Distressed Financial Assets Shine after Years of Poor Performance
October 5, 2024
By Mitchell Anthony
US Economy slows and market leadership takes a pause?
Financial markets across the board performed well in the third quarter of 2024. Equities gained again after three straight quarters of solid returns. Fixed income which had not performed well for many quarters saw strong gains as interest rates fell significantly, and alternative investments like bitcoin had another good quarter as well. Opinions about the economy changed significantly from week to week throughout the quarter. Many strategists were expecting soft growth or recession to emerge however this was not the case and GDP came in much stronger than expected at 3% which is well above the trend it had been on for several years. These strategists were worried about a hard landing in the economy and that the Fed’s actions to tame inflation would ultimately bust this economic cycle. Seems as though they were wrong! The Inflation cycle for the most part ended and with it came lower interest rates across the board from short-term rates to longer-term mortgage rates. The decline in rates was as much as 50 basis points or one half of 1%. Investors hoping for rates to return to the near zero levels of the last decade rushed into bonds and ran prices up and yields down. This seemed to most seasoned investors to be a bit premature?
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Mag 7 Stocks Boom in 2nd Quarter Despite Higher RatesMagnificent Seven stocks gain 17% in 2nd Quarter! The US economy finally seems to be on a path of slower growth; however, interest rates still remain quite high, causing investors to ponder why. At the same time, earnings growth for corporate America is waning as higher inflation has pushed wages up and corporate margins down. The areas of the US economy that are growing are narrow and centered on very strong secular consumption themes of artificial intelligence, web computing, cybersecurity, digital devices, and obesity. The broader part of the US economy is not benefiting from these consumption themes, and it is mostly benefiting the magnificent seven and a few other mega-cap names.
The long-awaited decline in interest rates that investors have been anticipating has been hampered by growing US debt. US government debt is now over $36 trillion and has grown from $12 trillion since 2010, and from $25 trillion to $36 trillion just over the last four years. As a result of this alarming acceleration in debt, investors are demanding higher returns on US treasury debt. The spread that US treasury debt pays over inflation is in excess of 200 basis points, which is close to a historic high. (Figure 1) Normally, US treasuries yield approximately 1% more than the inflation rate. That would put treasury rates at 3.6%, but they are currently yielding 4.6%.
Economic Review Q2 2024Work from Home There are several economic themes at play in the US economy. Working from home has been adopted and pushed by employees of corporate America and began during COVID. US employees have become comfortable with the unaccountability of working from home and many have refused to come back to the workplace. Tight employment has allowed these themes to continue. Employers want control back and have been monitoring the work that is being done at home by their employees. Employees have been found cheating and using keyboard software to imitate work while they leave their homes and do personal errands. Wells Fargo fired dozens of those employees last month who were caught with this software on their workstations at home. Employers are partially winning the battle, and it seems like we have a hybrid model that is being embraced where employees are required to be in the office at least 2 to 3 days per week. Regardless, this has been a headwind for productivity, but fortunately, it has been offset by artificial intelligence that is allowing employers to do work without as many employees.
US Debt at Troubling Levels As noted above, US debt is rising as budget deficits get worse, compounded by a decline in perceived credit quality for US treasuries. (figure 2) US debt service relative to GDP is at an all-time high, further stretching deficits. It is uncertain what the endgame will be and could be drastically different given a Trump victory versus a Biden victory.
Economic Growth The growth rate of the US economy is slowing, and GDP last quarter was only 1.4%. (figure 3) At the same time, corporate profits have gone flat for most of corporate America. Margins are eroding with higher costs of wages. The number of companies with strong earnings growth is a short list and seems to be related to the consumption themes noted above.
US Consumer The status of the US consumer is difficult to pin down. On one hand, the US consumer is enjoying wages that are growing above the inflation rate, while on the other hand, consumers seem to be at the end of reasonable capacity to consume. The amount of debt they have accumulated does not seem excessive yet with what is measurable, although there is phantom debt in the US economy related to buy-now and pay-later type terms being offered by many retailers across corporate America. It is estimated that phantom debt is currently over $300 billion.
Consumer sentiment has fallen, as has consumer confidence. Personal income and personal consumption are showing modest growth, but only because of population growth, and actual per capita consumption is in decline. Nominal retail sales are flat, and inflation-adjusted retail sales are in significant decline. Existing home sales have been flat and are now turning lower, and new home sales are starting to break to the downside a bit as well. Mortgage delinquencies are trending higher but still at very low levels.
The industrial and manufacturing side of our economy remains in a modest decline that began more than a year ago. Durable goods have declined, and only consumer services have tilted upward.
Inflation Data The inflation picture is improving steadily as both CPI and PPI have trended lower and are getting closer to the Fed's targets. This is occurring alongside steady but slower growth. Housing and insurance are still rising and are the strongest part of the inflation report. While inflation is trending lower, US debt is rising exponentially, keeping yields up despite lower levels of inflation.
Financial Market Review The financial markets have enjoyed three consecutive quarters of outstanding performance. The last quarter was again great for equities, but market leadership has narrowed with the magnificent seven far outperforming the S&P 500. The MAG 7 was up 17% vs. 4.3% for the S&P 500. MACM’s Dynamic Growth (DG) advanced 7.5%, 320 basis points more than the S&P 500. It was a difficult quarter for fixed income, whether you owned treasuries, corporate bonds, mortgage bonds, or municipal bonds. For the most part, they all lost money as interest rates tilted a bit higher during the quarter. Intermediate treasuries lost over 2%, while short-term treasuries and municipal bonds were mostly flat. As inflationary expectations subsided during the quarter, concerns built about the creditworthiness of the US government, and as a result, treasuries lost ground. The reckless spending by Congress and the current White House expanded government debt by over $10 trillion over the last four years. (figure1) Just not a great time to own fixed-income securities.
Bitcoin and Alternatives Bitcoin lost ground, as did other alternative investments like real estate and commodities. Real estate investment trusts mostly fell, with the XLRE dropping 1.9% and the IYR declining a bit over 1%. Housing REITs did a bit better. Bitcoin declined by over 13%.
In the equity arena, large-cap growth stocks continued to far outperform value stocks, as represented by IWF vs IWD. (figure 4) From a sector perspective, tech and communication services were the front runners, gaining 8.8% and 5.2% in the quarter, while materials, energy, and industrials lagged with losses of 2-4%. The secular growth theme that favors the magnificent seven is the wind at the back for growth. At the same time, the slow-growing global economy is a headwind for value-oriented industrials and financials. Foreign markets performed poorly, with both Europe and China producing returns half the amount of the US markets. These export-based economies are struggling in a world of slower growth and with no participation in innovation or technology-driven productivity enablers. Money has likewise stayed away from small-cap stocks that need stronger overall growth to thrive.
Economic Outlook The global economy is growth-challenged despite employment being very strong, but this is being offset by higher costs of borrowing money and a consumer who remembers those 1% rates and thinks they’re coming back. Employers are unhappy that their employees want to work from home, and it is unclear how this will play out. It seems like employees will have their way until the economy busts. Employment is likely to weaken just a bit, but not enough to bring down rates. Possibly by the end of the year, but not likely. There is some slight weakness brewing from the consumer, and it will likely get a bit worse. It seems unlikely that the economy will grow through this inflation problem quickly. Either a bust or a long two-year period of soft growth would end the cycle for inflation, but it doesn’t seem like a bust is on the horizon. While new home sales have held up well, it seems like the recent trend of weakness is going to continue, and strength is not on the horizon. Higher prices and higher borrowing costs have hit spending on goods, and consumer services are now likely to follow with weakness for the same reasons. Manufacturing outside of technology will remain soft until the consumer is better. Corporate spending on web computing is the lone bright spot.
Travel, web computing, high-density computers, leisure services, and digital devices are the best part of the economy, but eventually, even they can soften if the consumer does not get back on their feet again.
Financial Market Outlook The return on non-risk assets (4%) is still quite low relative to people’s recent memory, and hence most investors are unwilling to leave risk assets for 4% returns. As a result, money continues to flow toward risk assets. Also, fixed-income investments like treasuries that were perceived as risk-free are now being perceived as having some credit risk. Treasury rates would seem to be range-bound between 4 to 4.5%.
It would seem that money will continue to remain in risk assets. Equities seem better positioned than any other asset. There is still potential earnings growth to drive prices higher, and it is clear the magnificent seven are growing at a strong pace. These stocks will continue to lead the equity market higher, dragging along any companies associated with those same themes that are driving the magnificent seven.
Secular growth stocks are the place to be for the foreseeable future. MACM’s equity strategies are loaded with secular growth stocks that are driving excess return in our managed portfolios over the S&P 500.
We remain optimistic!
Figure 1 – Spread of Treasuries over Inflation over 10 yearsFigure 2 – Total Outstanding Government Debt over 20 years.Figure 3 – US GDP over last 5 yearsFigure 4 Large Cap growth ETF vs Large Cap value ETF( +8% vs -2%)
Exciting New Consumption Themes Drive Leadership in Market and Economy
April 4, 2024
By Mitchell Anthony
Overview
The stock market rallied along with other risk assets in the first quarter of 2024 similar to what was seen in the last quarter of 2023. The rally had narrow leadership and mostly centered on the excitement that is building in several areas of the economy that are seeing eye opening and astonishing innovation. That innovation has turned into strong demand for the products and services in areas of technology or technology enabled industries such as artificial intelligence, cloud computing, digital devices, obesity and weight loss drugs, and autonomous vehicles.
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Nervous Investors Return to Risk Assets…But Economy Remains too Strong??
January 19, 2024
By Mitchell Anthony
Investor’s hunger for high returns has driven liquidity back to risk assets despite nervousness about the direction of interest rates. Risk assets have performed like a yoyo over the last year as expectations for inflations have been up and down with changing economic data. There are no clear answers to some obvious questions that are on the mind of investors regarding the need for lower inflation? Will employment soften and will consumption decelerate? Investors are clearly hoping for weaker economic data that will support lower interest rates, friendlier fed policy, and as a result higher asset prices. Given the rise in interest rates that we have experienced it is only natural to think that consumption and employment will soften leading to sustained lower inflation. However this has not occurred yet and consumers continue to spend. While many investors worry there is something terribly wrong with the economy and a bust is on the horizon , the real problem is that the economy has too much underlying strength. Softer growth will be great news for stocks and bonds.Read more
Why are Investors leaving Risk Assets!
October 10, 2023
By Mitchell Anthony
Investors left stocks, bonds, REITs, and bitcoin in the third quarter as the uncertainty for inflation caused investors to hit the pause button for BUYS and contrarily build cash positions. Inflation is still above the Fed speeding limit and higher rates will prevail until inflation buckles. The rush out of risk assets hit treasuries the hardest with the intermediate treasury fund (TLT) down 13% from its July 31 highs dealing a blow to prudent investors who thought treasuries & bonds were a safe place to be. Stocks likewise declined with the S&P 500 down 5% and deeply cyclical value stocks as measured by the Russell 1000 Value (IWD) down over 7%. REITs declined 9% or more with office building REITs down over 15% (BXP) and residential property (REZ) faring a bit better at -7%. MACM’s Dynamic Growth portfolio performed better with a modest decline of 1.9%.
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Equities Rock Again - Are New Highs Ahead?
July 3, 2023
By Mitchell Anthony
Investors have returned to risk assets as recent economic data shows a Goldilocks like scenario unfolding yet again. A year ago it was unthinkable that the economy could slow enough to cause inflation to hit a wall without economic growth hitting a wall as well. Somehow the unthinkable is playing out and this Goldilocks like scenario has caused investors to embrace risk assets and give up safe returns of 5% or more in ultra-short treasuries. The S&P 500 rose 8.7% in the second quarter, MACM’s dynamic growth portfolio rose 11.3%, and NASDAQ triple Q’s rose 15.3%. While all of these indexes are still 5 to 10% below all-time highs there has been a substantial bounce in equity markets over the last six months, making an assault on new highs entirely possible. Value stocks were abandoned in favor of sexier growth stocks with the Russell 1000 growth Index advancing 12.8% compared to the Russell 1000 value index returning only 4.1%. The allure of fixed income was lost and treasuries for the most part were down 2 to 4% in the quarter.
The stability of the economy combined with much lower inflation drove the performance in the markets!
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Markets Rally Big in Q1! Can it Continue and with What Leadership?
April 10, 2023
By Mitchell Anthony
The first quarter of 2023 was volatile for both the economy and the financial markets. Expectations for economic growth and expectations for inflation mostly fell during the quarter but optimism for the soft landing ultimately prevailed. Inflation has been a tremendous burden on the US economy for the last two years and consumers are close to the end of their discretionary savings and they have been spending more and getting less for quite a while now. Consumers have yet to show frustration or walk away from the higher prices but it would seem that this sort of mentality is near. The financial markets mostly performed poorly in 2022 as inflation ran out of control and the Fed looked terribly behind in his job fighting inflation. Stocks, Bonds REITS, and Crypto all fell hard. However optimism has started to prevail in 2023 as many of the leading economic indicators showed clear signs of a significant slowdown that will curtail if not end the inflation cycle that we have endured. At this point it is unclear what lies ahead for economic growth but inflation seems set to re-anchor near the 3 to 3 ½% level by the end of 2023.Read more
First Major Banking Collapse Since 2009 – What Does it Mean?
March 11, 2023
By Mitchell Anthony
Silicon Valley Bank (SVB) collapsed yesterday as depositors withdrew cash! This is the first major banking collapse since the great financial crisis of 2008. While the crisis and details of this takeover are still unfolding the early visibility we have reveals that this failure is not part of a systemic problem within the US economy and we are unlikely to see other banks fail in a similar manner. The problems and circumstances that led to the default seem unique to this highly specialized regional bank that worked almost exclusively with the start-up tech industry in Silicon Valley. At first blush it would appear that the majority of major banks are sound and not subject to the unique circumstances that brought down this highly specialized bank. The problem that we have is the fact that banks are not required to disclose or mark to market their bond portfolios that are being held to maturity or they hope to hold to maturity. There could be significant unrealized losses on these portfolios. This crisis may force banks to reveal their bond portfolio status and it could certainly require them to start paying higher returns on cash deposits. Investors are obviously bracing for the worst and the stock prices for almost all banks plunged by as much as 20 to 30% over the last few days as the crisis unfolded. We believe the crisis and the plunge in bank stock prices likely represents a value opportunity. We have been underweight banks in our portfolio since the pandemic began for reasons such as this!Read more
Can Markets Move Higher with Inflation Finally Heading Lower?
By Mitchell Anthony
December 23, 2022
Financial markets have been extremely volatile throughout most of 2022 as high inflation shocked the economy and central banks around the world reacted with significantly higher interest rates. The inflation battle has taken significant time to even dent inflation and the path out of the crisis is still unclear. As a result stocks, bonds, and commodities have all been volatile as inflation and the cost of money is critical to the success of an economic cycle.
Inflation peaked in October and has begun to tilt lower but the path back to the feds target of 2% inflation is still very uncertain. Fixed-income securities have declined in value substantially throughout most of the year as the fed pushed rates higher although the decline has paused over the last few months. Equities have followed a similar path but a modest rally has begun several times that is now again struggling. Yields on treasuries have quadrupled this year reaching as high as 4.5% but falling back to 3.7% today.
The equity market has ebbed and flowed since the June bottom and three rebounds have occurred. While the first two failed, the third has been quite strong narrowing the S&P 500 loss to -18% YTD.Read more
Economy Stays Strong but Risk Assets Move Lower Again in Q3
By Mitchell Anthony
October 10, 2022
The US Economy has found a way to avoid recession despite a record rise in interest rates.
Consumption in the US economy has remained resilient despite a record rise in interest rates and the highest inflation in 40 years. This is somewhat unexplainable but likely tied to the fiscal stimulus that was poured into the US economy in a plentiful manner by the U.S. Congress as it worried about getting the economy back on its feet after Covid. Investors and strategists seemed almost certain that the US economy was headed for recession in the first half of 2022 as the FED began to raise rates aggressively, however after two quarters of negative GDP optimism for economy growth has sprung back to life and the 3rd quarter is expected to be positive with over 2.5% GDP. Actually the US economy was never seemingly in recession despite the negative growth. Unemployment has remained at near record lows and with it came a return to strong consumption. That’s the positive spin, however as we all know inflation is out of control and central bankers are in the position of busting it even if it means busting the values of all risk assets as well as consumption and employment. The Fed has been at work raising rates and investors have been doing it right along with the Fed. Mortgage rates have risen from 2.5 to over 7% currently (figure 1). Surprisingly housing has not busted and consumer spending has continued to grow. Strong Employment seems to be the backbone of the economic resilience. Consumers still have liquidity from Covid stimulus, though it seems to be waning based upon a notable increase in credit usage.
Here good news on economic growth is bad news for our inflation problem as inflation needs to cool rapidly to avoid significantly higher rates and the economic slowdown has not arrived as thought and is truly needed!Read more