.4%) MoM to an annual adjusted rate of 5.12M in June. This is the lowest reading since June 2020 and below forecasts of 5.38M. This marks the fifth consecutive month of decline with housing affordability weighing on consumers. Median existing home price was $416K, up 13.4% form a year ago.
  • U.S. Housing Starts – contracted (2%) MoM to an annualized rate of 1.56M in June, the lowest since September 2021. The housing market is starting to cool with high mortgage rates putting downward pressure on home buyers as single-family starts fell (8.1%).
  • U.S. PMI Composite Flash – came in at 47.5 for the month of July, down significantly from the 52.3 reading in June, with private sector outputs sharply declining. This was the sharpest decline since May 2020, and all gains made during the Ukraine invasion have been wiped out. Export orders fell, but overall new orders expanded slightly. Employee retention, cost cutting initiatives, price inflation and charge inflation have all put downward pressure on production, albeit the inflation numbers are starting to trend down.
  • U.S. Manufacturing Index – the Philadelphia Fed index shows a fourth consecutive month of decline, contracting to (12.3) in July, the lowest reading since May 2020 and far below expectations of a flat reading. Shipments index slightly increased, but inventory and unfilled orders indexes remained negative. Future indications show firms are expecting overall declines in activity and new orders, but an increase in shipments over the coming months.
  • Eurozone PMI Composite Flash – fell to 49.4 in July after a reading of 52 from the month previous. This marks the first contraction in the private sector since February 2021, thanks to a slowdown in factory activity and services. Output and new orders contracted for the first time since the pandemic lockdowns and job growth steadied running at a 15-month low. Inflation remains high, but is moderating, but business expectations are bleak for the coming months.
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