Missed Perception

The greater the mismatch between perception and reality the greater the opportunity
– Mark H. Tekamp

“AI Frenzy Propels Stocks to Monster First Half” read the headline in July 1st’s Wall Street Journal. J.P. Morgan’s
Chief Global Strategist David Kelly was quoted elsewhere as believing “the outsized sway of technology giants over
US stocks is likely to persist, absent a major market rout.” Outsized it certainly is as the average stock in the S&P
500 declined 2.45% during the quarter in contrast to the index’s rise of 4.28%. “The Magnificent 7” stocks (Nvidia,
Apple, Amazon, Tesla, Meta, Alphabet (Google) and Microsoft) have risen 33% year to date in contrast to 5% for the
remainder of the index with the S&P 500 itself returning 15.29%. Six of the indices’ eleven sectors were negative for
the quarter, as were the MidCap and SmallCap indices and the venerable Dow Jones Industrial Average. Foreign
Developed Markets fell 0.54% though Emerging Markets rose 5.65% outperforming the S&P 500. Interest rates
finished close to where they began the quarter, allowing fixed income securities to earn their cash flow without an
appreciable decline in their market value.

The Federal Reserve seems to have succeeded in convincing the financial markets that any reduction in interest rate
this year will be modest and likely to be late in coming. Beneath the surface though a very great deal has changed,
and investors may wish to pay heed to this emerging reality. The engines of the US economy are exhibiting sufficient
thrust for the time being to keep it aloft, but it is clearly losing altitude and its ability to obtain a “soft landing”
increasingly in doubt. The Atlanta Fed’s GDPNow real GDP estimate for this year’s 2nd quarter was forecasting
growth for the quarter at over 4% six weeks ago. The current estimate is now 1.5%. Real (inflation adjusted) Personal
Consumption Expenditures one year ago were growing at a 3.25% annualized rate. It is now 0.8%. Two years ago,
employment was growing at a three-month average rate of 300,000 and the unemployment rate was 3 ½%. Now
employment is rising 177,000 and the unemployment rate is 4 ½%. Interestingly, full-time jobs have actually declined
on a year-over-year basis with the increase in employment solely attributable to the rise in the number of part-time
jobs. Meanwhile inflation shows increasing evidence of drifting down to its 2% target. The Fed’s preferred measure of
inflation, the Personal Consumption Expenditure (PCE) Core Rate (excluding Food and Energy) is at 2.74% but
excluding Healthcare, notoriously difficult to calculate due to the timing of the reset on insurance premiums, it is
below zero.

Much of the market forecasting fraternity is suggesting the possibility of a market correction due to a visibly slowing
economies effects on corporate earnings. An alternative and possibly more accurate view is that earnings are no
longer the primary driver of equity market returns having been supplanted by valuations. This is evidenced by 14% of
the 26.3% 2023 return and 8% of the 15.3% year to date return of the S&P 500 attributable to that source. And what
is the primary determinant of valuations? Interest rates because the primary demand for capital is no longer the
provision of capital for investment in the “real” economy but to provide sufficient liquidity to roll over the $300 trillion of
global debt. Lower interest rates increase the ease with which the $100 trillion global economy can roll over the
approximately $60 trillion in global debt that will mature this year. The “balance sheet” of the global economy lacks
sufficient size to retire the debt and so, like an interest only mortgage, it must be refinanced. So long as the global
financial markets permit this all things are possible. Should the day ever dawn when it does not nothing is.

The effects of the Federal Reserve’s lowering of interest rates by possibly 2% over the next six months may not be
just the extent of the rise in the equity markets but where that rise may disproportionately occur. Perhaps the market
we’ve been experiencing this past year and a half hasn’t been a bull market in stocks but rather a relatively small
share of the totality of the market experiencing something approximating a mania. Extending one’s time horizon an
additional year is helpful to obtain some additional perspective. 2022 was not a good year for investors in the stock
market with the S&P 500 declining 18.11%. Investors who purchased $1,000 of each of “The Magnificent 7” at the
onset of 2022 would have earned $4,193 by June 30, 2024, but $3,200 of those earnings came from Nvidia. The
$6,000 invested in the other six stocks would have returned 6.31% per annum, a lower return than that of 7.27% for
the S&P 500. Perhaps it isn’t the seven that are so magnificent but the one that has no equals.
60/40 portfolios returned 1.84% for the quarter and 9.90% through the year’s first half. The equity 60% share returned
2.20% and 10.60% year to date. The 40% fixed income share was +.80% for the quarter and is +.75% for the year. It
should be noted that Commercial Backed Securities (CMBS’s) are significantly outperforming the fixed income
universe as the prospect for lower interest rates is leading the market to become increasingly confident that the
commercial mortgages composing those securities will be able to be refinanced at reasonable rates when their
refinancing dates occur.

Mark H. Tekamp/July 6, 2024

Sold on Gold?

“So extraordinary a rise in the market price of Gold in this country…pointed to something in the state of our own domestic
currency…”

– The Report of the 1810 House of Commons Select Committee on the High Price of Gold

May’s reputation as unfriendly to stock market gains has long been noted as evidenced by the mantra to “sell in May
and go away.” The wisdom of that advice, at least for this year, was belied by the S&P 500 providing investors with a
return of 5%, the best performance for the month since 2009. That the love affair of investors for all things related to
AI had not yet reached the peak level of their passion was manifested by NVDIA’s 27% return for the month with
Apple joining in with 13% and even the normally pedestrian utility stocks rising 9% on the prospects for the increased
demand for electricity to power all of those artificial IQ points. Small Cap stocks modestly outperformed “the 500” and
even bonds rallied with many sectors of that market finding their way to close to break-even returns year to date.

Though having outperformed the S&P 500 by almost 40% in the past twenty-five years gold has been relegated to
being among the most forgotten of asset classes. Those proclaiming its virtues are not even dignified by being
compared to a species of animal, a bull or a bear, but that of an insect, “gold bugs.” Though the spotlight that once
shone upon it now increasingly shines upon bitcoin in the past eight months “the barbarous relic” has risen by
25 ½ % which begs the obvious question why? Historically gold tends to do well when inflation is rising, which it isn’t,
when interest rates are low, which they aren’t, and the US dollar is losing value which, at least in relation to most
other currencies, is not currently the case. Something is causing gold prices to rise at a very rapid rate and the
answering of that question might possibly offer some insights helpful to our understanding of a great deal more than
just that of the price of precious metals.

One of the most notable characteristics of life in the United States in the past third of a century has been the contrast
between the rate of growth of our wealth which has increased at a 3.3% real (adjusted for inflation) annual rate from
1990 through 2022 and the .45% annual increase in the median family income. This is further evidenced by the
performance of the US stock market which had a value equal to half that of our national economy in 1990 but was
50% larger in 2022. In other words, for whatever reason, the stock market has grown at an annual rate almost three
times faster than that of our economy.

Accompanying the rise in the stock market has been the growth of our federal government debt. From 1990 until the
Global Financial Crisis of 2008 that form of debt and the national economy grew at an approximately equal rate with a
level hovering near 60%. In the fifteen years since then federal debt has grown at a rate twice that of our economy
and is now at a level of 120%. In the past six months through April the US Treasury issued $16.8 trillion in new debt
with $15.7 trillion of it required to repay the debt that matured during that period. These are figures for six months.
Annualized, that level of debt issuance is now almost 25% larger than our national economy.

Since the onset of 2020 an acre of Iowa farmland has increased by 59 ¼% through 2023, the price of gold 55%
through May 31st and the median selling price of an existing home by 43 ½% through March. Could it be that the
underlying force propelling upwards the value of those assets is an effect not so much of the increase in their value
as it is the loss of the value of the paper money we are using to purchase those assets with? In other words, perhaps
the true source of the inflation we are observing may be an effect not so much of the rise in the price of what we are
purchasing but the decline in the value of what we are purchasing it with. And if this is true, then how should this
affect our perception of the future as investors if we are now experiencing a shift in “the balance of power” between
“paper” assets and those which are perceived as possessing real intrinsic value?

First, it may be wise to assume that the issuance of accelerating volumes of money is not likely to be reversed in the
next several years and so the sunny weather overhanging the current landscape of the financial markets may well
continue to exhibit a relative absence of storm clouds for some time. Second, it may also be wise to take note of the
relative sizes of those markets that may prosper in this future possibly unfolding scenario and those that may not. The
bond market is $130 trillion, the equity market $65 trillion, the gold market $14 trillion and bitcoin $1.4 trillion. Indeed,
it may well be the variance in size of the gold and bitcoin markets that explain the variance in bitcoin’s 100% return
the past three years and gold’s 24 1/4%. Perhaps though there is also an element of confirmation of the ever-present
relationship between risk and return.

60/40 portfolios returned 3 ¼% for the month erasing April’s decline and increasing year to date portfolio values to
their year-to-date highest level of 8 ¾%. The 60% equity share returned 4.7% with all sectors positive but with large
cap growth’s return of 6.4% notably outperforming value’s 3%. The 40% fixed income share returned 1% with modest
interest rate declines creating modest increases in the market value of those securities.

Mark H. Tekamp/June 6, 2024

Words For the Herd

“Genius abhors consensus because when consensus is reached, thinking stops. Stop nodding your head.”
–Albert Einstein

CNBC headlined on April 12th “Dow tumbles 475 points, S&P 500 suffers worst day since January as inflation woes
erupt.” Three days later UBS advised investors to prepare not for Fed rate cuts but quite the opposite suggesting
“Fed hiking rates to 6.5% is a real risk”. The financial markets had stepped into 2024 with 65% of market participants
expecting three or more rate cuts during the year. By April 18th that share had fallen to 20%, exceeded by the 30%
expecting none or actual rate hikes. The S&P 500, which started the month sporting a handsome 10.3% return, saw
that gain cut by more than half by April 19th though recovering modestly by months end with a decline of 4% for the
month but still +6% for the year.

The financial markets are doing their best this year to act in the role of Pinocchio to the Federal Reserve’s Geppetto.
Investors with memories reaching back to the start of 2023 may recall that virtually the entire fraternity of economic
forecasters was predicting the onset of an economic recession during the year. Instead, the US economy became the
focus of much admiring commentary with US economic growth rates of 2.7% for the year inhabiting a separate
universe from Canada’s ½% and Germany’s -0.3%. Let us occupy most of this commentary with thoughts on why this
was and, perhaps more importantly, the likelihood of its continuance.

It would be very difficult to discuss the current state of the US economy without focusing attention upon the federal
government’s fiscal response to the shuttering of much of our national economy in 2020. Looking at a chart of federal
spending reveals two massive increases, the 2nd quarter of 2020 and the 1st quarter of 2021. From that point federal
spending fell sharply remaining relatively stable until 2023 when it began to rise again, albeit at a more modest rate,
powered higher by the inflation-based adjustment in federal benefits payments (think Social Security). Those
increased benefits were paid for by higher levels of borrowing by the federal government with those increased
benefits then circulating through the US economy. This likely explains a great deal of our higher rate of economic
growth last year.

A bit more history but with this part measured in increments spanning decades. In the 1970’s and 1980’s the inflation
adjusted economy grew at an average annual rate of 3%. The 1990’s were a decade of transition and in the 21st
century to date we’ve seen that rate decline to 2%. There is much in economics that isn’t simple but explaining the
source of economic growth is. There are two factors that are the sources of that growth; the numbers of people
working and the level of their productivity. In the three years ending in 2023 our population grew .845% and
productivity .602% at an annual rate. That gets us to 1.447%. That is the rate we are likely migrating back to and any
notable variances to that rate of growth are likely to be temporary in nature.

A misfortune being experienced by those of our fellow citizens making their living in the real economy is their having
to pay higher prices for the goods and services they consume without an offsetting increase in their income to pay
those higher prices due to lagging growth in wages. The result will likely be lower levels of consumption, declining
rates of economic growth and falling levels of inflation. Those higher rates of growth for federal transfer payments are
now behind us so we’re likely to find the economic climate a good deal chillier than what we’ve been experiencing.
This is not necessarily a forecast of economic recession but growth rates starting with “1” likely will soon be upon us.
So, what about the financial markets? Intermediate to longer term interest rates may decline though possibly not by a
great deal. Think mortgage rates starting with a 6 and possibly 5. Prepare to say goodbye to 6% six-month certificate
of deposit rate “specials.” As unemployment rates begin to rise the fed will likely cut interest rates by 2% and possibly
more. The stock market, which is only just now starting to catch up with the future state of this reality, could rise by
another 15%. This is the world that investors inhabited from the time of the Global Financial Crisis of 2007-2009 to
the pandemic of 2020. Nothing has really changed as the final rippling effects of the pandemic subside and so this
may well be our future. For investors these are prospects they may well find pleasing in the experience.

60/40 portfolios which returned 7.8% in the first quarter gave back 2.35% of that return in April, ending the month with
year-to-date returns of +5.4%. The negativity was sourced almost solely by the previously discussed decline in the
equity markets with the slightly superior performance of foreign markets offset by the 6% decline in the small cap
space. Fixed income was slightly positive thereby protecting portfolios from experiencing more pronounced declines.

Mark H. Tekamp/May 8, 2024

Springing Into Summers

“There are three kinds of lies; lies, damned lies and statistics.”
Mark Twain; North American Review; 1907

S&P Dow Jones Indices, in its commentary for March 2024, headlined “Despite uncertainty surrounding potential Fed
rate cuts, economic strength and diminishing recession fears led to the best Q1 U.S. market performance since 2019,
with the S&P 500 up 11%.” The S&P 500 returned 3.2% for the month but the equity markets revealed some
evidence of a rising tide lifting all ships. The Value share of that index returned 4.6%, twice that of Growth’s 2.1%.
Energy stocks powered higher 10.6% versus Info Tech’s 2%. Foreign Developed Markets and Mid Cap stocks
outperformed the S&P 500 rising 3.8% and 5.6% respectively.

Lawrence H. “Larry” Summers has a resume to impress even the least impressionable. Secretary of the Treasury
from 1999 to 2001 under President Clinton, Former President of Harvard from 2001 to 2006 and Director of the
National Economic Council under President Obama from 2009 to 2010. In other words, a fellow citizen viewed as
accomplished, very wise, and with opinions worth respecting. So, on March 23rd when the former Treasury Secretary
sent out the following tweet, it became a subject of much discussion.

“I don’t know why the Federal Reserve is in such a hurry to be talking about moving towards the accelerator (cutting
interest rates). We’ve got unemployment, if anything, below what they think is full capacity. We’ve got inflation, even
in their forecast, for the next two years above target. We’ve got GDP growth rising if anything faster than potential.
We have financial conditions, the holistic measure of monetary policy, at a very loose level.”

With all due respect to the former secretary, I would like to suggest that he could scarcely be more wrong and why
the Fed should start aggressively lowering interest rates very soon if they don’t want to push the US economy into an
economic problem largely of its own creation.

First, unemployment. The report that commentators tend to focus upon is the Bureau of Labor Statistics (BLS’s)
household employment survey. It has indeed been reporting robust increases in employment. Prior to the pandemic
ADP, the nation’s largest payroll predecessor(s), household employment survey, Challenger & Gray’s number of
businesses reporting job cuts, and the ISM manufacturing and non-manufacturing employment indices all tended to
align with one another. Post pandemic that is no longer the case. Of the five cited here four indicate an economy now
growing slowly with ADP’s household survey showing employment growth in the past year of 642,000 in contrast to
the BLS’s 2.93 million. The ISM’s and Challenger & Gray align with the ADP data. It is the BLS data that is the outlier.
This is seemingly confirmed by financial markets no longer responding meaningfully to BLS’s monthly reports.

Second, inflation. The most hotly debated of all current economic topics, let’s see if we can bring a measure of clarity
to this noisy subject. Goods represent 40% of what we consume. Year over year goods inflation is 1.1% so the issue
resides on the 60% services side which employs 70% of US workers so wage rates are the crux of the inflation bears
arguments. On a quarter over quarter basis, as measured by the Bureau of Labor Statistics (BLS) Employment Cost
Index for Private Wages & Salaries, that index peaked at 6% at the end of Q3 2021. It was just over 5% at the end of
2022 and is now at 3 ½%. At its current rate of descent, it may well be at 2% by year’s end. It correlates with a lag of
approximately three months, the Fed’s preferred inflation measure, Core PCE Services ex Rent. That would lead that
measure, currently at 2 ½%, to fall below 2% later this year.

Three. The economy is growing above its potential. Another statistical anomaly. As measured by production (GDP)
the US economy is indeed growing but as measured by growth of income (GDI) there isn’t any. US retail sales growth
has mostly disappeared, growing 2.4% from June of September 2023 but 0.2% From October 2023 through February
2024. Mortgage rates are near 7%, existing home sales are down 33% from their best levels of the past five years
and with interest rate on auto loan rates reaching 10% vehicle sales are off 14% from their best levels in five years.

Four. Financial conditions are at a very loose level. He must be talking about the stock market. The interest rate on
small business loans is at 10%. Small companies need bank credit to grow, and the supply of that credit is 1% below
its level of a year ago. For our economy to grow the supply of money must be rising and it isn’t. As measured by M2,
that level has fallen by 4.3% in the past two years. Increasingly it’s looking like deflation that should be concerning us.

60/40 portfolio investors can celebrate 7.8% returns for the quarter with 8.2% returns on the 60% equity side and
7.2% on the 40% fixed income. For the month portfolio returns were 3% with equal contributions from equity and fixed
income. The fixed income side was aided notably by the 6%+ rise this quarter in commercial backed security values.

Mark H. Tekamp/April 6, 2024

Disguising the Surprise

That’s the American Dream, Can only be seen behind closed eyes;
Allowed to touch but can’t touch the prize; that’s the hook,
The bait and switch of hand is no surprise – “Sleight of Hand” ; Jeremy Betts

The February stock market couldn’t find its way to the front page of the March 1st edition of The Wall Street Journal
having to settle for a headline on the front of that day’s Business & Finance section “Nasdaq Notches a Record
Close”. Barrons, choosing to deflate talk about lighter than air objects, headlined “The Stock Market Looks Like a
Bubble. What Is It Really?” Perhaps the publication was mocking that week’s Economist’s cover of a bull being lifted
airborne by a bouquet of balloons though livestock’s 12% rise in prices is one of the few assets to outperform the
S&P 500’s two month return of 7.1%, its best start to a year since 2019 with 5.3% of that total coming in February.
Most investors would welcome signs of inflation in their portfolio returns but with 60/40 portfolios still down 5.7% over
three years many investors are not only not airborne but actually underwater.

A year ago, 99% of economic forecasters were predicting a recession in 2023. Of course, in the contrarian nature of
such things, the inflation adjusted rate of growth last year was 3.10%, above its 2.20% average annual rate of growth
in the prior ten years. Properly chastened, 76% of the forecasting fraternity believe the possibility of a recession this
year is 50% or less. Of course, the opinion that matters most, that of the Federal Reserve, is either more nuanced or,
if you prefer, confused. While expecting a 50% reduction in the US economic growth rate this year to 1.5% and with it
expecting inflation to decline further to 2.4% the Fed’s chairman has also stated publicly “…we have a strong
economy. The labor market is strong…with the economy strong like that, we feel that we can approach the question
of when to begin to reduce interest rates carefully.” Careful may be the chairman’s view of his approach to matters
but the previous two times this century the Fed had its Funds Rate at a level more than 2% above the rate of inflation
was 2001 and 2007 and our experience of the economy in the following year was, shall we say, interesting.

Four numbers, -0.38%, -0.64%, +1.93% and 3.1%. The first is M2, the most commonly used measure of money in our
economy. It is declining. The second is the extension of credit by the US commercial banking system. It is also
declining. The third number, the actual value of loans and leases extended by our banking system, is positive but it is
less than the fourth number, 3.1%, which is the most recent year-over-year rise in the consumer price index aka
inflation. Small business depends upon the banking system to extend credit and that supply of credit is declining. As
the source of 50% of the jobs and 43.5% of our economy how can small business be expected to grow in a declining
credit environment and how can the US economy be expected to grow if half of it isn’t?

Could our nation’s central bank profess to doing one thing while preparing to do something else? Certainly, no
certainty here but just supposing. The Fed, responding to the inflation resulting from the federal government’s public
policy response to the pandemic, began raising its Fed Fund’s Rate in March 2022 with its final increase occurring in
July of 2023. The inflation and those higher interest rates resulted in the market value of outstanding US Treasury
debt declining by 31%. (Lower bond prices are the source of negative portfolio returns these past three years.) Now
for a little history. Prior to the Global Financial Crisis commercial banks held very little in reserves at the Federal
Reserves. After it the Fed adopted an “ample reserves” policy and commercial banks now hold $3.5 TRILLION at the
Fed for which they are earning 5.4% and which is costing the Fed close to $200 billion in interest payments per year.
From October 1, 2023, through January 31, 2024, the US Treasury issued $9.6 trillion in new debt, 92% of which was
used to provide the necessary funds to pay off its maturing debt. The public currently holds $27 trillion of US Treasury
debt, 16 ½% in Treasury bonds with an average interest rate of 3.1%, 52 ¼% in Treasury notes with an interest rate
average of 2.3% and almost 22% in Treasury bills with an interest rate of 5.4% and maturity dates of up to one year.

The US Treasury is now paying $870 billion on its debt exceeding the $822 billion defense budget. What if the Fed
were to lower interest rates to say 3%, stop paying interest on commercial bank reserves forcing much of that $3.5
trillion into the US Treasury bill market allowing it to notably lower its interest payments on those securities while
having something left over to buy up some of that treasury debt now trading at 69 cents on the dollar? Perhaps that
equity bull might be looking for something with a bit more of a charge in it than lighter than air balloons!

Over the span of a year, it continues to look like the S&P 500 starring as Snow White with almost everything else
looking like dwarfs. Roughly stated, “the 500” is +30% with mid-cap stocks up half that much, foreign developed
markets looking like mid-caps, small caps up half as much as mid-caps and foreign emerging markets splitting the
difference between small and mid. Dare one say it? Mid-caps outperformed “the 500” in February and it is starting to
“feel” like a party to which more are invited. In February 60/40 portfolios returned 2.9% and are now +4.5% year to
date with equities contributing 4.6% to February’s return and fixed income 1.6%.

March 3, 2024/Mark H Tekamp

Running With the Bulls

”There comes a time in the affairs of man when he must take the bull by the tail and face the situation.”
WC Fields

Providing substance to the thesis that many investment prognosticators would rather be right than rich, the financial press’s take on 2023 was surprisingly curmudgeonly. The Wall Street Journal, in its December 30 edition, headlined “What Did Wall Street Get Right About Markets This Year? Not Much”. Barrons, in its January 1st edition, bemoaned the S&P 500’s inability to close at an all-time high headlining “The Stock Market Saved Its Biggest Disappointment for the Last Day of the Year” taking a rather grinch like view of the indices 24.2% return for the year while reminding readers that 2023 was the first year since 2012 that the index had failed to make at least one record high during the year.

Stock market investors new best friend, Federal Reserve Chairman Jay Powell, was having none of the punditry’s proclivity towards negativity as he offered the promise of what every investor had at the top of their shopping list, lower interest rates! At the chairman’s press conference on December 13th, he spoke words that got stocks hot ‘round the world “if the economy evolves as projected, the …appropriate level of the federal funds rate will be 4.6% at the end of 2024…” There! He said it! Rate reductions of ¾ of a percent next year! From the moment those words left the chairman’s mouth at 2 pm that day to the market close two hours later the Russell 2000, an index of small US companies, rose 4%.

Could it be that markets are starting to “sniff out” something missed by almost all of those ophthalmologically challenged market commentators? A perusal of the data the Fed releases at the conclusion of its meetings reveals that the Fed expects US economic growth to decline from 2.6% in 2023 to next year’s 1.4%, a near 50% deceleration of expected growth in the economy and materially below the 2% rate widely considered “normal”. Those numbers also reveal the Fed expects inflation levels to decline further next year to 2.4%, very close to the Fed’s inflation target. Economists dispute the exact level of interest rate which neither contributes to nor detracts from economic growth rates, but opinions tend to gravitate towards ½% above the rate of inflation. Simple arithmetic is the 2.4% expected rate of inflation + ½% neutral rate of interest equals 2.9%, versus the current Fed Funds rate of 5.5%, offers the prospect of 2.6% possible rate reductions next year. This may be the true source of the sweet aroma wafting upwards past the nostrils of stock market bulls. It may also be that the truly contrarian call for 2024 is for investors to ask themselves “as bullish as you are, are you bullish enough?”.

As we prepare to cast this fed rate tightening cycle into history let’s take a look at an explanation for it resting on the possible existence of ulterior motives, while acknowledging the reality of the near to total misalignment of its cited cause and actual effect. We’re not cynics but are fond of the phrase “cui bono” (who benefits). If the objective that exceeds all others in order of importance is the maintenance of the solvency of the United States government, and if the key measure of that solvency is the outstanding market value of US Federal debt in relation to the nominal (non-inflation adjusted) value of the US economy, then perhaps we have a useful starting point. In the ten years ending 2019 US nominal GDP grew at a 4.1% annual rate. In the three years from Q3 2020 through Q3 2023, due to the higher rate of inflation, that rate rose to 6.3%. With the rise of interest rates the market value of previously issued Federal debt declined in value. On January 1, 2022, the outstanding market value of US Treasury debt was $23.4 trillion. From January 1, 2022, through November 30, 2023, the US Treasury issued $3.9 trillion of additional debt but as of November 30, 2023, the market value of that debt had risen by “only” $765 billion meaning that 80% of the value of the “new” debt was offset by the losses experienced by the holders of the “old” debt. Whether this confluence of circumstances was coincidental or not, it did allow the United States Treasury to issue trillions of dollars of new debt while achieving the remarkable outcome of the outstanding balance of US Treasury debt remaining stable as a share of US GDP from 2019 through Q3 2023. Cui bono?
S&P Dow Jones Indices, in their recapitulation of the 2023 market, remained focused on the Magnificent Seven stocks, AI and info tech but that is starting to acquire the feel of yesterday’s story as small cap stocks 12.8% returns for December notably outperformed the 4.5% return of the 500, value outperformed growth, real estate’s 8.7% exceeding info tech’s 3.8% and even foreign developed markets 6% outperforming. The fixed income tortoise finally caught up with the equity hare as 60/40 portfolios returned 13.8% for the year with the equity share returning 22.35% for the year and fixed income eking out a miserly 1% but the tortoise did awaken returning 6.875% versus equities 11.5% for the quarter and 4.875% versus equities 5.50% for the month with the portfolio providing overall returns of 8.75% for the quarter and 5.25% for the month. 60/40 portfolio investors longing for the day when they recapture the remainder of their 2022 losses may not have to wait very much longer as they are now but a modest 4 ½% away.

December 30, 2023/Mark H. Tekamp

Foller the Dollar

”I found a dollar the other day, it lay there on the ground; I wondered who had dropped it, and I had to look around…”
The Value of a Dollar Poem; Janice M. Pickett

CNBC headlined its story of the stock market’s final trading day of November “Dow jumps 500 points to new 2023 high Thursday capping 8% November rally”. Though only separated by a single month, October seemed recast as an occupant of an alternative reality as that month’s unwelcome tricks were thankfully subsumed by November’s treats. The S&P 500 returned 9.1% for the month and is now up 20.8% for the year. Unlike every other month since February this was a party to which all sectors of the financial markets were invited as mid-cap stocks were up 8.5%, small cap stocks 8.3% and foreign developed markets 9.6%. Even the previously woebegone bond market participated as ten-year treasury rates declined by half a percent to 4.4% allowing the majority of fixed income securities to migrate from negative to positive returns year to date albeit with most sectors of that universe providing modest returns in the low single digits.

The source of the sudden turn in fortune for the financial markets is to be found where it almost always is these days, in the words from arguably one of the most famous men on the planet, US Federal Reserve Chairman Jerome Powell. At the press conference on November 1st, following the fed’s two day meeting, it wasn’t so much what he said, that the fed had opted not to raise interest rates which was not really news since no one expected that to happen anyway, but rather that the fed had chosen to hold interest rates at current levels to allow it to determine whether rates had risen to a sufficient level to permit it to claim the accomplishment of its mission of pushing inflation back down to its 2% target. Attempting to square the circle of the sizzling 5.2% annualized inflation adjusted economic growth rate for the 3rd quarter with a rapidly declining inflation rate, the chairman essentially said that since he didn’t know what to do, he would opt to do nothing.

Like so much of our current perceived state of reality, the proper correlation of causes and effects appears to be a form of art increasingly served rarely. Let it be offered as a suggestion that the market that is the most important one is that which establishes the value of the US dollar. The reason why is the existence of the two numbers that matter most; global debt which is $300 trillion and the size of the global economy which is $100 trillion. As global debt has grown at a rate notably faster than that of the global economy for the past several decades, the world has lost its ability to retire that debt and therefore must continually refinance it. In other words, to “roll it over” in a fashion much like the extending of the terms of the maturity on an interest only mortgage. Since the Global Financial Crisis of 2008, the money that is borrowed to pay off current debt through the issuance of new debt is required to be collateralized; the borrowers’ use of securities as a means of guaranteeing their ability to repay their debt. Though the US represents only a quarter of the world’s economy, 70% of global debt is financed using the US dollar and the preferred form of collateral to support the issuance of that debt is US Treasury securities. The global financial system has become a debt-based system dependent upon the ever-increasing supply of US Treasury debt and that, dear reader, is the reason why the US dollar has assumed the role of the financial market dog wagging the equity market tail.

As the US Federal Reserve has raised interest rates from ¼ % in March 2022 to 5 ¼% currently, the result has been to increase the flow of foreign capital into US dollar-based assets resulting in an increase in demand for dollars and an increase in its value. This matters because a more expensive dollar makes it more expensive to “roll over” the global debt mountain. From March 1, 2022, to September 27, 2022, the US dollar rose 17.3% and the S&P 500’s declined 14.5%. From October 5, 2022, through August 1, 2023, the US dollar declined 8.2% and the S&P 500’s rose 22.6%. Since October 28th the US dollar has declined 3.2% and the S&P 500 has risen 11.8%. So, what should investors now expect from these markets? The growth of US budget deficits, which has been the source of much of the US economy’s surprising strength this past year, is now starting to wane. US inflation levels may quite possibly undershoot the fed’s 2% target. This is what the financial markets rally in November is starting to “sniff out”. US equity markets, excluding the mega cap tech stocks, haven’t done particularly well the past two years leaving midcap stocks currently valued at 13.6 and small cap stocks 13 times 2024’s expected earnings. Even the equally weighted version of the S&P 500 is trading at 15 ½ times this year’s earnings. With reasonable valuations, falling inflation and declining interest rates we may quite possibly be setting ourselves up for some very interesting times.

For 60% equity and 40% fixed income investors the onset of the year through the end of Octobers was all about a great deal of motion with little in the way of forward progress. November’s portfolio returns of 6% received contributions of 9% from the equity share with fixed income contributing 1.5%. The equity contributions were relatively evenly distributed with large cap and small cap US and foreign returning between 8% and 9%. Year to date portfolio returns are now at 8.2%.

Mark H. Tekamp/December 6, 2023

The Great Rate Abate

”What is easiest to see is often overlooked”. – Milton H. Erickson

After two years, could it have been for the entirety of that time that it really was so simple? Recollecting how many thousands of words have been written debating the prospects for economic recession, inflation rising or falling and the prospects for a notable decline in the stock market due to falling corporate profits, one is struck by how many false paths have been followed. Could it be that the entire time we were gazing into our crystal balls attempting to divine the future, what we were most fearful of was what was being experienced? What if the bear market we were so afraid of experiencing these past two years, due to our need to navigate our way through an aggressive Federal Reserve rate tightening cycle, is not something we need fear as part of our future but is now part of our past?

From January 1, 2021, through May 31, 2022, the consumer price index had risen at a 9% annualized rate in those seventeen months with 10-year US Treasury rates tripling from .93% to 2.85%. From June 1, 2022, through October 31, 2023, the annualized rate of inflation has fallen to 2.6% but with Treasury rates continuing their rise to 4.88%. In the past two years through October 31, 2023, the two-year total return of the S&P 500 of -5.95% obscures the true state of negativity of the financial markets. 60% equity & 40% fixed income portfolios have declined 15.64%. The version of the S&P 500 with each stock in that index equally weighted has declined 13.9% and the S&P 600, an index of US small cap stocks, has fallen 18.6%. The price of the average investment grade taxable bond in the United States has declined 15.4%. Of the major asset classes only gold and commodities have provided investors with positive returns.

With Jay Powell preparing to take his victory lap for having placed the inflation genie back in its bottle, it might be interesting if we were to pause to consider the strength of the correlation between the falling inflation rate and the timing of the fed rate increases, which began in March 2022. Three months after that first rate increase, the inflation rate reached its peak in June 2022, although the fed had only raised interest rates by 1.5%, or less than one-third of the total of the 5% increases from March 2022 to its most recent increase on July 25th of this year. Energy prices had risen by 70% from October 2021 to June 2022. Since then, they have fallen 34%. Is that the fed’s rate increases or geopolitics? What about all of the press conferences in which Jay Powell stated that inflation was unlikely to fall to acceptable levels without a slowdown in the rate of economic growth? If this was true, then why has the rate of inflation fallen so significantly while the inflation adjusted rate of US economic growth has risen from 1.8% in the year ending October 2022 to 2.95% this past year? Perhaps the greatest mystery has been why so many of the American people have either been convinced, or perhaps convinced themselves, that the pain of higher interest rates has been in any way contributory to the return of the rate of inflation to close to its pre-pandemic levels.

Let’s be clear that the Federal Reserve is responsible for setting the Federal Funds rate, an interest rate establishing the cost of overnight borrowing, NOT the interest rate on 10-year US Treasury bonds which is set by the supply and demand for those securities in the financial markets. Nonetheless, it is quite plausible to suggest that the increase in short-term interest rates has been a significant contributor to the rise in the 10-year treasury borrowing rate. It is also a simple matter to establish that the behavior of interest rates have been the single greatest contributor to the return, or lack thereof, of the equity markets. From April 1, 2021, through December 31, 2021, the interest rate on ten-year treasuries declined from 1.72% to 1.52% and the S&P 500 rose 19.8%. From October 1, 2022, through July 15, 2023, the ten-year treasury rate remained unchanged at 1.74% and the S&P rose 27.4%. The correlation is obvious and should provide a great deal of hope to investors in the financial markets. If the Federal Reserve is responsible for the raising of interest rates and the Federal Reserve is done raising interest rates AND equity markets only need stable if not declining interest rates to move to higher levels, then perhaps it is time to prepare for the possibility of much better times for investors in the not very far distant future.

60% equity & 40% fixed income portfolios returned -2.35% in October and are now up a miserly 1.48% for the year. The S&P 500 was -2.10% for the month though up 10.7% year to date. Mid-cap and small-cap stocks were both down over 5% in the month and both now show negative returns for the year with mid-cap stocks -1.30% and small-cap -5%. Foreign developed markets were -3.5% for the month but still +3% for the year. The story of the equity market year to date remains frustratingly consistent; a stock market that continues to rise on the backs of eight single companies; Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Netflix, Nvidia and Tesla. Netflix is the worst performing of the eight returning 39.6% and NVIDIA the best returning 179%. The eight companies now represent just under 50% of the S&P 500 Growth Index which explains that indices 15.26% return year to date though down notably from its return of 26% on July 28th.

Mark H. Tekamp/November 7, 2023

Strive for Five!

Best things dwell out of sight, The pearl, the just – our thoughts. Most shun the public, are legitimate and rare. “Best Things dwell Out of Sight” – Emily Dickinson

The Wall Street Journal of September 29th treated its readers with a pair of kid gloves headlining its article describing the performance of that month’s equity markets “Stock-Market Rally Sputters in New World of Soaring Bond Yields” as the months -4.8% return transformed the 3rd quarter’s return to a -3.3% and applying a haircut to its year to date return reducing that figure to +13.1%. S&P Dow Jones, in its commentary of the month’s market, chose to describe it as a market rally that “fizzled,” citing 10-year Treasury yields rising to 15-year highs, renewed inflation concerns and worries about the Fed’s “hawkish” guidance. Talk of “soft landings” seemingly went AWOL amid increasing references to the possibility of “crashes” and some market commentators citing what they perceive as parallels between current market conditions and those preceding the market conditions of 2008-2009. Proving that fear can be contagious, the needle of the CNN Fear & Greed Index now finds itself residing in the Extreme Fear space.

A consumer of commentaries on the economy and financial markets should be struck by the increasing length to which those commentators are going to find evidence to support their narratives. Demography, one of the longest term of variables, is cited to support the thesis that inflation is likely to remain higher for longer. Federal budget deficits, which have been large for a long time, are now at a crisis point. Another reason for the likely persistence of inflation is that the US workforce has grown militant and increasingly prone to demand very high wage increases though only 10% of the US workforce is unionized. Another source of worry is that those same workers that are demanding significantly higher wages, as they spend down their pandemic sourced savings accounts, are viewed by some as increasingly likely to default on their credit card debt and sink under the burden of their renewed student loan payment obligations. What they do not include in their narratives is that those same households’ cost of servicing those debts, in relation to their income, is below that of any year in the past thirty-four years. And US corporations, which are claimed by some to be about to buckle under their need to refinance their debt at today’s much higher rates, are currently able to service those same debts at a cost that, in relation to our national economy, is at its lowest share in more than forty years and 40% lower than four years ago. Perhaps the greatest surprise for those willing to step outside the realm of opinion into that of fact is how stable this year’s economic environment is with a great many of the various indicators used to measure the current state of our national economic well being represented by close to horizontal lines; in other words, our national economy is very much in “steady as she goes” mode.

Why bother with the financial markets, the beleaguered investor may be forgiven for asking. 60 (equity)/40 (fixed income) moderate investment portfolios have created negative returns in the past twenty-four months. The losses aren’t large, likely near 6%, but why not just step over to the sidelines and roll over six-month Treasury bills paying 5 ½% with NO risk? No need to worry about inflation, recession, government shutdowns budget deficits etc. Once things “look” better, say after the presidential election next year, one can always get back into the market and experience the better days to come. This seems like such a sound proposition it is tempting to view its logic as very close to compelling. History though may offer a counter argument. We are either at or very close to the end of this rate hiking cycle; the seventh since 1984. In the prior six episodes the S&P 500 returned ON AVERAGE 20% in the succeeding twelve-month period. Market declines are the price investors pay to be in the stock market. Perhaps the price is close to having been paid. Perhaps the greater risk is missing the reward. Recent market behavior provides additional evidence to support the possible wisdom of not exiting this market. Call options are a “wager” on higher stock market prices and put options are their opposite. Negative wagers on this market are currently at the highest levels since two prior times this past twelve months. This first time, December 19th of 2022 the market was 10% higher on February 2nd. On March 8th the market was 15 ½% higher on July 28th.

Q3 2023 provided investors with something they had not experienced in the year’s first half, with the fixed income portion of the portfolio outperforming that of the equity. This was partially attributable to the equity market’s overall decline of 3% in the quarter. The fixed income share though, experienced modestly positive returns of 1.5% leaving 60/40 portfolios -2% for the quarter and +4.6% year to date. Equity markets in the quarter offered investors little in the way of safe harbors as most equity holdings created returns of between -2% and -4% with small cap stocks underperforming a bit more. The relatively good behavior of fixed income during the quarter was attributable to interest rates rising in the intermediate to longer term maturity range but shorter-term maturities remaining relatively constant allowing investors to earn their cash flow without declines in the value of their principal.

Mark H. Tekamp/October 7, 2023

Bytes, Apple & the Atom

When the woman saw that the tree was good for food, and that it was a delight to the eyes, and that the tree was desirable to
make one wise, she took from its fruit and ate; and she gave also to her husband with her, and he ate. Genesis 3:6

The news of the final trading day of August, if it was news, decidedly didn’t seem particularly “new”. “Morgan Stanley analyst predicts S&P 500 could leap another 11% this year boosted by “Magnificent Seven” stocks”. So opined Fortune. Apple Ends Historic Winning Streat. The i Phone 15 can’t come soon enough” from Barrons. And finally, from MarketWatch, “Alphabet Inc. Cl A stock outperforms market on strong trading day”. The hottest month of the year didn’t exactly warm up the financial markets but, perhaps anticipating autumn, it certainly did bathe them in a sea of red. S&P Dow Jones publishes a collection of sixty indices at the end of each month. Of the sixty fifty were red with the thirty covering the domestic stock market containing only three not of that hue. For the S&P 500 it might have been worse as the index was down 4.7% by the 17th prior to rallying 3.1% to finish down 1.6% for the month. The negativity was more pronounced everywhere else as small cap stocks slid 4.1%, midcap stocks 2.8%, foreign developed markets 3.7% and emerging markets 4.4%. Ten-year US Treasury rates starting the month at 3.97% hit a peak of 4.34% on the 21st finishing the month at 4.12%.

The most pronounced sound for those listening to the financial markets may have been that of the towels being tossed in by those market observers harboring opinions bordering the optimistic on the economy or the financial markets. The recession, though deferred, is most certainly coming. Inflation, though indisputably lower, may soon reverse course though that may not matter since Jay Powell seems determined to throw the rocks of higher interest rates until something breaks. The stock market is certainly overvalued, and US federal finances are in a state not too far distant from the catastrophic. Rather than seeking to speak truth to the market though, perhaps it might prove to be more profitable listening to what it is saying. Homebuilding stocks are up 20.6% in the past three months, more than twice the S&P 500’s 8.3%. The returns on those stocks most sensitive to the rate of economic growth are now outperforming those stocks least sensitive to it at a rate that is at ten-year highs. Finally, one of the best contrarian indicators has proven to be the rate of change at which investment strategists are lowering their price targets for the stock market. Century to date those levels have only been exceeded in 2003 and 2009, years AFTER major bear markets. What’s not to love?

Peter Thiel is famous for having said “you can invest in companies that deal in bits or you can invest in companies that deal in atoms.” This was his exhortation to invest in companies that are asset light and knowledge intensive (technology) rather than those that are asset heavy and make stuff composed of atoms (industrials). Certainly, those who took his advice when he spoke those words in 2014 have been well rewarded. In 1997 the services share of the economy was 80% larger than that of the industrial. Today it is 170%. Interestingly though, there are a collection of businesses that exist within the Industry sector of the stock market whose returns have nearly doubled at 260% the 131% return of the Information Technology sector in the past five years. Companies composing that industry such as WillScot Mobile, MYR Group, IES Holdings and Primoris Services are not exactly household names. The companies we are discussing are in the Construction & Engineering business.

Could it be that our economy is migrating to a new era in which the rewards are earned disproportionately by those companies which make rather than break things? A not small part of the story here is that the industrial part of our economy has now reached a size where even modest shifts in favor of the industrial part of our national economy represent very large changes in revenue and earnings for companies that are just not that large. WillScot Mobile (WSC) for instance had revenues in the second quarter of $582 million versus Apple’s $81.80 billion, with the latter company’s market capitalization of $2.93 trillion exceeding that of the former’s $8.092 billion, making Apple 362 times more valuable. Finally, the Bureau of Labor Statistics (BLS) employment growth forecast for the period 2021 to 2031 is interesting with the five greatest expected growth rates being Support Activities for Mining, Electrical Equipment & Component Manufacturing, Power & Communication Lines & Related Structures, Utility System Construction and Building Construction.

As mentioned above, for investors August was a veritable sea of red but it might have been, and actually was intra month worse, as 60/40 equity/fixed income portfolios finished down for the month 2.6% but better by 2% than their levels on the 17th of the month. Only equity investors holding concentrated exposure to energy stocks saw green while everything else wasn’t. The equity share of portfolios, though down 2.6% for the month, is still showing handsome returns of +14.6% year to date. Fixed income though continues to lag as higher interest rates percolate their way throughout the yield curve creating negative returns of 2% for the month and -4.5% for the year leaving portfolios with returns of 7 ½% year to date.

Mark H. Tekamp/September 2, 2023