Nolte Notes 3.22.21

March 22, 2021

The days are longer than the nights and the weather is beginning to warm up. Baseball starts in 10 days! Summer is just around the corner. The economic “issue” is that inflation is beginning to heat up as well. Getting lumber or copper for homebuilding or gas for your car is costing a whole lot more than a year ago. As a result, interest rates are rising and pushing the Fed to recognize that an ill wind that blows does nobody good. Inflation, in the words of the Fed, may be transitory, but for how long? Expectations are for an economy to be blowing hot during the summer as economies open around the world. With all the stimulus and people going back to work with extra money in their wallets, inflation may be around for something more than a transitory period. To be fair, the Fed has pulled the punch bowl from the party well ahead of things getting out of hand, but this time wants to wait until they start seeing the party really rolling before raising rates.

Last week’s economic data was less than stellar, but the key report will not be showing up until April’s jobs report. The weekly jobless data is stuck in low gear, without much change since Halloween. However, the continuing claims are about double that of early 2019 and about two-thirds of the peak in 2008/09. Other data points are indicating the economy is healing, albeit very slowly. The coming jobs report will be informative as to the type of jobs coming back. In early March, the jobs report showed a large pick-up in hospitality jobs, restaurant, hotel, and bars. The trend is expected to continue as various states are loosening the restrictions of the past six months or so. Commodity prices are beginning to roll over a bit, energy prices have dropped from their recent highs and agriculture prices are down for March. So, while inflation indices could continue to rise in the months ahead, some prices are beginning to decline. As vaccinations increase and economies open, the main debate is how much pent-up demand is out there. Many are hungry to get out, others remain cautious. Trying to guess human behavior after this year is a fool’s errand. We will watch how things unfold rather than trying to guess.

The direction of interest rates has been the focus of investors over the past month as rates on the 10-year bond is now at the highest level in over a year. However, looking back at the 10-year yield, rates have been in a range between 1.50% and 3% since mid-2011. Before collapsing to under 0.60% last summer, the yield on 10-year bonds was near 2%. The concern today is that inflation is going to spike, and the Fed will have to step in to raise rates. The Fed has stepped in early, anticipating the inflation that never came. Today, they want to see inflation before beginning to tighten rates. They should be on the sidelines until sometime in 2022.

The battle between growth and value continues to rage during March and has been dependent upon the direction of interest rates. When rates rise, growth stocks falter. When rates ease, growth races higher. Growth stocks are all about future expectations for earnings that get discounted back to a price today. As rates increase, that discount rate also increases, pushing today’s value lower. More cyclical stocks that are tied to economic growth benefit from a better economy. They tend to be very leveraged to economic growth, doing very well as the economy recovers and booms, and collapsing when the economy hits a recession. We have been concerned that growth stocks have “discounted” every possible bit of good news in their price, so any change could mean much lower prices if those expectations are not met. While not necessarily as egregiously priced as the tech bubble in 2000, many growth stocks are still priced for perfection and could fall dramatically if those expectations are not met. Meanwhile, little is expected of the consumer related stocks in the face of the pandemic. As the economy opens, many will do very well as consumers return and spend money. That rotation from growth to value is likely to continue in the weeks/months ahead as people start to feel better about mingling with others.

Interest rates are likely to continue to rise as economic growth should also rise dramatically over the summer months. While that growth may be temporary, investors will still fret about potentially higher inflation and a Fed that may begin to tighten monetary policy and push interest rates higher still.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 3.15.21

May 15, 2021

As we “celebrate” the first anniversary of the “just two-week lockdown” to bend the curve, the economy remains a mess even though Wall Street is doing fine. Another $1.9 trillion will be doled out over the coming weeks and months to help the economy and those impacted by job loss recover. Until the economy opens fully, it will be hard to restore jobs, especially in the service sector. Market psychology has shifted from benefiting companies helped by working/staying at home to a hopeful reopening of the economy. The bond market is sniffing inflationary pressures and concerns about the time when the population is unleashed from a restricted lifestyle. Interest rates have increased significantly and this week we will hear from Fed Chair Powell regarding their position on keeping rates low for longer and when it will begin to shift. As the weather warms and vaccines find arms, the summer is expected to be “more normal”. Anything less will be a huge disappointment after the past year.

The economic damage of the past year is still very evident in the weekly jobless claims figures. The average of the past year is roughly 50% higher than the average during the financial crisis. The response from the government has been multiples more than during 2008-’09. Unlike that period, this one is completely health related and will take broader vaccination and local governments to relax restrictions on the service economy to realize a stronger recovery. The inflationary worries have not yet shown up in the “official” data, as both consumer and producer prices were as expected and are still well below the Fed’s 2% target. That will change in the coming months as commodity prices have jumped by over 20% since the end of last March. Even pulling out the usually volatile food and energy, prices are expected to soon be above that 2% level. If consumers have money to pay the higher prices, inflation can linger. The extension of various programs into fall may allow many to have money in their pockets and keep the pressure on prices. Once the economy fully recovers, wage growth will be the key driver for “durable” inflation. This dynamic will be under the microscope at the Fed meeting and the press conference that will follow. The markets are sure to react.

The bond market has been at the center of investor’s focus as longer-term bond yields have been rising in response to expectations for higher economic growth and inflation. The impact has been felt more in the treasury market and to a lesser extent the corporate bond. Corporate bond (and to a lesser extent) municipal bonds are dependent upon the health of the specific issuer. Better economic growth and higher local tax revenue will benefit these parts of the bond market. The huge issuance of treasury bonds to pay for the various pandemic programs will have a tougher time to be absorbed within the market, pushing rates up on government bonds.

After being neglected for the better part of 10 years, other parts of the markets are indeed waking up. Small stocks are up better than 20% just this year. Energy, the black gold variety, is up over 40%. While much of the attention has gone toward technology, this shift toward “everything else” has been picking up steam over the past six months. Some of this is due to expectations for better economic growth. Energy has been pushed down so far that it was impossible to find storage a year ago and you could get paid to hold it (assuming you had a few tankers in the backyard!). Today, pump prices are at or over $3/gal. Smaller stocks tend to be more domestic and do not have as much international exposure as their larger cousins. Many of these companies suffered in the early days of the pandemic and for those surviving, they are likely to thrive as growth picks up.

Interest rates and investor ebullience may be the only things to derail the markets over the long-term. Over the short-term, stocks may take a rest especially in front of the Fed meeting this week. Volatility has not subsided, but few notice it when stocks rise!

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions

Nolte Notes 3.8.21

March 8, 2021

“To everything there is a season… a time to gain and a time to lose.” Using a synonym for turn, Wall Street prefers “rotate, rotate, rotate”. Since the most recent “bottom” in the market just ahead of the election, there has been a rotation in the markets from technology toward more cyclical issues. Due in large part to the decline in COVID cases around the country and opening states like Texas and Mississippi, there is hope that summer will be full of concerts, ballgames, and movies. While maybe not at capacity, the expectations for “normal” has pushed investors toward companies that benefit from fully opening the economy. Inflationary worries have also crept back into investors’ minds, although Fed Chair Powell gave no indication of adjusting their low rates for a long-time policy. Commodity prices have picked up very noticeably as many indices tracking them are up over 15% from this point a year ago. If the economic expectations are indeed correct, it will be a time to build up and dance, rather than to mourn.

Expectations were high for the last chat by Fed Chair Powell before the Fed enters their “quiet” period ahead of their next meeting in mid-March to address the rise in rates. He basically said that there remains plenty of “slack” in the economy and any inflationary pressures are like to be “transitory”. To translate, with employment where it is today and the gains reported last Friday, were it to continue, it would take until late 2023 before the economy made it back to employment levels last seen just before the pandemic started. He (and the Fed) also believes that the rise in commodity prices will flatten out in the months ahead as supply and demand begin to balance out. There have been so many disruptions due to the virus, that getting goods into the economy has been tough, so what is available can be had at a high price. That should moderate as businesses open, and money begins to flow around the economy. The employment report on Friday showed the impact of businesses opening as many of the “new” jobs were in leisure and hospitality. As weather warms and (maybe?) restrictions eased, employment gains should be quite large in the months ahead. The bigger questions will be whether prices begin to moderate or will the Fed have to deal with rising inflationary pressures.

The excitement was not in stocks, but in the bond market last week and seemingly for the past month as investors wring their hands about incipient inflation. We have been down this road more than a few times over the past couple of decades. Commodity prices are up over 20% vs. a year ago, their fastest rate in 10 years. The steepening yield curve, or long rates rising fast than (the nailed down) short rates is a typical response. These bouts do not last long, a few months or so, before commodity prices begin to decline. What is normal too, is a steep yield curve. We have had more than 2 percentage point differences between short and long-term rates for years. Starting with 9/11/01, the next three years saw a very steep yield curve. Again, starting a year ahead of the stock market bottom in March of 2009 and for the next eight years the yield curve was steeper than today. What is less typical is the flat curve that we have had up until a year ago. During those periods, stock investors did just fine.

The death of technology has been called for quite often over the past few years. The rotation toward value and away from growth has had its moments before investors headed back to technology. Even international, where technology is a small portion of their economies is seeing investor interest pick up recently. The top stocks within the various popular averages are down an average of 10-13%, with the top 5 averaging a better than 20% drop. As we have highlighted often over the past few years, technology companies are selling at very high multiples given their recent earnings and sales. If the economy does indeed begin to re-open, people will be wanting to have “experiences” once again rather than be tied to a technology device. Just maybe this time we see the move toward other parts of the market as a lasting “thing”. Markets usually shift leadership coming out of recessions. This one has just taken longer than most.

We will be watching the yield curve and commodity prices to judge the staying power of any inflationary pressures. Bond investors are likely to suffer additional declines in value as yields rise. Finally, full passage of the stimulus package could be a signal to “sell the news” as investors have been buying the rumor for months.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions

Nolte Notes 3.2.21

Sign, sign, everywhere a sign. Yield is one sign that the equity markets were watching closely last week. As yields rose investors became cautious about adding to their equity exposures as there is now slowly becoming an alternative to stocks. Investors also stopped buying technology stocks as aggressively as they had been during the summer months and into early fall. Again, expectations for an economic re-opening are not only pushing yields up but stocks that will benefit from “going back to normal”. Merging has also been a favorite activity among the “SPACs”, or Specialty Acquisition Companies that are created with the express purpose of buying companies to list them directly on the US exchanges vs. going through an initial public offering. Many of these SPACs have increased in value, even though they have not yet bought another company. It is like spending two dollars to buy a dollar. Do all these signs point to the end of the 11-month rally? We will need to wait to see some more signs before making that final call.

The correction of the past two weeks has only hit the “normal” range of 3-5%, but already investors have begun panicking about the end of the rally. There are still over 70% of the stocks within the SP500 that are trading above their long-term average price. The net number of stocks rising to falling is still at a high level. Finally, the rotation to other parts of the market (other than technology) is a long-term healthy development for the market. Economically speaking, the data is decent. Retail sales continue to boom on the back of government checks sent out at the end of 2020. Real estate is doing very well due in part to historically low mortgage rates and a desire to move out of the big city as many companies are allowing working from home as a long-term proposition. Manufacturing is doing extremely well as companies work to supply all the goods that have been purchased over the past six months. There remain shortages of a variety of goods like semiconductors, that have been in high demand and supply is struggling to keep up. It is the imbalance between low supplies and higher demand that has given rise to the concern about higher inflation. So far, the reports of inflation are not (yet) high enough to warrant long-term concern.

The widening spread between short-term and long-term bond yields has been an indication of a return toward some stronger economic activity. Fed Chair Powell, in his testimony before Congress last week, reiterated their desire to keep interest rates lower for longer until the economy completely heals from COVID. Unfortunately, as we have repeated over the past six+ months, money is not going to make the economy better, until people are willing and able to go and do as they please as had been the case before the various state shutdowns. The seeds may be already sown for some unintended consequences of too much easy money for too long that will impact the financial markets in the future. For now, equities are living off the sugar high. The bond market is signaling that higher economic activity is already here and not really in need of additional stimulus. However, once the economy fully opens, many people will likely need additional aid until their prior jobs fully return.

Last week was a wild one for stocks, but in the end, saw a continuation of the rotation toward more cyclical parts of the market. There will be some corrections and short-term returns to what had been doing well, however, over the coming few years, the markets should be moving toward more cyclical companies and away from the technology favorites of the past 10 years. It is not that many of the technology companies are not good companies and have provided tremendous value to both shareholders and users alike, it is that these companies are selling at historically high multiples of earnings (and in some cases multiples of revenue) that it is unlikely for many of these company’s stock prices to continue their recent trajectory. There is a difference between buying a good company and buying a good company at a good price. Today, many good companies are selling at historically high prices to their underlying value.

The economy will continue to gradually and with many stops and starts along the way, demonstrate solid growth that should support stock prices and higher yields in the bond market. The Fed is not likely to move anytime soon and we will be watching the bond market for clues about an appropriate time to trim stock holdings.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 10.5.2020

Good-bye and good riddance to September, the first down month since the March market bottom. Though the quarter ending in September was very good, investors are increasingly worried about the election. With the revelation that President Trump has Covid, the election “season” gets tossed on its ear. The economic data from last week was generally good. The employment rate fell below 8%. That came as a large part of the unemployment left the workforce, while those looking for jobs took longer to find one. In general, the economic data signals a recovery that is losing its mojo and in need of additional stimulus, which given the President’s condition, may have a better chance than not in the weeks ahead. The coming week will be light on economic data points and will be the lull between the quarter end flurry of economic news and the start of earnings season. It is expected that earnings likely bottomed last quarter. Outside of the technology sector, how much did earnings really pick up from a slowly recovering economy? One final bit of good news. October is known for market crashes. However, it also marks the beginning of the best quarter of the year, especially in an election year.

While the markets snapped their four-week losing streak, it was not a pretty week. Trading volume rose as the markets declined. Investors anxious to buy early, were selling by the end of the day. Those strong opens and weak closes are not healthy over the intermediate term as it indicates stocks are held by “weak” hands. Unless stocks continue to gain this week, the advance decline line will put in the third “lower high” since August. Looking more like steps heading lower, it is another indication that stocks are still struggling to find their footing. A strong week this week could turn that tide and get the markets looking much better heading into the election as well as finishing up the year on a positive note. The market seems to be reacting more in the short-term to political news than the economic data, which is decent, just not as fabulous as it was a few months ago.

Just when things look precarious for bond investors, the bond markets surprise everyone. Yields have been rising ever so gradually. However, the “non-treasury” portion of the market, like corporate and high yield bonds continue to do well, taking their place as “equity like” bond investments. It is in this time of economic recovery that yields typically rise as inflationary fears enter the market, tight supplies, and rising spending. Usually the longer-term treasury yields rise to compensate for higher inflation rates, while corporate bonds “rejoice” as their changes of paying principal increase with economic growth. Surprisingly, the bond model is now actually forecasting lower interest rates. Higher utility stocks and lower commodity prices have been the key in shifting the model toward a better overall outlook on interest rates.

The better utility stock prices highlighted above is not all that great for stocks, as the utility index is performing better than the SP500. Since the SP500 peaked at the end of August, utilities are over 6% ahead of the SP500. Consumer staples and other “defensive” parts of the markets are shining compared to the broader indices. If the more defensive portions of the markets are leading, it pays to be cautious. Even the international portion of the market is doing relatively well. Down for September, but much better than the SP500. Last week the much maligned small, midcap and value portions of the markets took center stage. We have seen this show before, but like Bullwinkle’s hat trick, maybe this time for sure! The typical shift from growth to value has been expected for the past few years but has yet to make more than a month or two appearance. If the economic openings can stick, investors are likely to shift toward the more beaten down portions of the markets, which would mean value over growth.

As if on cue, the markets rallied last week, after four tough weeks in September. October, even with the historical reputation for crashes, marks the beginning of the best portion of the year. If the economic growth can pick up and we see a bit of help from Washington, investors are likely to be rewarded for being invested.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 9.28.2020

Without a furious rally early in the week, this will mark the first month since March that the markets have declined. Judging by the various comments in the financial press, an economic collapse is on the horizon. While sensationalistic, the economy is showing some signs of slowing in key parts that could spell some trouble. As has been the case since the beginning of the economic shutdown, we look at the “high frequency” data points to determine if things are opening, stagnating, or backsliding. From people moving through the airport to restaurant reservations to using phone apps for directions. All are showing modest improvement during the month of September, but that “rate of change” has slowed from the summer months. The weather has been very nice in the northern climes, but the beginning of fall marks the beginning of the end of dining outside. The focus, at least temporarily, will shift this week to the elections as the first of three debates is set to take place on Tuesday. The economic data will be coming hot and heavy afterwards, culminating in the monthly jobs report that will get the usual scrutiny. Another week of tossing and turning all night!

Fear is once again entering the financial markets. Last week marked the fourth consecutive week that the SP500 fell, the first time that has happened since August of last year and only the third time in the last five years. It is little wonder that investors are beginning to worry. Even the market decline in March was split into two terrible weeks around one positive. From a very short-term perspective, one third of stocks are trading below their short-term average prices, the lowest since the March bottom. Historically, the markets should rally some from this point, however the political and still rough economic data may keep a lid on any “friskiness” in the market. The volatility is likely to remain through the election. Once the election is in the rearview mirror, stocks could stage a yearend rally as investors sigh a bit of relief and turn back to the economic and virus data.

One of the indicators for the stock market is the spread between high yield bonds and treasuries. Historically, the spreads get very wide when the economy hits the skids and this year was no different. Once past, those spreads get smaller as investors begin getting comfortable with an economic recovery. This time around, those spreads are indeed much lower than in March, however they have hooked up over the last few weeks. This is being confirmed with a narrowing of yields in the treasury market. Both indicate the recovery remains in question and the potential for another leg lower in the economic data remains relatively high. Even the performance of the very safe utility sector has outpaced the SP500 nearly every day since the start of September. The uneven recovery is likely to keep investors on edge until we get better medical data on a vaccine.

One of the “tells” in this market is the action of technology stocks. They skated through the March decline and came out the other side as market leaders. They were leaned on heavily as people worked from home and ordered nearly everything online. Technology has become the “conservative” play if the economy struggles to reopen. However, one other sector also provides some insight into investors desires to take on risk, utilities. As we noted above, the utility sector has been performing well vs. the SP500 since the start of the month. This has coincided with the market correction and was also a leading indicator of the market decline early in the year. Small and mid-cap stocks have done well during September as investors sold some of their tech shares. That said, there has been no changes in the ranking of the various industry groups within the SP500. Technology remains at the top, while energy sticks at the bottom.

While stocks have fallen in four straight weeks, they may be ready to rise this week as investors may be coming back into the technology sector after many companies have fallen 15-25% this month. The debates, election and earnings will keep investors focused and still jumpy, so volatility is likely to remain with us for the next 4-5 weeks.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 9.21.2020

The rough season for stocks is upon us, and so far, the financial markets have not disappointed. Most of the focus is and has been on the technology sector, which remains overvalued on many metrics. Other parts of the markets have declined some, but at a much slower pace than technology. The big news of the week was the Fed meeting, where little was done, and plenty was inferred. It was not a surprise rates were held at zero and indications were for rates to stay there for at least a few more years. Inflation got a pass, and many wondered if inflation would ever be a problem again. Former Fed Chief Volker must be flipping in his grave! Chair Powell exhorted Congress again to pass additional stimulus as the Fed could only do so much for the average consumer. The financial markets reacted negatively, hoping that they would announce additional financial measures and monetary easing to help keep the markets going. When that announcement did not come, stocks headed south. The coming week will focus on housing, with the release of home sales for August. One thing to keep an eye on is lumber prices, as the prices have nearly tripled from their lows of early April to the end of August, only to drop by a third this month.

The meek may indeed inherit the world, but the laggards this year are getting their day in the sun this month. The higher the exposure to technology, the worse the performance – exactly the opposite of the results through the end of August. More concerning has been the breakdown of some of the market internals. Like the net number of rising vs. falling stocks. After peaking mid-August, ahead of the SP500 apex at the end of August, the net number is back to July levels, when the markets were 4% lower than today. Daily volume has been expanding when stocks prices are falling and contracting when they rise. Again, a recent development that points to additional weakness ahead. At this point, additional weakness is not a market collapse, but a rotation toward parts of the markets that have not done well this year and away from technology stocks.

The declaration by Fed Chief Powell that interest rates are likely to remain at current zero rates for the next couple of years means income investors will continue to be starved trying to get some income safely without being subject to the wild swings in stock prices. While inflation is not returning quickly, the Fed feels confident in their ability to stave off “runaway” inflation as Volker did in the 80s by nearly killing the economy after hiking rates into the teens. A chapter that I am sure investors would not rather revisit. The implication is that the Fed would be much slower in hiking rates as the economy gains steam. This would mean that inflation would be running a bit higher and without at least similar wage gains, the average worker could find themselves losing purchasing power. A worry for another year, but one that needs to be kept an eye on.

Technology is dead, long live technology! A rather perverse argument is making the rounds these days. If investors believe the economy will not be recovering and everyone will remain “in place” (whether working, schooling or just living), then technology will continue to be a winning bet. However, if the economy continues to recover (estimates for a 30% gain in GDP in the third quarter!) many of the other parts of the market and sections of the economy should regain their footing and perform well, especially relative to the currently expensive technology sector. Finally, there is some better performance from international markets. As the dollar has weakened and better virus numbers from many emerging market countries, they are beginning to perform better than the US market. In fact, since the end of May, emerging markets is handily ahead of the US. We have seen this “head-fake” more than a few times over the past three years. Maybe this time for sure!

The rotation toward value and away from growth/technology sectors continues to gain steam during September. We are looking (again) at international holdings and may begin to slowly accumulate shares in the months ahead. As has been the case for months, bond investors should be expecting minimal returns as interest rates are not likely to move much over the next few years.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 9.14.2020

Like the dog that finally caught the car, investors in the markets are wondering now that the market is/has corrected, now what? It is not likely that the correction is yet over, as many of the highest-flying stocks have “only” dropped 15-20% and remain significantly higher on the year. There has been a bit of rotation toward the more beaten down portions of the markets, although nothing is standing out as a clear winner. Back at the economy and virus updates, the weekly jobless data was less than inspiring. The weekly jobless claims have been dropping at an ever-slower rate and last week were essentially flat from the prior week. The flipside is the monthly report on job turnover (JOLTS), which shows plenty of openings and a low level of job layoffs. Finally, the inflation data was a bit hotter than expected, which is not a surprise, as the economy continues to open. The ability of businesses to increase prices after cutting during the pandemic is just coming back. The coming week is loaded with economic data and includes the Fed meeting, where we hope to find out more about how the Fed is likely to handle monetary policy. Finally, retail sales will be watched closely for an indication of consumers appetite to spend even as the extra government aid rolled off in July.

The SP500 has declined just under 5% so far this month, which qualifies as roughly halfway to an actual correction. Of course, there has been more pain in tech stocks, as they have jumped more than the rest of the market since March. As a result, more “value” strategies have been winning the performance race over the past two weeks. We have seen this shift a few times since March, as growth takes a breather for a few weeks and then comes roaring back. The market internals favor a continuation of the corrective nature of the market, with the net advancing stocks to declining at their lowest levels since early July. Half of the SP500 stocks are above their short-term average price which is well down from over 80% at the end of August. As investors begin to eye the November election, we expect stocks to be very volatile day to day, with a likely downward bias over the next few months.

Yield spreads, specifically the difference between the 2 and 10-year treasuries, have been very instructive in pointing the way for the economy. Historically, coming out of a recession, the difference in yields of these two securities get quite large very quickly. These “spreads” began rising quickly as the financial crisis unfolded, indicating the flood of money coming from the Fed. It took nine months to increase nearly 2 full percentage points. Today, after six months of “recovery” the spread has increased by less than half a percentage point. The implication is that instead of rocketing out of a recession with inflationary forces rising, this recovery is likely to be very tepid with little inflation. What this means for fixed income investors is a long period of essentially zero interest rates on savings and low interest rates in general for the next few years.

Signs of a still weak economy can be gleaned from the performance of the energy sector. This is the most sensitive to economic activity. After peaking at yearend, energy prices fell nearly every week before finally bottoming at the end of April and doubling over the following two months. However, since the end of June, oil prices have increased very modestly and by last Friday, closed at its lowest levels since mid-June. Technology joined energy as the worst performing sectors within the SP500 last week, while basic materials and industrials were at the top. Given the size of the technology sector at over 25% of the SP500, it will be the tail that wags the performance dog for the market. Some defensive sectors, like consumer staples and utilities (a bond surrogate) should hold up while the other parts of the market go through its normal corrective pattern. At this point, we expect nothing more than a correction, but that could change if the economic data fails to impress investors and the yield curve (described above) does not get steeper soon.

The repositioning of portfolios, taking profits in technology focused funds and shifting toward more value investments will continue IF the correction is more than past “head fakes” that we have seen since the March bottom. Bond investors are likely to see modest returns in the years ahead due to the very low interest rate environment today.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 9.8.2020

When Apple is larger than the English market and Tesla aligns with Visa, is this the dawning of the age of technology? With serious apologies to the 5th Dimension, it seems as though investors believe the is new age knows no limits. Indeed, Apple last week was larger than the entire equity market in England and Visa and Tesla were roughly equal in market capitalization. This new age may be showing signs of cracking, as the tech heavy OTC markets fell just over 6% in two days. Back at the economy, the much-awaited employment report was decent, but failed to excite investors. While still creating more jobs in one month than at any time prior to this year, the number was below last month, and prior months revisions were also lower. The sheer size of the monthly changes in all the economic data makes it hard to determine what is “normal” or how far we are from a more normal economy. We do know companies are making some of the temporary layoffs permanent and the consumer has pulled in their spending a bit during July. As makes its way to the autumnal equinox later this month, investors will be watching the election polls more closely, trying to divine the next big move in stocks. They may be looking in all the wrong places and instead should keep an eye on the economic data.

Could we finally be seeing the beginnings of a market correction that has been expected for the better part of two months? The tech run was going to end at some time, and without as much as a good reason (yet), investors started taking profits in companies that have run up 2-3 times their level just a few months ago. The broader market held up relatively well, but the tech market is providing some similarities to the late 1990s, if not with stratospheric valuations, but with still historically high prices to earnings estimates. Given that earnings will be taking a few years to reach once again the 12/31/19 peak, today’s prices project a total return of only a few percentage points from here. Better hunting grounds are in the stocks that have been left behind, like small US and even international. Staying away from tech in 2000-03 allowed investors to avoid the brutal 50% drawdown by tech issues in the aftermath of the 2000 tech bubble.

Interest rates bounced last week, providing little in the way of shelter from the equity storm late in the week. Investors felt the Fed’s shift toward “average” inflation will mean that inflation will be running “hot” in the years ahead and bond investors want to be compensated for that risk. However, as we highlighted last week, inflation is not likely to be running far ahead of the target 2% level due to slower population growth and lower overall productivity. Watching commodity prices as a clue as well shows pricing for a broad basket of goods remains below year ago levels. There should be plenty of time to get more defensive in the bond market ahead of higher inflation numbers. Right now, our best guess is that interest rates remain relatively stable around current levels for the next 2-5 years, so there is plenty of time before we need to worry about persistently higher inflation.

Almost as quickly as the calendar flipped to September, did stocks flip to the downside. As mentioned above, technology has been the main culprit for the particularly good markets since the March bottom and last week for the poor end of the week. We have seen technology stocks take a few breathers since the March bottom, most recently during July and again in late May. Each time, tech has come roaring back. Is this time different? It is way too early to tell, however the relative valuations of the sector vs. others as well as the large growth asset class vs. other asset classes are pushing levels last seen in 2000. We have begun to take some of the tech weight off the table in favor of more value and some small cap funds. The betting on Wall Street is that the Fed will ride to the rescue if the equity markets fall much beyond 20% from their peak levels, as they have done in past big market declines. As a result, investors are very willing to take risks beyond what makes sense in a “normal” functioning market. At some point that will change and maybe sooner than later.

As mentioned last week, we are shifting toward value and taking profits in many of the technology sector ETFs and individual names that have run up so much this year. While not yet increasing cash, we think the neglected parts of the market can do well through yearend, even if tech struggles.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.

Nolte Notes 8.30.2020

Outside of a few hours this month in Chicago, it has been sunny and warm. Outside of four trading days, the markets have advanced 18 trading days and jumped nearly 10%. With the Fed keeping rates at zero for the foreseeable future, and expectations for a vaccine for Covid, what is not to like about stocks? Like the weather in Chicago, it will change, and these warm, sunny days will be just a memory. The economic data continues to improve but remains a long way from “normal” or even looking like a recession. The markets do like the fact that the numbers are improving, which is more important than the magnitude of the improvement. Whenever the data points begin to turn down, the markets will struggle. Because of the historic economic shutdown, the seasonally adjusted data points have become useless. The adjustments have been made to incorporate seasonal factors in employment, retail sales, etc. However, looking at the raw data, weekly jobless claims continue to improve, and housing has been “on fire”. Both are key components of the overall economy and will need to show sustainable improvement in the weeks/months ahead for the markets to maintain a positive tilt.

The relationship between the stock market and the economy is strained. The economy, while improving, still has 10% unemployment. More layoff announcements are coming as business remains slow. The service sector, which has become more than two-thirds of the economy, is stuck in low gear without the economy completely open and due to continued concerns surrounding Covid. The coming week will be chock full of the heavy economic data points that will get analyzed over the holiday weekend. From the surveys on manufacturing and services (both are showing expansion) to the unemployment report on Friday, there will be plenty for economists to chew on. It is expected that another 1.5+ million jobs were “created” during the month of July. Finally, due in large part to government assistance, spending continues to expand. Nonetheless without an extension, spending may start contracting in the coming months as 27 million people are still unemployed. The economy is improving, just not as quickly as many expected five months ago.

The big news of the week for financial markets was not the Republican Convention, but the online version of the Fed’s Jackson Hole annual confab. Unveiled by Chair Powell was their new policy in addressing inflation. Going forward they will be focused more on the average rate of inflation rather than a target of 2%, which has been in place since 2012. As measured by the Fed’s preferred core personal expenditures (PCE) inflation has been fairly consistently below 2% since 1996. Various Fed programs, from quantitative easing to cutting rates to zero have not managed to boost inflation in over 20 years. Why? Some is due to the lack of population growth in the US (and in most developed countries) as well as a heavier reliance on technology. Those trends will not be reversing anytime soon, so no matter what the Fed is doing, inflation is likely to remain relatively low in the future.

August historically has been one of the poorest months for stocks and fast on its heels is September. This August was extremely good for stocks, and more gains are anticipated into September as economic conditions continue to improve. The market averages do not fairly represent what is happening to most stocks, as we have highlighted over the past few months. If we weight all the stocks in the SP500 equally, that average is still down for the year, while the SP500 is up over 10%. Technology stocks are up over 30% for the year, small stocks are down over 5%. International has barely made it back to the zero line. Finally, the disparity between “growth” and “value” is at its largest spread in history. So, while the markets may continue to rise in the months ahead, it is likely to be coming from the value parts of the markets. The market differences are becoming reminiscent of the late 90s, the last time technology ruled the markets to this extent. Investors holding “non-tech” faired rather well in the early 2000s as the market “averages” dropped from 2000-’03.

We have been slowly shifting away from technology and toward more “value” and smaller stocks. Over the coming years, the more ignored portions of the markets are likely to perform better than the headline technology names in the years ahead. Bond investors are not likely to see higher interest rates anytime soon, as the Fed will be keeping rates low for the foreseeable future.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.