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

Fine Without China?

The sun sets behind the mountains and the Yellow River flows into the sea;

To thoroughly enjoy a thousand mile sight, climb up another level – “Climbing Stork Tower” – Wang Zhihuan

August 1st’s Wall Street Journal’s celebration of July’s stock market rise headlined “S&P 500 Extends Winning Streak to Fifth Month of Gains” was subdued with another story that day cautioning “Earnings Season Threatens Lofty Stocks. The Benefit of Owning Stocks Over Bonds Keeps Shrinking”. Indeed, though concerns about imminent recession and persistent and elevated inflation have continued to fade, there is also the reality of longer-term interest rates rising, a 14% increase in oil prices and the US Treasury’s announcement on July 31st of its plans to borrow in excess of $1 trillion dollars in the 3rd quarter. Issues that offer questions with uncertain answers.
The writer of this commentary proposes to discuss the influence of China in the life of the US economy and financial markets in less than one page, seeking to accomplish an objective that others have sought to achieve through a much more profligate use of words. The reason is that it is becoming increasingly apparent that the imbalances of the relationship between the two countries have now reached such extreme levels that the time of their reversal has grown near. That poses the prospect of dramatic change as well as challenges for the global economic and financial markets over the next ten years. So, it may well be wise for us to expend the effort to understand these changes and challenges; an effort we will attempt to accomplish through our exploration of four specific topics.

First is that while China’s and the US’s economies have a profound influence upon one another, they are in no way similar. The foundation of our economic system rests upon the employment of capital where it is possible for it to earn the highest rate of return. China’s economic system, in contrast, can best be described as a communal form which seeks the highest level of output through the full utilization of employment and other resources. This explains what is often referred to as “the hollowing out” of our economy as much of our economic capacity has migrated to China and its much lower costs of production. This is reflected by investment representing 43% of China’s economy versus 21% of our own, with personal consumption composing 68% of the US economy versus 38% of China’s.

Why this matters (point #2) is because China’s trade surplus with this country, $383 billion in 2022, is financed through its employment of debt which, since the global financial crisis of 2008, has grown at a rate much faster than its economy. While its total debt in relation to the size of its economy is half that of the US, our economy, when measured on a per-capita basis, is six times greater. This means that China’s ability to service that debt is one-third of that of our own. The global economic system must ultimately balance and so China’s trade surplus is the mirror image of US federal budget deficit, which now exceed the size of the US economy for the first time since World War Two. As the economist Herb Stein posited in 1986, “if something cannot go on forever, it will stop.”

Point #3. In 2000 China represented 7 ¼% of the global economy. It is now 18 ½% with that country the source of one-third of global economic growth the past forty years. It is the producer of 60% of the world’s cement, 50% of its steel and is the consumer of more than 50% of its aluminum, coal and iron ore. As a significant share of the world’s manufacturing capacity migrated to China, the cost of manufactured goods declined, leading to lower levels of inflation, falling interest rates and rising levels of global debt. Much of China’s trade surplus with the United States, and its resulting accumulation of US dollars, was recycled back to the United States through its purchase of US treasury securities, freeing up capital in this country for employment in the financial markets, explaining at least in part, the long running bull market in US equities.
Our final point is that the current geopolitical tensions between the United States and China should perhaps be understood as an effect rather than a cause. The two countries are destined to “decouple” from one another, not entirely but to a significant extent, because, quite literally, we can no longer afford one another. Each will go its own way and that, in the economic and financial sense, changes everything.

The July stock market was a dispenser of equal opportunities as the share of the market participating in the recent uptrend broadened significantly with the 5.5% rise in small cap and 4.1% in mid cap exceeding the 3.2% of the S&P 500. The value share of the S&P 500 returned 3.4% versus 3% for the growth, and energy stocks’ 7.3% return notably outpacing technology’s 2.6%. 60/40 portfolios returned 3% for the month with the slightly negative returns on the fixed income 40% pulling down the 3 ½% contribution of the equity 60%, leaving portfolio returns at 10% year to date.

Mark H. Tekamp/August 6, 2023

The Recent Past Won’t Last

Yesterday is a mystery-where it is today; While we shrewdly speculate flutter both away

Emil Dickinson – “Yesterday is History”

“Market Monster 2023 Rally Defied All Expectations” read the headline in the July 1st Wall Street Journal. “Stocks burst out of a bear market with the Nasdaq Composite up 32% posting its best first half of the year since the 1980’s” began the story. Interestingly, 2023’s first half return for the S&P 500 of 15.9% places it as tenth best in the years since 1951 serving as a counterpoint of 2022’s -15.6% as the third worst. (note that these are “price only” returns and do not include returns attributable to dividends). While technology stocks continue to grab the headlines Carnival Cruise Lines was the month’s best performing stock returning 67.7% for the month and 133.6% for the year with Delta Airlines the fifth best up 30.9% and 44.7% respectively. Providing further evidence of the notable broadening out of the market in June was the outperformance of small cap and midcap stocks returning 8% and 9% respectively versus the S&P 500’s 6 ½%. For those keeping score the S&P 500 is now just 6% from reaching its all-time high of January 3rd of last year.

With the rising temperatures of summer seemingly having sent the bear population back into hibernation perhaps it might be helpful to recognize the existence of some creeping shadows whose outlines are becoming visible. While not necessarily having a significant impact on our economy until next year we should not forget that equity markets tend to begin to discount such events approximately six months prior to their actual appearance. In the interests of brevity, we’ll focus upon just three; mortgage and student loan payments, the downward migration of the number of job openings in relation to job applicants and the coming depletion of the surplus savings of the US population.

The market for single family homes in the US is composed primarily of the resale of existing homes as that volume exceeds the purchase of new homes by a factor of seven to one. The average mortgage payment in this country is $1672 and most of those are fixed at rates of between 3% and 5%. At current interest rates the average payment is now $2300. Homeowners have been loath to sell their homes as evidenced by a near 20% decline in the volume of existing home sales year over year which has acted to support housing prices. The decision to move though, in most instances, is one that can be deferred but not postponed. Gradually, owners will sell, buyers will buy, housing prices will adjust downwards and increasing numbers of households will be faced with notably higher monthly mortgage payments. Add to this the US Supreme Court’s ruling on June 27th that 42.3 million Americans who have enjoyed three years of forbearance on making payments on their $1.6 trillion in student loans will need to start making payments in October on those loans averaging $275 month.

Investors stepped into 2023 being continuously reminded, by almost everyone with an opinion on the subject, of the inevitability of the coming recession. This year is now half over, and an increasing share of those prognosticators have come to believe that our national economy may slow but will continue to, at worst, muddle along. A significant likely contributing cause to our having avoided more challenging economic circumstances is the $2.6 trillion we received, primarily from the federal government, for pandemic relief. We’ve spent that down to $1.2 trillion as of April and, at the current rate of their depletion, household savings will be back to their pre-pandemic levels in just about a year.

Finally, many have been struck by the plethora of “help wanted” signs just about everywhere one is able to spend their money, as prominent as American flags at a 4th of July parade. This is a significant contrast to the first eighteen years of the 21st century when those seeking work outnumbered the jobs they were seeking. That started to change even prior to the pandemic but by the onset of 2021 job openings outnumbered those seeking them by over two to one. Currently we’re at 1.6 with that rate heading steadily lower. With that rate still elevated, workers losing jobs can easily find another so the slowdown in the rate of new job creation has not yet translated into higher rates of unemployment. But should the economy continue to experience a decelerating rate of growth, those losing jobs will end up becoming unemployed and the rate of growth in wages will lessen.

Ok. The end of June is the end of the month, end of the quarter and end of the first half of the year so lots of numbers. So far this year it’s been up to the equity part of the portfolio to do all of the heavy lifting of creating positive portfolio returns. Year to date the 60% of the portfolio that is invested in equities has returned 13 1/2% but with portfolio returns over that time returning +7% the 40% fixed income share has contributed -3% as stubbornly persistent and elevated interest rates remain that way. June contributed 6% or just under half of equities’ year to date returns. The great majority of the second quarter’s earnings were earned in June and roughly equal shares of those 7% portfolio returns were earned in both the 1st and 2nd quarters.

Mark H. Tekamp/July 8, 2023

Heads & Tales – December 2020 Commentary

“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.”
-John Adams, the 2nd President of the United States

Investors may not be currently celebrating all aspects of the current state of their lives, but it would be understandable if they were to pause to tap their pocketbooks an extra time or two and proffer a smile. Three months ago, investors were celebrating near breakeven, but the 4th quarter made it a year of some cheer with the average 60/40 equity/fixed income investor up 11.2% for the quarter and 13.7% for the year.

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At times, from the perspective of portfolio management, its best to spend the entirety of the twelve months dancing with “the one what brung you” but for this year’s 4th quarter it would have been an excellent idea to “change partners”. The S&P 500 was +18.4% for the year and +12.1% for the quarter. Not bad. Small cap stocks though were +31.3% for the quarter but a more modest +11.3% for the year. Financial stocks were +23.2% for the quarter but -1.7% for the year. Technology was up 11.8% for the quarter matching the return of the S&P but their +43.9% for the year more than tripled it.

Inflection points, as they relate to financial markets, are particularly challenging because they happen very infrequently and yet when they do, a great deal that we found to be useful in understanding the past is of limited value in our understanding of the future. We need a new playbook because we’re playing in a different game.

So, lets pause and entertain a number of “what if’s”. What if both inflation and interest rates are no longer going to remain at these levels but will instead be heading higher? What if we are poised to experience a migration in the “balance of power” from the financial markets to the real economy resulting in the returns of the financial markets becoming increasingly dependent upon the return those assets earn in the real economy? What if we are entering into a renaissance of work where working people earn more and capture more of the wealth that they create?

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Lest the commentator be thought to have lingered too long at the holiday punch bowl, lets add some facts to support this forecast of future reality. Central Bankers. The good news is that they do have the ability to learn from their mistakes. The better news is they’ve made plenty, so they’ve learned a great deal. After the Global Financial Crisis Ben Bernanke set out to save the financial system. And he did. Then he set out to help the economy by lowering interest rates believing that lower rates would lead to an increased demand for borrowing. But they didn’t as households were more focused upon survival than lifestyle enhancements. So, all that money the Federal Reserve, and other central banks around the world, created got stuck on their balance sheets instead of flowing into the real economy.

The United States Government is aware that as it seeks to carry the economy through the pandemic the key to its success will be to migrate money from central bank balance sheets to household bank accounts. This year the budget deficit will be our friend as it will create additional economic demand as well as contributing to the wave of liquidity that will support the financial markets in the year ahead. That increased amount of money in your pocketbook? Spend some of it!

Mark H. Tekamp January 3, 2021

Rotation Flirtation – November 2020 Commentary

“Change is the law of life. And those who look only to the past or present are certain to miss the future.”

– John F. Kennedy

November may not have included Christmas, but it certainly left investors feeling thankful. The best single month for the Dow Jones Industrial Average since 1987. The best November for the S&P 500 since 1928. The DJIA was up an eye watering 12.14% for the month, the S&P 10.95%, small cap stocks 18.17% and foreign developed markets 15.26%. At the end of October there were pockets of green surrounded by nearly equal areas of red. One month later global stock markets look like the Emerald Isle.

The four strongest sectors leading the S&P higher for the month were, in order of their performance, Energy (+25.85%), Financials (+16.90%), Industrials (+15.97%) & Materials (+12.51%). Interestingly, since 1960, there have been only three other periods when these four sectors were simultaneously up over 10% during the same two-week period, 1973, 1981 and 2008. Those prior three instances occurred either late in recessions or early in an expansion. On average the market was up 24.3% one year later. Perhaps in 2021 Christmas will be a twelve-month holiday!

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Much commentary on the market has sought to explain November’s gains through the perspective of public policy responses to the pandemic such as the rolling out of vaccines, the possibility of additional stimulus or other means of encouraging economic activity but the numbers may actually be telling us the economy is not only not on life support but actually dancing. Corporate earnings in the 3rd quarter were HIGHER than those of the 4th quarter of 2019 and are now at their highest levels in history. Home sales are UP 41.5% versus a year ago and 29.1% from January. The inventory of homes available for sale has collapsed from 6.8 months in April to 3.3 in October, the LOWEST level on record going back to 1963. New orders for durable goods, a key measure for business investment, are up 43.7% from their April lows and are now just 2.2% below their February pre-pandemic levels. Behind the dark print of most news headlines lies a great deal of positive economic sunshine!

Proponents of portfolio diversification have at times in recent years felt like a traveler waiting at the station for a train whose arrival seems to be perpetually delayed. $10,000 invested in the S&P 500 ten years ago is now worth $39,447. Had those funds been invested in foreign developed markets that same $10,000 would have grown to only $17,425. Invested in the half of the S&P described as value stocks that amount of money would have grown to $28,548, not bad but significantly less than the $45,777 reward for having invested in the other half of the S&P representing growth stocks. US small cap stocks performed at a rate equal to three-fourths that of the S&P growing to $27,661. Technology stocks would have grown to $57,235 and Energy stocks would have SHRUNK to $7,676.

November delivered to investors the most dramatic change in stock market leadership since 2008. S&P value stocks were +12.88% versus growth’s +9.70% though their year to date returns are -2.07% and 28.24% respectively. The S&P’s 10.95% return for the month was exceeded by foreign developed markets 15.26% but the S&P is +14.02% versus foreign 5.33% for the year. Energy stocks were +28.03% for the month more than doubling technology’s 11.43% but the latter is +36.08% for the year while energy stocks are still in the basement -36.47%. Is the market changing its melody? Stay tuned!

Mark H. Tekamp December 2, 2020


Know Member – October 2020 Commentary

“When we make the unfamiliar familiar, make the unknown known, make the uncomfortable comfortable…we can then expect the unexpected” – James K. Glassman 

The writer of the article in Friday, October 30th’s Wall Street Journal was clearly mystified. Even the headline for the article was mystifying. “Pandemic Brings New Restrictions on Restaurants and Retailers as Demand is Rising”. The article went onto include the following passages. “Surge in U.S. Coronavirus cases comes as more people are dining out and stores struggle to find workers ahead of holidays. Outback Steak House’s president says the chain hasn’t seen a drop in dining demand since Covid-19 case counts started climbing again this fall.”

Most commentaries on the outlook for the economy are as chilly as the looming Winter weather. Following are some quotes from someone who is generally considered to be an economic optimist. “Challenging times abound”, “stimulus tailwinds are fading, and economic growth appears likely to slow down until more stimulus is passed and/or a vaccine is widely distributed.” Most American’s believe in their ability to pursue what they believe to be reasonable precautions to safeguard their health and that of others but Americans want their lives back and it’s a pretty good wager that happens because, as the above quotes from the Wall Street Journal indicate, it is already happening.

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How badly was our economy damaged due to the public policy response to the pandemic? In the second quarter of this year the reported decline was 34.3% but that was a one-quarter figure annualized. Americans could be forgiven for being under the impression that our economy had shrunk by a full third in three months. For some clarity, it may be helpful to look at the size of the US economy over the prior three quarters for a more accurate measure of where we were and where we are. At the end of 2019 US GDP was at 21.73 trillion, at the end of 2020’s 1st quarter 21.54 trillion, 2nd quarter 19.41 trillion (a decline of 2.04 trillion or 9.5%) and at the end of the 3rd 21.16 trillion (an increase of 1.64 trillion or 8.4%). So that leaves us down $570 billion through the end of the 3rd quarter of this year or 2.6% so if the 4th quarter number is one-third of the 3rd quarters we’ll be back to where we started the year.

Friday’s Wall Street Journal also included the cheery headline “Market ends worst month since March”. How bad was it you ask? Well, the venerable Dow Jones Industrial Average was down 4.53% for the month and is down 5.38% for the year. The S&P 500 fell 2.66% but is still positive 2.77% for the year. Something curious though happened in October’s market. Mid-cap stocks were UP 2.17% and Small Cap stocks 2.58%. This looks more like a sector rotation than a flight to safety. US Treasury yields were up modestly but high yield bond yields declined. Europe was down 5.62% but Asia was up 4.81% perhaps providing evidence that it may not be the pandemic that is driving markets so much as market’s fear of how public authorities will choose to respond to it. Emerging markets were up 2.04% and Frontier Markets, which are the highest risk equity markets on Earth, were up 4.19%. For 60% equity/40% fixed income portfolios returns were a negative 1 ¾% leaving portfolio returns year to date positive though barely so.

Christmas is coming. The best is yet to come! And yes Virginia, and for you who live in other states, there will be a pandemic pause!

Mark H. Tekamp October 31, 2020