Client Note July 2021

August 5, 2021

July saw another positive month for most US equities.  The S&P500 gained 2.3%, led by growth stocks.  Top sectors were technology, healthcare, and utilities.  A return to growth stocks by investors aided technology shares, while a decline in interest rates gave a lift to utilities.   Energy and value stocks were down on the month, alongside emerging market equities.  And finally, large cap stocks dramatically outperformed small cap stocks. Essentially, it’s a moderate investors market.  The riskiest areas, like small cap and emerging markets, after a stellar start to the year, have been very much sideways the past few months, while the broad indexes continue to grind upward.   Energy is similar in having had a dramatic beginning of the year and now, since early June has been consolidating.   I am optimistic that the areas that have been languishing the past few months are near the end of this consolidation and should see higher prices into the third quarter.

Bond prices have generally risen as interest rates have fallen.  Junk bonds were flat while higher quality bonds saw price gains.  Given the weaker small cap performance and junk bonds underperformance, markets appear in a slightly risk-off mode, even as the major stock indexes continue to climb.  This is generally reflective of the doubt regarding the continued rapid economic growth experienced over the past 12 months.  Riskier stock price stopped going up in March, bond yields peaked in May, and only recently we have gotten worse than expected economic data in a lower revision of Q2 GDP growth and a few misses in employment data.  PMI and ISM indicators are meeting and beating slightly, almost exclusively due to ‘prices paid’ factors.  Higher prices are a positive, even if selling a similar amount of product.

Inflation, on a year over year basis is running “hot”, posting a 5.4% (CPI June). CPI for May was 5%. July is expected to be 5.3%.  There are two key items to remember when looking at inflation data.  The US was only starting to come out of lockdowns last summer (case effects) and the federal government was sending checks to all households (direct stimulus), working and non-working.  This glut of cash has caused serious anomalies in the CPI figures.  Used car prices up almost 100%.  New cars up 7% and travel costs up substantially, from depressed levels.  Today, supply chains and businesses have re-opened to a large extent and there are no more checks forthcoming.  I expect inflation numbers to come down substantially for the remainder of the year, which should support bonds, dividend paying stocks and to a lesser extent, precious metals.

Looking ahead, I maintain my upward bias towards stock prices, with the caveat that we will likely see more volatility, 2-4% weekly variations perhaps.   Interest rates could ease further as economic data comes in slower and slower, as we have now passed the peak growth period.  The US economy will continue to expand, albeit more slowly.   If we could see mid- and small- cap stocks do some catching up, it would give me more confidence that financial markets have more room to the upside, but this has yet to take hold.

Adam Waszkowski, CFA

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Client Note April 2021

May 10, 2021

The close of April brings us 1/3 of the way through 2021.  After a very rapid start in January and subsequent pullback, April was a strong month across all asset classes.  For the month, the S&P500 gained 5.8%, gold gained 3.8%, corporate bonds gained 1% and long-term Treasuries gained 2.4%. Stocks in Asia have weakened while European shares have been catching up to the US.  Portfolios gained in April and the average Moderate portfolio is up 6% year to date.

We are still in a “value over growth” market, where traditional industries like materials, industrials, financials, utilities are outpacing the growth areas like technology and biotech.  We had been in a market were large-cap growth” (aka technology, aka FAANG) and small-cap stocks had been dominating, but since mid-February markets have been driven by dividend paying stocks and other cyclical areas.  This will likely continue until evidence that we are not going to grow as rapidly as investors currently believe.   Friday’s massive miss in unemployment (1million new jobs expected; 266,000 actual) may be the first data point that could show a much more moderate pace of growth going forward.

The still high expectations of rapid growth see inflation data as evidence that the economy is about to run red-hot.   If we read below the headlines, we can see that commodity prices like lumber are being driven by more than US housing demand.  A years-ago beetle infestation in Canada has limited US lumber imports; sawmill shutdowns due to Covid, AND housing have been sources of supply disruption.  The combination has pushed prices to extreme levels.  China is the world’s largest consumer of raw materials.  China’s early control of Covid-19 and truly massive stimulus spending (approximately 10% of GDP in 2020) has underpinned demand for such commodities and agricultural products.    This makes much more sense than inflation driven by US aspirations to get back to pre-Covid levels, which saw sub-2% growth for several years.  In addition, supply chain disruption due to a varied array of local shutdown conditions across the US has made year over year comparisons and identifying specific bottlenecks a challenge.   Currently, China’s credit impulse is on the wane, while US stimulus takes the reins in 2021.  US stimulus usually takes longer to impact the economy, however.  In the longer run, the US needs to maintain our reserve currency status—by creating enough US dollars for the rest of the world to use—but that is a topic for another day.

I expect forward-looking estimates of growth in the US to decline to more normal levels and at the same time, interest rates and inflation expectations to decline moderately.  Interest rates have been sideways now for almost 10 weeks. I will be looking for further confirmation of this in economic data into the end of the quarter.

 

Adam Waszkowski, CFA

 This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision. Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Client Note March 2021

April 13, 2021

The first quarter was marked by two distinct phases. The first phase was a continuation of markets climb from the late October early November lows which peaked in mid-February. The second phase was characterized by a distinct outperformance in value or cyclical areas of the market. This is the third instance in the past 16 months where we have seen value outperform growth.  Generally, this does not persist for more than a month or two.

The S&P 500 gained 5.5% during the first quarter while the aggregate bond index fell 3.7%.  Oil gained 26%, aiding the energy sector’s gains of 31% and gold fell by 10%    Corporate bond prices fell by 5.4%. Junk bond prices were unchanged.  This is a slightly odd relationship, but indicative of ‘risk-on’ alongside a rise in interest rates.   The gain in the general stock market and decline in bonds (and gold) left most balanced and multi-asset portfolios flat or in the low single digits.  With energy up, bonds and gold down, and seemingly only the largest companies are carrying the general stock indices higher.

Most recently, gold appears to have formed a “double bottom” in late March and has made slight gains. Stocks continue to grind up, but with the largest names leading.  This contrasts with the period from April 2020 to February where micro- and small-cap stocks dramatically outperformed large stocks.  If we do not see a re-rotation into smaller stocks and those outside the major indices may be the prelude to a larger market pause in the coming months.

Bonds too may have realized a bottom in mid-March as prices have been net sideways.  A bit more improvement in prices (rates lower) should begin a nice rally, giving a reprieve to the general investor who have gained in stock prices, but lost some on bonds, especially for the more conservative.

How could or would interest rates actually decline?  Again, we see in the media how ‘everyone’ knows rates are going higher and inflation is at the door due to either ‘cash on the sidelines’ (doesn’t exist), or bank savings, or ‘pent up demand’.  Once ‘everyone’ knows something its more likely the near-term trend is over or soon will be.  We may already see this in gold and bonds, as interest in these areas is low, while SPACSs and cryptocurrency are all the rage currently.

Inflation concerns are due to the recent and quick rise in rates that have its roots in price increases due to supply-chain problems and the Asian/China resurgence and stimulus.  Supply chains issues will be resolved on their own in short order.  High prices attract businesses to produce more/fix problems which lead to lower prices, the essence of a free market.   Very recent news tells us that China’s credit impulse/stimulus has begun to wane.  The past 10 years we have seen two previous large credit cycles in China.  China is a massive buyer of raw materials and we have seen prices in commodities rise the past year driven by easy money from China.  There is about a 3–6-month lag time until we see the impact of a change   in China’s rate of credit creation.   Given that this China credit data is already 4 months old should mean, as recent price action alludes, a decline in interest rates and commodity prices and thusly, inflation expectations.

While stocks look to have another 5-7% upside momentum, the asset classes that have faired worse recently should see gains alongside stocks.  As mentioned in the past Notes, its post July 4 that concerns me the most when we may see a flattening of economic growth and decline in expectations of rapid growth which can weigh on risk assets.

The reason I am concerned about the second half of the year comes from a few places.  Valuations are exceptionally high right now.  Many metrics are above 1999 levels.  This is commonly discounted due to the low interest rates.  If we are elevated over 1999 levels, how much more elevated should we accept? Another element to today’s market is the ever-present Fed liquidity.  Yes, the Fed could continue as long as there is dollar-denominated debt to liquify.   And finally, there is the current expectations that we are entering a new era of high growth.   Its this last item that is most sensitive to changes in short term economic and Covid data.

The high growth thesis stems from stimulus in the pipeline and the observations that inflation is occurring.   Stimulus, or government infrastructure spending will take years to filter through the economy.  Inflation as measured by the CPI varies greatly, while the PCE is smoother (and what the Fed watches).  One can clearly see the past overshoots of the CPI vs. the PCE, and PCE is trending down.  Once supply chain issues are resolved/lessened and Chinas credit impulse fade, its likely CPI will catch down to PCE.

If inflation expectations come down, while job growth and spending data come in cool, beginning in the next few months, we could see forward expectations and valuations come down, pulling ‘risk assets’ with it.  Add in any kind of Covid 4th wave or failure at herd immunity via vaccinations, we could see the most powerful driver of asset prices, optimism, take a hit; and along with it create a more volatile period for stocks.

Adam Waszkowski, CFA

 This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision. Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Client Note December 2020

January 12, 2021

2020, despite a massive pandemic and a severe global recession, central banks, with some fiscal assistance from governments, have managed to keep financial asset prices elevated.  Significant declines in revenues, profits and employment arguably the worst since the 1930’s alongside surging stock index price levels, have conspired to give us the most overvalued market since 1929 or 2000 (some argue “ever”).    How long can this endure?  Depends on when central banks begin to whisper about ‘normalization’.

For 2020, the SP500 gained 18.4%, the aggregate bond index gained 7.5%, and gold gained 26%.  European shares eked out a positive year while the Asian indexes fared very well.  My conservative portfolios gained mid to upper single digits while the average moderate portfolio gained a bit more than 13% on the year.   The pullback in Moderna and precious metals provided a weak end and lackluster start to the year.    The energy sector was the worst sector in the SP500, losing 28% and the tech sector fared the best gaining 48%.  Healthcare and energy are likely to be strong outperformers in 2021.  The addition of TSLA to the SP500 has increased the risk of market volatility. Past observances of new additions to the index show they generally perform worse than prior to their addition.  TSLAs outrageous market value (valued more than the 9 largest global auto makers combined; selling at 28x sales) and the 7th largest company in the index, put the index and any sector it is in at risk of increased volatility.

Gold and gold miners are at risk of starting another correction.  Recent lows at Thanksgiving are being approached.  The rally from late November to January 6 was the largest run up since gold’s consolidation began in August.  However, IF we can hold the longer-term uptrend, upside potential is significant.   Bonds too, are seeing prices under pressure as metals/lumber/agriculture/oil prices’ surge is generating calls of “Inflation!”.   It’s quite early to claim prices are going up due to renewed growth.

Asia came out of the COVID-19 lockdowns much quicker and effectively than western nations.  This re-opening (as a result of very stringent testing/tracing/ and effective lockdowns) allowed those economies to re-stock and re-open driving up demand and prices for raw commodities.   From 2015 to late 2017 base metal prices and oil were moving up quickly.  Cries of inflation were heard then as well.  Inflation never showed up (unless you count 2.1% as INFLATION).  This is due directly to US consumer spending growth, or lack thereof.

Aggregate consumer spending is significantly below trend.    Dig a little deeper and you can see many economic indicators picked up in 2015 through 2017, then rolled over during summer 2018, after the brief impact of tax reform (most of the benefits went to the top where additional money isn’t spent). Current total annual spending was $14.8trillion and growing at 4.2% for the past few years (income at almost the exact same rate).  MOST recently spending has declined the past few months while aggregate income also is declining.  Today we can see the next few months will likely show a spending gap of $1trillion.  A $1trillion gap is almost 7% of total spending and reflects the concurrent GDP output gap and an outright decline in GDP of around 4% year over year.  Looking ahead, the real problem may lie in the US inability to deal with the virus effectively.  Yesterday, an article stated that in Ohio, 50% of nursing home workers are refusing the vaccine.   Layer in low compliance with mask mandates (>70% compliance in order to be effective), and I truly wonder if an end to the virus is, in fact, in the offing.

As a consumer driven economy, the point is, while one can find prices of products higher (or packaging smaller at the same price), we spent a lot less in 2020 and will continue into 2021.  And unless personal spending increases, we should not see a difference in the economy or inflation going forward.  This may bode well for bonds.  TLT the 20-yr treasury bond elf, gained more than 15% in 2020, but has fallen a similar amount off its highs this summer.  Expectations for higher rates may have gotten ahead of itself and we could be near a low in prices.  Layer in the fact that bets against prices are near extremes may indicate the decline in bond prices is nearing an end.

In addition, or perhaps running parallel to the decline in spending is the truly massive amount of people on unemployment insurance.  In 2006, Continuing Claims for unemployment insurance hit a low of 2.35 million.  This began to increase in early 2007 and hit a high of 6.62million in June 2009, after the Great Financial Crisis. By June 2010, this fell to below 4.5million, and continued to decline into October 2018 to 1.65million. Claims remained flat until February 2020.  May 9, 2020 claims hit 24.91million.  And over the past 8 months has receded to only 5.1million.  It was only in November that our current Continuing Claims for Unemployment Insurance fell below the GFR Peak in 2010.  The number and duration of unemployment today has not been seen in the post WWII era.  Fortunately, today, we have unemployment insurance and a Federal Reserve acting to support financial markets (almost perpetually since 2009).

We should not expect any kind of normalization in the economy or improving numbers at least until employment, and thusly spending, improve rapidly.  This is completely dependent upon containing the spread of covid-19.

Due to the length and depth of the declines in spending and employment, the longer-term collateral damage will not be seen until things begin to normalize. Once all the rent and loan deferments, PPP loans, random stimulus checks, and enhanced unemployment benefits disappear we will be able to see the extent of the long -term damage.   Ironically, that knowledge will come at the same time we declare victory over this virus-recession and may be concurrent with a market decline.

In the meantime, let us hope the Fed does not mention ANYthing about tapering the current $120billion per month they are pumping into the financial markets, hoping that the Wealth Effect is more than theory.  So, while prices continue to climb, we will participate and listen intently for any signs the Fed is “confident” enough to reduce the variety of market interventions currently underway.

 

Adam Waszkowski, CFA

This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision. Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Client Note November 2020

December 2, 2020

The headlines are touting how November was the best month in 30 years.  It was a very strong month that also had the benefit of October closing at its low on October 30th.  The September and October lows are the bottom of the sideways range we have seen since early August.  The post-election rally has broken out above that range and we are likely to see higher highs in the near term.  I do not expect to see more than a 5% decline in the coming weeksThe SP500 gained 11% on the month, bringing it up to 12.1% year to date. The first four days of the month saw the SP500 gain 7.4% and since then has been a slow grind up. Woe unto those who were out of the markets for whatever reason in early November.

While the S&P 500 gained 11% in November, our average moderate portfolio gained 7% on the month.  Bonds (TLT) gained slightly, and gold went from 1880/oz. to 1780/oz, a decline of 5.6%.  Gold has given up 15% from its all-time high in early August through November’s close. If one looks very closely at GLD’s price movement, there are two approximately equal declines of 11% since August.  This may indicate the end of the decline.  Gold has gained more than 3.5% the past 2 days. Over 1850 should be the all-clear.  The only changes I have made in the precious metals area is to have sold gold miners in August and then buying that portion back recently. Gold has dramatically outperformed stocks over the past 2 years through August, but stocks have been catching up during gold’s respite. I remain bullish on gold and stocks.   Bonds and interest rates continue to vacillate, with prices continuing to ebb as expectations of economic growth assume a higher demand for and ability to obtain new credit.

Over the past few months, the number of individual stock holdings has waned as markets have fluctuated.   Expect to see several names added soon with our usual starting allocation.  One name that we have held for several months finally came to life in November as its vaccine was approved.  I plan to continue to hold MRNA and look to reduce it gradually into higher prices.  Its weight in portfolios has grown so much that its weight amongst other holdings is too high, which could lead to too much portfolio volatility.

On the sector level, energy has come up strongly, outpacing all other sectors the past month.  This may seem counter intuitive, given that there is a Democrat coming into the White House.  The energy sector was so undervalued/oversold/hated that it has no where to go but up.  Since the recent low October 28th, the sector had climbed some 45%(!!) through November 24th.   More recently it gave up almost 30% of the initial climb.  Ideally, another 10% decline would make for a great long-term entry.  Energy has been exceptionally strong the past month and is still substantially below where it was early this year.

Overall, we are on track for a very solid year and I am optimistic going into first quarter of 2021.  Sentiment has been and likely will remain the primary driver of asset prices near term.  Fundamentals have a long way to catch up and traditional metrics remain at ‘all time most expensive’ range.  While sentiment can carry prices further, we really need to see earnings catch up substantially in Q1 and Q2 to avoid any large “air pockets” for prices.   Sometimes prices climb much faster during the anticipation of good things (back to normal life for example) and then progress slows.  The grind in prices since the first week of November might be an indicator of such.

Adam Waszkowski, CFA

 This commentary is not intended as investment advice or an investment recommendation. Past performance is not a guarantee of future results. Price and yield are subject to daily change and as of the specified date. Information provided is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Information provided has been prepared from sources deemed to be reliable but is not guaranteed by NAMCO and may not be a complete summary or statement of all available data necessary for making an investment decision. Liquid securities, such as those held within managed portfolios, can fall in value. Naples Asset Management Company, LLC is an SEC Registered Investment Adviser. For more information, please contact us at awaszkowski@namcoa.com.

Client Note April 2020

Equity markets moved up strongly in April.  The S&P500 moved up 12%, and currently off 3% from the April 29th intraday high.  Gold jumped early in the month, then flat for a gain of 7% in April.  Long treasury bonds moved up in price by 1% but have been on the wane since April 21st.   Most asset classes have been rangebound (+/-3%) since early to mid-April, reflecting a decrease in market momentum.  The average moderate portfolio gained approximately 9% vs the SP500 gains of 12% in April.  Year to date, through April 30, SP500 is off 9.9% while most portfolios are very close to 0% year to date. 

Economic data continues to come in at extremely negative levels.  Auto sales fell by 45% April 2020 vs April 2019.  China, in February saw a 90% drop.  Current market sentiment is bearish and consumer confidence declined from 101 in February to 71 in April.  This is similar to the decline from February 2007 to June 2008 (the month Fannie and Freddie’s first attempted bailout, after losing 50% of their value that month), which saw a decline of 35%.  This could be another reflection on how this recession is being ‘front-loaded’.   We have seen already how GDP and employment has fallen as much as the entire 2008 Great Financial Crisis, but now expect robust rebound by year end.

In light of all this, equity markets have remained buoyant, after the March decline.  This may further indicate the front-loaded- ‘ness’ of this economic period.  And at the root of it all is the expectation that the economy will rebound strongly in the second half and especially in the 4th quarter of 2020.  While GDP estimates for Q2, which will come out at the end of July, range from -10% to -30% (annualized basis), some estimates for Q4 are as high as +20%.    I believe that we are again priced for perfection.  The past few years saw valuations (price to earnings, price to sales, etc.) elevated with expectations of an acceleration in earnings and wages to justify the then-current prices.  Today a significant economic rebound is priced into the market.   If the economy in late May and June isn’t picking up quickly enough it could put pressure on equity prices.  It depends on re-opening the economy and that depends on subduing the pandemic.

We have seen momentum decline recently and thus increases the potential for volatility in equity markets.  If the S&P500 cannot breakout above 3000 in the near term, we’re likely to remain rangebound vacillating +/- 6%.  Bonds and gold are at a point where they are testing support and have the potential to move several percent as well.  If we are to remain rangebound, my preference would be to reduce risk until there is more confidence in further upside.

On a side note, I have significantly reduced the amount of cable and national news I watch on TV.  It’s the same sad and fearful story we’ve heard the past 6 weeks.  I have noticed I feel better doing this.  A client went back north recently and was surprised/disheartened at the difference in the local news in Naples vs the local news in the tri-state area.  Avoiding the bad news TV and enjoying the good news of spending time with family/projects/hobbies/exercise can be an important factor in getting through this time and being ready to embrace the other side of this crisis.

Stay safe and thank you,

Adam Waszkowski, CFA

The Yield Curve Un-Inverting Is Not Your Friend

I have talked about this phenomenon before and must do it again today.  All over the news recently is how the previously inverted yield curve is now no longer inverted.

Yield curve inversion is when short term Federal Funds Rate, set by the Federal Reserve, has a higher yield than longer term rates.   The most common curve-inversion metric is the Fed Funds rate versus the 10-year Treasury bond.  One can also make comparisons between the 30yr, 10yr, 5yr, 2yr and 1yr Treasury yields.  Inversion is regarded as an indicator of a higher risk of recession in the near future.

The chart below shows, in blue, the spread between the US 10 year Treasury yield and the Fed Funds Rate.  The orange is the Fed Funds rate, set by the Federal Reserve.  Red is the 10-year Treasury.

We can see without a doubt that the past 3 recessions (grey bars) were preceded by a decline in the 10-year yield to BELOW the Fed Funds Rate.  Longer term bonds carry higher rates of interest primarily due to inflation expectations.  The natural state is to have the longest-term bonds pay more than shorter term bonds.

When the 10-year is below the Fed Funds rate, the curve is said to be inverted, as its expected longer-term rates are normally higher than short term rates (the Fed Funds rate is an overnight rate).  The curve un-inverts when the 10-year yield goes back above the Fed Funds rate.

The financial media have spilled a lot of digital ink on this topic.  When it first inverted, reports were based on a recession indicator.  Now that it has normalized slightly, I’m seeing reports that the recession risk has passed.

The chart below clearly indicates that the past 3 recessions began as the curve un-inverted. Recessions are the grey vertical bars.

resteepening 11 2019

The process the last 3 times this has occurred was that; 1) market-driven yield on the 10-year bond went down, generally due to deteriorating economic conditions. 2) the 10-year gets below the Fed Funds rate (blue line under the 0% level), inversion. 3) The Fed begins to lower rates to stimulate the economy. It continues to lower rates basically until the recession is over (orange line).  4) The 10-year Treasury bond yield remains flat or vacillates some as the Fed lowers its Fed Funds rate below the Fed Funds rate, un-inverting.

The problem lays in that the Fed is doing the ‘un-inverting’, not market forces.  Had the Fed left rates alone at 2.5% and the 10-year market-driven rate had gone up (due to increasing economic activity)—THAT would be healthy and a good sign for earnings and the economy. 

It is important to remember that stock prices and the economy are only loosely tied together in the short term, stock prices can rise and remain elevated in the early stages of a recession.  Also, it is possible that the curve inversion is falsely predicting a recession, however this indicator has a very high success rate.

Adam Waszkowski, CFA

Client Note August 28 2019

August has been a volatile month.  Since August 2, the SP500 has seen 5 moves of 3-4% in both directions for a net, -3%, through today.

Gold, gold miners and long treasuries (TLT) continue to do well putting portfolios into the green for August.  For August, gold +9%; miners +15%, TLT +11%.  Prior to this almost 12 month run in these areas, it was commonly known that ‘gold is languishing”; and “rates will go up”.  Now, its “gold hits 5-year highs”, and “rates seen to continue to fall”.  Often by the time the media reports it widely, the trend is nearing completion.

As we approach Labor Day and the seasonally worst time of the year (Sept/Oct) I am watching for the SP500 to at least stay over 2850, and if we can get over 2940 it opens the door to climb further-but until then markets are under pressure.   Small cap, international stocks are still well below their highs.

Recently it appears the when the US Dollar weakens, US stocks fall while ex-US are more stable.   If the Fed continues to acknowledge further Fed funds rate cuts are likely, this can weigh on the Dollar—unless Europe et al jump ahead and push rates lower via more bond purchases.   So, we may see relative outperformance from ex-US stocks.

Of the individual names purchased recently, one has bee sold out.  IPHI was falling as the sector and general market was climbing, falling below a recent low in July.  The loss was less than 5%.  Cannabis remains under pressure.  Curaleaf reported 200%+ gain in year over year revenue and today saw a drop of 9% at the open, followed by a 23% climb!  This may mark a turn for the sector, but a reversal of these gains will see us abandon this sector in the near term.

The yield curve inversion has been big news.  The 10-yr treasury yield crossed below the 2-yr yield on 8/13 and again on 8/27.  While many other curve inversions have been occurring, this pair, coinciding with a 700 point down day on the Dow has gotten much attention.  The past 3 recessions have occurred as this curve normalizes, that is un-inverts and re-steepens.  I first pointed this out in my quarterly Observation piece January 2019.

 

Adam Waszkowski, CFA

Yield Curve Inverts (again, and continuing)

Yesterday, and this morning, the yield on the 30-yr Treasury bond made its all-time historic lows.  This is extraordinary, especially given the vast amount of stimulus and low unemployment rate.

However, the news on the teevee seems to be harping on the Yield Curve Inversion regarding the 10-yr and 2-yr treasury rates.   This is old news.   Yield curve inversions have been everywhere over the past several months, yet barely a mention from the mainstream financial press.  What I was expecting when I turned CNBC on late in the day was the never-before-seen rate on the 30-yr going below the Fed Funds effective rate.   Additionally, the classic ‘inverted yield curve’ is when the 10yr treasury rate goes below the Fed Funds rate (which tracks closely to the 90-day t-bll), which almost occurred January 2019 and again in March.   This inversion first took place May 23rd well into the stock market swoon that began on May 1.

Below is a chart of the Fed Funds rate, 2-,5-,7-, 10-, and 30-yr rates.  In a normal environment the curve steepens from low short-term rates to higher long-term rates.  Inflation expectations and time value of money are what drives this structure.  So, when we see longer term rates move below shorter-term rates it is at a minimum, unusual.  Analysts generally agree that when this normal structure changes, that changes in the economy and markets are afoot.

Yield Curve Inverts - Rates below Fed Funds

As you can see, yields have been falling since late summer 2018.  This coincides with many data points (durable goods, autos, housing starts, etc.) that peaked and began to move down, indicating slower growth (still growing but slower and slower).   It was the last rate hike (light blue line) where the structure began to invert, and March 2019 when rates began to invert strongly.   There was very little reporting about the 2-/5-/7-yr rates going below the Fed rate.   The reason behind the lack of attention is that the stock market was doing well.   If stocks are up, any negative news is spun as “investors brush off X”.   Ignoring information that doesn’t agree with what we see or would like to see is a form of confirmation bias.

In 2007 Bernanke raised rates right through the 10-yr yield to slow down the real estate bubble.  Powell has raised rates and ended QE, making effective rise in the Fed rate much higher and faster than past, going against other central banks, leading to a very strong dollar.   Powell’s statement in July and fair economic data today, make a rate cut in September unlikely, despite market rates screaming to lower.

As I have mentioned before in my Observations, while there will be a recession again in the US, when it occurs is difficult to predict.  The last 3 recession were immediately preceded by a re-steepening of the yield curve.  Stay tuned!

Winter Solstice

They say its always darkest before the dawn, which seems appropriate as we meet the Winter Solstice today, at the lows of 2018.

There is a lot of commentary out there right now about hos investors are ‘worried’ about certain things like Brexit, slowing economies in China and Europe and if that slowing will seep into the U.S.  All these areas of concern have been with us for most of the year.  I have pointed out the Chinese credit impulse (slowing) more than a few times.  Housing and auto sales have been slowing for months.  The only difference is now there is a market decline and all these issues are being discussed.   If the market had not been declining these issues would still be with us, only accompanied by the tag line: “Investors shrug at concerns in Europe”.

In past posts I have described the coming year over year comparisons, 2018 v 2019, regarding earnings and GDP growth.  Every time I have mentioned that 2019 will look much worse than the stellar numbers put up in 2018, thanks largely in part to the one time cut in taxes.   That gave markets a boost and it was hoped that business investment, and wages would go up as a result.  Well it’s the end of 2018 and were still waiting.

The Federal Reserve gave a modest tip of the hat towards global economic concerns by reducing its estimate of rate increases in 2019 from 3 to 2.   There were even rumors that the Fed would skip raising its rate on December 19th and guide to 0 rate increases in 2019.   The Fed NEVER overtly bows to market or political pressures outside of an official recession or panic.   The Fed is in the process (as usual) of raising rates into the beginning of a recession.   Besides the yield curve, there are several other indicators that make recession in 2019 likely.  These indicators have been leaning this way for several months, and finally have tipped far enough that the markets are now concerned and discounting this likelihood.

As this is likely the beginning of a bear market (average -33% post WW2 era), we should expect large rapid moves, both down AND up in the markets.  During the bull market, a 2-4% pullback was common and quickly bought.  Today we see 2-4% intraday moves that continue to fall to hold support.  I expect several more percentage points south before a significant rally in stocks in the first few months of the year.   This will be an opportune time to reassess one’s risk tolerance and goals over the next 1-3 years, as well as make sure that one’s portfolio is properly diversified across asset classes. When stocks go down there are often other asset classes that are performing better, the core idea behind diversification.