History Or Mystery?

The mystery of man has no beginning and no end. His intuition and feeling unfold and blend. The Mystery of Man – William Hermanns

 

For investors, the experience of March may have felt a bit like a walk in the park, but readers of the financial press perhaps wondered if it was a book best placed back on the shelf. “Strong Finish Can’t Salvage Tough Quarter for Stocks” opined The Wall Street Journal on the month’s final day with that publication adding, in another article, “Bond Market Suffers Worst Quarter in Decades.” Bank of America cautioned “Stock Surge Is a Bear Market Trap with Curve Inverted.”

Investors may have felt themselves in the need of seeking the ministrations of a chiropractor as the S&P 500 offered an experience realized only for the twelfth time in the more than three-hundred quarters since the conclusion of the Second World War; returns of both plus and minus “double digits”. From January 3rd to the quarter’s lows on March 7th the S&P declined 13% followed by an 11% rise by March 28th. Let us hope that history will repeat itself this next quarter and year as the S&P was positive the following quarter ten of those eleven prior times with average returns of 11% and positive returns in all instances the following year with returns averaging 30%!

And what of that inverted yield curve “B of A” cautioned us about? The Federal Reserve, confronted with inflation numbers three times greater than its cited 2% target, grew the talons of a hawk and shredded the script from which it had only recently invited others to read. On March 16th, the Fed raised interest rates ¼%, its first increase since December 2018 and set expectations for similar increases at each of its remaining six meetings this year cautioning that it would be willing to consider increases of ½% should inflation remain “elevated and persistent”. Interestingly, the fixed income markets responded most dramatically in widening the “spread” between the rates on 90-day treasury bills and 2-year treasury notes to their widest levels since 1994. And so why should we care? Because it is the markets way of communicating its view that inflation is indeed transitory with future inflation expectations rising less than that of longer dated interest rates. Though media pundits are chirping about inverted yield curves, the reality is that inflation adjusted future interest rate levels on 10-year treasury bonds are actually rising. And that, my friends, may also be predicting higher rates of economic growth later this year and may also explain a rising stock market.

Putting together the puzzle pieces of various market returns is certainly an exercise in the interesting. Utility stocks are considered by many to be “bond surrogates” as they are valued more as sources of income rather than growth. With 20-year US treasuries declining 5 ½% for the month one might not have expected utility stocks to rally 10 1/3% for the month. With natural gas prices rising 27 ½% and oil 10% for the month, gold prices rose, a beat of the drum here, 1 ¼%. And with rising geopolitical tensions leading to, one might think, an increasingly risk averse investor population, the world’s best performing stock market for the month and quarter was…Brazil, delivering returns of 15% and 35% respectively.

The S&P 500 returned 3.76% for the month and -4.62% for the quarter with the growth portion 4.45%/-8.56% and the value 3.02%/-0.13%. Small Cap stocks hit the snooze button returning 1.16% for March and -7.54% for the quarter. The stock market party was for US attendees only as foreign developed markets were 0.52% for the month and with those markets underperforming the S&P with a -6.46% for Q1. For 60% equity/40% fixed income investors the quarter delivered a -4.0% return (0.66% in March) as the negative returns on equities -4.75% (+2.4% in March) were, unhappily for investors, married to fixed income’s -3.0% returns in Q1 (-2.0% in March).

 

Mark H. Tekamp, April 6, 2022

Eyes On the Size

The reflection on the surface of the water is often mistaken for the mysteries that lie beneath. Likewise, the reflection of the moon is mistaken for its own light.” – Thomas Lloyd Qualls, Painted Oxen

 

The 14.4 % decline in the S&P 500 from the market close at year’s end to its low for the month on January 24th is what captured the headlines. Forbes Magazine mused “Will Inflation Cause a Stock Market Crash?” Kiplinger’s queried “Could the Stock Market Crash for Real?” Fortunately for investors, the market rallied from its nearly three week swoon, closing down for the month -5.2%. It may though be in the real world that we inhabit as workers and consumers that the most interesting story of all is beginning to emerge.

It’s been nearly forty years since Americans last viewed inflation as a possible threat to their economic wellbeing and it is now cited as item number one on our “worry list,” exceeding even those concerns related to the pandemic. But perhaps we should not view it as necessarily evil in all of its manifestations. Those who pay particular attention to economic statistics may be able to recall approximate rates of economic growth of 6.90% annualized in last year’s 4th quarter. That number is cited as “real” so one might think that is the number that matters most, but at least in this instance, it isn’t the “real” world that we inhabit but rather that of the “nominal”. The real GDP growth number is adjusted for inflation, the nominal rate which we hear about much less frequently was 14.30%, the highest number this century to date. Think about it. Do we adjust the value of our paycheck for inflation? The value of our investment portfolios? The rate of change of revenues in the business in which we have an interest? Suddenly, those rates of growth for the companies owned by shareholders are experiencing very significant increases in their revenues and profits. What might this mean for the stock market?

The US and global economies which, since the Global Financial Crisis of 2007-2008 have been mired in the world of small numbers, are starting to emerge into a world in which those numbers are no longer so small and that may be preparing to change a great deal that we’ve grown used to this past now almost fifteen years. For years, the rate at which money circulates through our economy has been in a state of steady decline, but that too is beginning to change as the rate of change in bank lending that was described with numbers starting with 3s and 4s, increased in December by 14.80%. Simply stated, an extended period of time in which it was difficult to create a real rate of return by investing in the real economy, due to an excess of capacity, may be ending. It may be that fact that will increasingly come to influence the financial markets.

Often forgotten in the obsession in recent years over what central banks are doing, may be preparing to do, or are not doing, is that interest rates are the arbitrators between the demand and supply for money. If the demand is falling due to declining economic growth rates, then interest rates would also be expected to decline. Ten Year US Treasury rates fell to a low of ½% in July 2020. One year ago, they were at 1% and in the past two month have risen from 1 1/3% to now almost 2%. Inflation expectations are falling back rather than rising so that increase is the market’s way of anticipating accelerating economic growth rates. That is good news.

Investors may recall that profits were difficult to come by in the 3rd quarter of last year as the S&P’s 4.65% decline in September offset its gains the prior two months. The market subsequently rose 10% the following three months which made 2021’s 4th quarter the positive experience that it was. It was that same 10% that was consumed in January’s market decline though the markets monumental reversal of 4.4% on the 24th set forth a recovery in the market’s fortunes scissoring that decline by half. The outstanding quality of the market pull back was its variability as the S&P growth stocks fell 9.4% but value 2.2%. Energy stocks, inhabiting seemingly their own universe, rose 17.4%. US small companies declined 8.4% and foreign stocks, which for what has seemingly felt like forever, reversed their irritating propensity to go up less than US stocks in a rising market but to go down more in a declining market, fell a modest 3.6%. 60% equity 40% fixed income portfolios saw declines for the month of approximately 3.25%.

 

Mark H. Tekamp| February 5, 2022