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%.

The economy is not much different but?

 

The declines in Risk assets make some wonder – Is there a bad economic bust brewing? What might be wrong economically?  Is it all about uncertainty?  Seems like it’s mostly about the latter as the economic environment has not changed much and things are mostly the same as it has been all year. Economic growth has been modest,  but the big economic slowdown expected by most strategists for over a year given the level of interest rates, has not emerged.   Investors are impatient with the inflation and are no longer willing to stay fully invested in an environment that is unfriendly to risk assets.  This unfriendly environment that I speak of regards the high inflation and high interest rates that we have today.  Nirvana for the stock market and risk assets is an environment of slow tepid growth with no inflation and ultra-low rates.  But that is not the case and we have 3 to 4% inflation with moderate growth.  Certainly not the nirvana that investors expected by now.  It could be around the corner and it’s always the darkest right before the end of the storm however the current run for stocks and bonds has paused until economic softness emerges or a plunge in inflation that would change expectations for the course of the Fed significantly.

 

Economic Review Q2 2023

 

Economic growth may be slowing but it hasn’t become visible yet. Consumers are just not balking at the higher prices of goods and services and continue to find ways to pay up.  Employment has remained strong and consumers seem to have access to debt to borrow beyond their income.  Remember we want the economy to slow because that’s what will drive lower inflation expectations and friendlier FED policy. Yeah of course it would be great to have growth stay strong and inflation tip over but that is highly unlikely and investors would then just worry that it’s only temporary even if it did happen briefly.

 

Not a lot of rot in the economy to note

 

Certainly there is a crisis in commercial real estate. And we also know that banks are not near as liquid as they might be because of poor investments when rates were very low just a few years ago.  Subprime loans on Autos are also a problem.  For the most part there is not a lot of overcapacity in any sector of the economy that would cause job problems if consumption slows dramatically.  Hence the risk of a very hard landing seems minimal.

 

Where’s the strength?

 

If we look at the leading economic indicators we see quite a bit of strength still. The Inflation we have helps the economy grow although no one seems to like to grow through price hikes. However the CPI which fell to 3% year-over-year in June is now back up to 3.7% year-over-year. CPI ex food and energy looks a bit worse (4-5%) for consumers but good for the producers and retailers of food and energy. They are not going to give up those price hikes as long as they can push them through.  Unemployment is still very low but has ticked up to 3.7% from 3.3% six months ago. Consumer confidence has fallen again but this indicator never helps us much as consumers will always tell you how miserable they are despite spending aggressively. Consumer wealth is still high with elevated stock indices and real estate prices still driving consumers to spend. Consumer services are the strength of the economy currently with experiences still on the mind of consumers. Technology and productivity equipment including artificial intelligence are being purchased in a significant manner by corporate America and push the economy and job creation forward.

 

Where’s the weakness or the soft underbelly of this economy

 

If we look at what’s weak in the economy.  Anything that’s financed with credit is concerning which includes housing, autos, & large durable goods.  Consumer savings have fallen considerably from their peaks of a few years ago and may impact consumption. Consumers with under six figures of income have already started to balk at the high price of goods and services.

 

Themes of Consumption that are still in place.

 

  • Defense products steady?
  • Healthcare services strong?
  • Housing sales holding at modest-moderate levels
    • Prices are high and are an impediment to consumption given rise in rates
  • Experience demand still strong
    • Travel strong
    • Eating out remains strong and growing?
    • Restaurants struggling with labor costs
  • Web Services status is unclear? Talk of AI strength
  • Digital device demand strong?
    • Stay at home consumption – Ecommerce

Financial Market Outlook

 

As stated earlier the move higher in risk assets has paused until there is a break in the negative news-flow regarding inflation or the drivers of it.  For the most part everything has been unfriendly for the last two months. The best stocks and equity groups would involve e-commerce, entertainment and leisure, secular growth companies leveraged to productivity including artificial intelligence, digital devices, and web services.

 

I don’t believe an economic bust is on the horizon and hence not a significant bust for risk assets either. However risk assets could decline another 10% as we await the soft economic news.  Eventually the economy will soften and inflation will dissipate but is it a few months away or years away?

 

We remain optimistic…