Happy Fall-ish! I have a scenario/question for each of you: Have you ever woken up, in the middle of the night, and needed to go to a familiar spot? You know the path as you’ve experienced traveling it before, yet you’re reaching, in the pitch black, and the familiar door handle isn’t there! You wave around a bit and incrementally move in the direction you know well, yet…it’s just not there…or is it? THEN…it appears out of no where…
The 3rd quarter came to a close with US stock gauges and Treasury bonds notching their worst quarters since September 2022.[1] While the rapid tightening of monetary policy is likely coming to an end globally, persistent inflation has prompted the US Federal Reserve to adopt an outlook of “higher for longer” despite increasing uncertainty with economic data. Below are some key things to note:
Globally, stocks ended the quarter with their worst monthly selloff since February.1 A further rise in interest rates across the board made the July-September quarter the worst for MSCI’s global all-country index since last year. 1 2023 thus far has seen notably narrow participation to the upside as a handful of mega-cap growth companies have moved higher while the equal-weighted version of the S&P 500 — where the likes of Expedia Group Inc. carry the same index weight as Microsoft Corp. — is now roughly unchanged on the year. The small-cap tracking Russell 2K index currently trades around the same levels as 2018. 1 Historically this dynamic has not been representative of a new bull market cycle in stocks.
Treasuries are heading for a record 3rd straight annual loss, after sinking 12.5% last year. 1 The US aggregate bond market ended the quarter down roughly 14% since the end of 2021. Ultra-short-dated US government bonds (which continue to be our largest allocation for clients) have been a safe harbor as yields on 3-month T-Bills are currently north of 5% and at levels last seen in 2007.1
Americans outside the wealthiest 20% of the country have run out of extra savings and now have less cash on hand than they did when the pandemic began. This comes as the increase of consumer loan rates over the past two years, in percentage terms, is about 5x larger than the 2002-2008 period.1 While US households and corporations have remained resilient to higher interest rates due to what was excess savings created during the pandemic, some possible cracks have started to show:
The US consumer is starting to quantifiably slow as rising gas prices crimp spending and the delinquency rate on credit cards reaches the highest level in more than a decade. And that’s before student loan payments restart in October.
A measure of consumer confidence slumped to a four-month low in September1 as inflation and a deteriorating outlook for the economy weigh on people.
Despite the speed of the central bank hikes, the amount of outstanding debt globally rose to a record $307 trillion in the first half of 2023. This debt, in particular of the high-yield variety, is set to come due over the next few years. Defaults could rise rapidly going forward and the impact of higher interest rates would slowly filter through to consumers and companies that need to refinance.
US-China tensions are rewiring global trade, as the US seeks to reduce supply-chain reliance on geopolitical rivals. Simultaneously, Beijing is seeking to strengthen both economic and political ties with various nations forming adversarial alliances to status-quo US interests. The global economic structure is shifting, and worldwide economic growth will likely be far less supported by the same economic relationships that defined the last 30+ years. We feel this creates both risks and opportunities within portfolios in the quarters and years ahead.
Our current core focus is generally on the following:
The current 3-month T-Bill yield is higher than both the S&P 500 earnings and dividend yield. This is the first such occurrence since the late 1990’s. 1 In the absence of a renewed upshift in economic activity and corporate earnings we remain tactical and relatively defensive towards stocks. Pockets of opportunity are to be found globally with risk management being critical.
Ultra-short, dated treasuries are extremely attractive on a risk/reward basis as stocks and longer maturity bonds continue to show positive correlation, which has been rare over the last few decades. We are also monitoring the following closely as these dynamics strongly impact markets: commodity market price trends, central bank interest rate decisions, & economic/corporate activity.
Our portfolio management continues to be guided by a data-driven, quantifiable approach with our proprietary price & economic data signals as well as our experience. This allows us to track the prevailing foundation of the economy from a high level and also measure and act on when we believe markets are either front running or ignoring key fundamental information across the business cycle. Our process has guided clients through uncertain times (in the proverbial middle of the night) before and we’re confident we’ll find the familiar destination without face-planting and breaking something along the way. The latter, we believe, is critical to remember in today’s environment as opposed to getting there the quickest.
As always, we welcome any and all deeper conversations around any topic and remain immensely grateful for the opportunity to work with each of you.