Collide-A-Scope

Life is like an ever-shifting kaleidoscope – a slight change, and all patterns alter. – Sharon Salzberg

 

The headlines of the various stories in the July 30th Wall Street Journal seemed to leave little doubt as to which direction this current version of the economic train was heading. “Recession or Not, the Recovery Has Ended.” “Are We in a Recession Now?” “Jobless Claims Hold Near Highest Level of the Year.” “Inflation Hits Fresh Four-Decade High.” “Heard on the Street: Recession Isn’t Necessary for Investors to Feel Bad.” With that by way of counsel another headline “S&P 500 Posts Best Month Since 2020 as Stocks Rally” seemed as out of place as a rose in a briar patch.

Certainly investors who, for much of the year, were long on suffering even as they were wishing they had been short on stocks, were grateful for the respite in their experience of a sea of red as the S&P 500 put in an 8% rise for July and 12.8% since the, don’t we hope, lows for the year on June 16th which, perhaps not coincidentally, was the day after a meeting of the Fed’s Open Market Committee where they voted to raise interest rates .75%. Curiously though, while with the one hand the Fed was raising the Fed Funds Rate, the interest rates set by the other hand, that of the financial markets, are declining. The high for the 2 Year Treasury Rate was 3.45% on June 14th. It currently rests at 2.85%. The 10 Year Treasury Rate peaked that same date at 3.49% and has since fallen to 2.68%. The financial markets, which, on June 14th, were predicting 90- day interest rates to reach 4.25% by year end now expect that rate to rise to just 3.50% at the beginning of December and then to begin to decline. In other words, the financial markets are predicting the Fed will be lowering interest rates before the end of the year. So, pray tell, what is going on here?

Could it be that the explanation is to be found in the news story headlines in the first paragraph of this commentary? The Fed is raising interest rates and those higher rates are threatening to, if not yet actually having already done so, push the economy into the purgatory of recession. Possibly, but not likely, as evidenced by a number of counterfactuals. Why is the stock market rallying? And not just that it is but how it is. The two best performing industries of the S&P 500 are, since June 16th through July 27th, Automobile Manufacturers +26.8% and Homebuilders +25.2%. And of the four sectors of the S&P 500 up the most in the month of July three of the four, Real Estate, Consumer Discretionary and Industrials (the fourth is, not surprisingly, Technology) are those sectors that tend to rally at the BEGINNING of an economic recovery. So truly we do have a collision of narratives here with headlines trumpeting recession and the stock market rally saying recovery.

Dare we say that it may be Goldilocks? The economy may be slowing enough to allow the Fed to hit the pause button on further interest rate increases after another likely .50% on September 21st that may allow an avoidance of notable damage to corporate earnings. Possibly there is another factor at work here as well. Inflation comes in two “flavors,” demand-pull and supply-push. The former is the classic “too much money chasing too few goods.” The latter, one less frequently commented upon, is a lack of supply leading to higher prices. The Fed can certainly reduce economic demand by raising rates sufficiently to push the economy into recession, but interest rate increases don’t do a thing to increase the output of gasoline or beef. Help though may be on the way. Producer Prices measure the cost of economic inputs, for instance the price of lumber as a cost of constructing a new house. The prices of Core Crude Goods, a rate excluding food and energy prices, is up 7.1% year over year and has been declining. The Headline rate, which does include those items, is up an eye watering 58% year over year but since June 1st energy and agriculture prices have fallen 7.45% and 10.24% respectively. So maybe it’s getting close to the time for the Fed to declare victory over inflation and to redirect its focus upon supporting economic growth rates.

If indeed Goldilocks is about to be served her meal just the way she likes it the good times for investors may be much closer to their beginning than their end. The S&P 500 is still negative 12.6% for the year, certainly a much better number than the low in mid- June of -22.5%, but corporate earnings are actually up for the year so the decline is solely attributable to a falling valuation level which is down to 17.2 times earnings, close to its historical average of 16. The story for Mid Cap and Small Cap stocks is a distinctly different one with their trading at 12.7 and 12.4 times their respective earnings. Also worth noting is that the US economy may, for the near future, be experiencing a rate of growth exceeding that of most of the rest of the world so, with their earnings being almost solely dependent upon domestic demand, which may be yet another characteristic in their favor.

So, some good news at last. For 60/40 portfolios the equity portion returned a cool 8% with Foreign’s 5% pulling that figure down below that of the S&P 500 but with small cap’s +9.60% partially offsetting it. Fixed Income contributed a modest +.50% aided by the month’s interest rate declines to overall portfolio returns of 4.5% reducing the negative year to date figure to -10.7%. Here is hoping for a hot August!

 

Mark H. Tekamp, August 1, 2022

Vision Decision

“Every man takes the limits of his own field of vision for the limits of the world.” Arthur Schopenhauer

 

As we reached the end of the month, the quarter and the first half of the year the commentary on the economy and the financial markets was, in a word, grim. “Brace for Recession Shock After Worst Rout in 52 Years” Bank of America warned. “Stocks End Lower, Capping Off The Worst First Half In More Than 50 Years” Zacks.com headlined. Blockworks Daily, not appearing to be certain how to answer the question asked, “Did we survive?” The first quarter’s -4.60% return on the S&P 500 now looks like a walk in the park compared to the second quarter’s -16.4% containing within its confines the two worst months of a not very good year’s -20% draw down with June’s -7.6% being exceeded only by April’s -9.0%.

Investors are left to wonder if it would be best to exit the market with the .80 cents remaining of their beginning of the year $1.00, rather than to risk further losses in their already depleted portfolios. Declining markets create their own reality. With everyone who has sold glad that they did, and with the barrage of negative commentary offering multiples of reasons to sell, why continue to remain invested in a market which has offered nothing but pain this past six months? Certainly, the mood of our fellow citizens is gloomy. The University of Michigan’s Consumer Sentiment Survey has been measuring the emotional state of this nation for many decades. We’ve known some less than happy times including May of 1980 when interest rates were at 20% with double digit rates of inflation and unemployment reflected in that index at 51.7%, and the Global Financial Crisis of 2008-2009 when it was 55.3 in December 2008. June 2022 though, marks the historical low of our spirits with it now at 50.0.

We are now one year into our cohabitation with inflation. In fact, last year’s near 5% market decline in September of that year was in response to the Federal Reserve’s going public with their plans to terminate their Quantitative Easing program in preparation for their commencing a cycle of their raising interest rates in what is now this year. If we could see that train coming down the track heading towards us, then why the increasingly negative response from the stock market as we’ve progressed through this year? Some might offer the one word response “inflation.” But, if we knew inflation was an issue one year ago and its level isn’t notably worse than anticipated then, to repeat, why the decline in the stock market? The answer is not the inflation but the Federal Reserve’s interest rate increases of which we’ve now experienced three.

The global financial system is a highly leveraged one and a system that has become increasingly more fragile as the level of borrowed money upon which it rests has risen. The Federal Reserve’s interest rate increases are applying additional stress to that system and the stock market, and financial markets globally are concerned quite simply that “the Fed” may continue to raise rates until something “breaks.” The bullish case rests upon the belief that if we know this, they know it as well and thus are looking for a reason to terminate further rate increases sooner rather than not. That excuse may be presenting itself right here and right now as the economy is displaying notable signs of deceleration, accompanied by increasing evidence that inflation has passed through its peak levels and is prepared to trend downwards. Evidence of this is not very difficult to find. Copper and wheat prices declined 14.4% and 16.1% respectively in June. Natural gas prices fell 28.23% from June 7th to 30th. Crude Oil (WTI) prices fell from $122.11 to $105.76 per barrel from June 8th t the 30th, a decline of 13.4%, and 10 year treasury rates declined from 3.43% on June 13th to 2.94% at months end. Those are very large changes and would seem to provide incontrovertible evidence of a slowing economy with significantly declining inflationary pressures. Quite likely we are approaching the time when the Federal Reserve will declare victory over inflation and choose the new war against the possibility of economic recession to which it will redirect its focus. When this happens, investors should not be surprised to see a notable reversal in the downward trend stock prices have been on this first six months of this year.

June was negative as we’ve discussed, but also interesting is the similarity of the numbers expressing that negativity. Accompanying June’s negative 7.6% read was growth’s -7.8% and value’s -7.5% with small cap stocks down 7.8%. If this is misery at least there’s company. 60/40 (equity/fixed income) investors received at least a small measure of relief with the stabilization and subsequent decline in interest rates as bonds delivered a near break-even performance. Investors in those portfolios find themselves negative 14.32% for the year with 10.5% of that negativity being realized in the second quarter. We all look forward to the better days to be experienced and we look forward to sharing that experience with you!

 

Mark H. Tekamp, July 7, 2022

Is Jay Your Pal (Powell)?

“Choice without alternative is only a sleight of hand, it is a magician’s force-play during which you believe you have free will, but your fate has already been decided.” – Garth Stein

 

Federal Reserve Chairman Jerome (Jay) Powell certainly left no chance for misunderstanding on where he stood on incarcerating our country’s least wanted intruder, inflation. Speaking at a meeting of the International Monetary Fund (IMF) on April 25th the estimable chairman offered up these comments. “Getting inflation back to the 2% goal is a critical policy imperative right now. It is absolutely essential to get price stability…”. True to his words the Federal Reserve increased interest rates by ½% on May 4th with some believing that another ¾% may be forthcoming at the conclusion of their next meeting on June 15th. These folks are serious!

The stock market year to date has been an unhappy companion on this journey towards placing the inflation genie back into his jar, closing out the month -12.8% year to date with the 10 Year US Treasury rate having started the year at 1.52% reaching 2.83% at month’s end. Still, if one peels back the veneer of the seeming reality created by those numbers, something VERY interesting is happening beneath the surface.

If the trade weighted value of the US Dollar acts as a thermometer measuring the health of the global economy, the patient has been in a feverish condition most of the year having risen by 9.5% by May 12th. That increase has since diminished to 6.4%. The S&P 500, which was down 5.5% for the month on May 19th, closed the month eking out a +.2% return. Perhaps most interestingly still, the 2 Year US Treasury rate, which had risen to 2.78% by May 3rd finished the month at 2.47%. So, when it comes to the future direction of interest rates, do the financial markets know something that Jay Powell doesn’t know, or at least is not saying? And does this explain the recent recovery in the stock market and the decline in the value of the US Dollar? Stay tuned.

The size of the US federal government debt just passed a nice round number this past month. $30 trillion. In 2021 the US Treasury spent $400 billion paying the interest on that debt at an average interest rate of 1.5%. At current rates that level would be near 3%. If The Fed raises interest rates to sufficient levels to push the country into recession, tax revenues go down appreciably, the deficit widens and the government needs to issue increasing volumes of debt at higher interest rates. Is this REALLY what “uncle” wants? Could “uncle” actually want perhaps a bit of a whiff of inflation to devalue that $30 trillion (and growing) while holding interest rates at levels that “uncle” can afford to pay? Is this “the sleight of hand” that the financial markets are starting to see with the resulting “hawkish” talk of The Fed but “the dovish” walk of the bond market?

Financial market commentators have begun to ask “does the Federal Reserve still love the S&P 500?” remembering fondly those days of yore when every banana peel the stock market would encounter on its journey to steadily higher levels would be met by “the cavalry” of another interest rate cut by the Federal Reserve. Investors should reassure themselves that the answer is most assuredly YES! though not perhaps for the reasons they suspect. An increasing percentage of income taxes are being paid by the wealthier cohort of our fellow citizens and a very large share of their “contributions” are not derived from ordinary income but rather from the realization of capital gains. It is interesting to look at a chart of the rise and fall of tax receipts and the year over year rate of return of the S&P 500. Rest assured. The US Government does care about the stock market.

It has been a challenging year for investors with very little in the way of “safe harbors” to preserve capital with the S&P -12.8% year to date and with interest rates having risen even the bond index (AGG) -9.3%. 60/40 stock/ fixed income investors are looking at losses of approximately 12%. Those losses have narrowed modestly the past several weeks but still investors wonder whether this will get worse and when will the financial markets start to rise rather than fall. The days since May 19th hopefully offer a harbinger of the better days to come with the S&P having risen 6% since then. We’re looking forward to better news in the months that follow!

 

Mark H. Tekamp, June 3, 2022

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