Nolte Notes 4.18.22

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April 18, 2022

Like the Easter Bunny jumping around the yard, the markets have been hopping back and forth for much of the past few months. There are many reasons to be skittish, from the continuing conflict in Ukraine to a still uncertain withdrawal of liquidity by the Fed. Following the pandemic, the Fed was forceful and quick to flood the market with liquidity. Now that inflation is running well over their 2% target, they are measured and careful about pulling back on the surfeit of money floating around. In fact, many of the indicators of “financial stress” still show the markets very stress free. The inflation numbers last week were in line with expectations. However, the core rates (excluding food and energy) were lower than expected, giving rise to the thought that “peak inflation” is here and the rate will begin dropping in the months ahead. Retail sales were up last month, but unit sales were roughly flat, with higher prices making up the “gains”. The coming week is relatively light, but earnings will get into full swing. There will (always!) be something to watch in the markets. Expect the unexpected in the weeks ahead.

The alternating excited and depressed markets have been a boon for traders, but not so much for long-term investors. Sentiment is getting very bearish, as evidenced by the Amer. Assoc. of Individual Investors (AAII) weekly data. The widest spread between bulls and bears since 2013, ahead of a seven-year run for stocks. Volume has been expanding on market declines, indicating investors are turning tail anytime there is a sniff of bad news. Interest rates drop a bit one day, and it charges stocks, especially the growth style. The daily market moves are relatively easy to determine a reason why, but that reason is exclusive to that day and does not carry forward to the next as investors focus on something new. When will the back-and-forth end and a new trend begin? The trillion-dollar question without (as of yet) an answer.

The inverted yield curve has not only re-inverted but has gotten relatively steep quickly over the past few weeks. So too, the difference between high yield bonds and treasuries has also declined from their recent peaks. Does that mean the recession call is off the table? Maybe. However, it will depend upon how aggressive the Fed is over the coming months and whether they stick to their inflation fighting mantra or revert to making sure the equity markets stay elevated. One component of the bond model is commodity prices, which remain near all-time highs and have been up over 40% on a year over year basis for more than a year. If we are indeed close to “peak inflation”, keep an eye on commodity prices to lend some additional credence to that claim. Hard to see inflation rolling over soon.

Year to date, there is at least a nine-percentage point difference between growth and value, whether looking at large, mid or small stocks. The divergence is a big change from the past few years, when growth was king of the market. Familiar names like Apple, Microsoft and Nvidia have all declined this year, while rather uncommon names like Abbvie, Duke Energy and pick an energy stock have all seen gains year to date. Investors have not given up on the familiar and embraced the “unusual”, but if the trends continue through the summer months, those smaller gains in the big cap names may come under pressure as investors lock in “any kind” of gain. The defensive nature of the market is not unusual given the turmoil of the past six months in stocks in general. Volatility is up, worries abound, so investors are looking at companies and sectors that can still do well no matter the outlook. If inflation continues to be one of those worries, look for commodity companies to continue their run higher as well.

Earnings season will be interesting as companies discuss employment, input costs and whether they can pass them along to their consumers. Inflation and the Fed are likely to be key themes well into the summer. Will interest rates ever come back down again? If the Fed can not contain or rein in inflation, look for higher still interest rates this year.

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 4.4.22

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April 4, 2022

The first quarter was a tale of two periods. The first two months, when the markets fell over 10% and then late February when stocks rallied back to within 5% of their all-time highs. With everything that has been tossed at this market, it is a wonder that stocks have done so well. Higher inflation, the invasion of Ukraine, a Fed hiking rates and some discussion of Covid have all cycled through the headlines during the quarter. The employment report on Friday was indicative of the shift in the economic landscape. Last year spending focused upon “stuff”, as consumers remained in some semblance of “stay at home”. Today, with most all mask mandates gone, people are looking to get out and about. The shift in spending has moved to “experiences” as people realize that life is indeed short. Employment gains were in hospitality, restaurants, and retail. The amount of time people are unemployed has fallen to just under eight weeks, a low not seen (outside of the pandemic) since 2000. There remains plenty of folks on the sidelines, judging from the very low participation rate. What comes next? Could be anything from a ripping rally or a decline to retest those February lows.

The economic data over the quarter has been overshadowed by the geo-political environment and the market reaction to all the news. The quarter ended with two-year yields above ten-year treasury yields for the first time since 2018. What happens next, within the equity markets, could be a rally. Historically, stocks do trade lower, but have finished higher over the ensuing year save for the year following the 2000 inversion. The volatility within the market was among the top 15 quarters since 1945. Here too, history would argue that stocks should be bought following these bouts of volatility, as they have generally finished higher a year later. Even after a big rise in interest rates, stocks finished higher a year later. Monetary policy is not yet tight, and rates have barely moved from the zero level and remain very low from a historical perspective. Will Fed Chair Powell be more focused on fighting inflation, or will he keep an eye on the financial markets reaction to higher rates? The answer could provide the road map for equities in the months ahead.

The bond market suffered worse losses than the stock market. Unusual to be sure, and the worst quarter for bonds in over 40 years. The Fed has signaled they will continue to raise rates through the year and want to see rates above 2% (now 0.50%) on short-term bonds. The long-term implications will be interesting if rates are able to get to those levels and stay there for a while. Interest payments on the huge amount of debt will begin to squeeze out other forms of spending. The “inversion” of the yield curve discussed above does start the clock on a recession countdown. The timing of any recession is less than certain, as it could be anytime over the next three years. The bond market is already expecting a recession AND a Fed that will begin cutting rates by 2024. If the market is to be believed, interest rates will not get too high and ultimately will reverse lower over time.

The “two-part” market, falling, then rising during the quarter, was also reflective of overall sector performance. Growth was under pressure from late in 2021 until the market bottom in February. From there, it led the market higher during March. This was in the face of higher rates, which are supposed to hurt the technology sector. A flatter yield curve is supposed to hurt financials, as banks usually make money on the difference between short and long-term rates. Financial were among the better performing sectors in the quarter. Energy, of course, led the way as prices rose dramatically. Can it continue or will consumers shift spending away from gas? Historically, higher energy prices do not last long as additional supply comes onto the markets at high prices. The other “odd” sector were utilities. As interest rates rise, utilities tend to perform poorly as investors flip over to the safety of bonds to get income. Typical relationships over the past quarter did not seem to hold given the economic backdrop.

Historically, stocks can continue their March rally into the remainder of the year, even as the economic headwinds build. Higher rates and rich valuations could temper those gains, so expect more back and forth in the markets in the months ahead.

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 3.14.22

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March 14, 2022

“The Bitch Is Back” was a top song in 1974 by Elton John. Why bring it back now? That bitch could be inflation, that is back and has politicians grabbing for the “WIN” (Whip Inflation Now) buttons. Buttons that President Ford used to acknowledge the high rates of inflation. Today the administration is pointing toward Russia as the cause of the inflationary problems that are staring everyone in the face. The seeds for inflation today were planted a couple of years ago, by cutting rates to zero and flooding the financial market and economy with money. Core inflation rates were at multi-decade highs beginning in April of ’21 and have been rising ever since. Russia has only exacerbated an already rough situation that the Fed is finally beginning to acknowledge. Their meeting this week will finally start the process of “normalizing” interest rates. Given the current rate of inflation, that level could be much higher than many are expecting. Complicating the situation, the economy is already showing signs of slowing. Additionally the Fed has never hiked rates with a yield curve this flat since the bad old days of Paul Volker, when he slayed inflation with rates well north of 10%. Yep, the bitch is back, and it will be difficult to get rid of this time.

Much of the economic data took a back seat to the news from Ukraine and the geopolitical news surrounding the war. Consumer prices came in just shy of 8% and may go higher still as the impact from higher commodity prices works its way into the economy. Not surprisingly, consumer sentiment fell last month as prices began to spike. Slowly there is a shift in psychology from “when will I get this delivered” to “how much am I going to pay for it”? Within the inflation data too has been a slight shift toward the services and away from goods. Used car prices dipped ever so slightly, while airfare and live entertainment are showing signs of rising as mandates are being generally lifted. Wednesday will be a big day, as the Fed will announce a hike in rates and the news conference following by Chair Powell will likely set expectations for future increases. Along-side the economic news and Fed announcement will be the ongoing war in Ukraine. For as long as that continues, commodity prices will likely continue to rise, albeit at a bit slower pace than the parabolic rise of the past month.

The bond index has fallen nearly 5% so far this year as interest rates rise. Even last week, as stocks fell, bond prices also fell. Is there safety anymore in bonds? Are they still an alternative to stocks? Yes, and yes are the short answers. Individual bonds have a certain maturity when face value will get paid out, so in those cases, the losses are temporary. For bond mutual funds and ETFs that do not have maturities, their losses continue to pale compared to stocks. Short-term bonds and those that are “inflation protected” have done well in this environment. The rougher part of the market has been those tied to corporate and high yield bonds which act more like stocks than bonds. Bonds are still a good stock market offset, if not always providing positive returns.

The themes of this year continue to play out. Technology related issues have struggled as investors shift toward more “value” parts of the market. Surprisingly too, small US stocks have performed well, likely due to their being sheltered from international trade issues. Companies that are providing improving cash flows, dividends and are valued near their long-term valuation ranges are also doing well. Of course, basic materials and commodities continue to rise at a crazy pace, as the energy sector within the SP500 has already jumped 35+% this year. Given the significant rise in a short time, it may be a good opportunity to begin taking some of those gains off the table. By selling some of the winning positions, it will provide some cash to take advantage of other parts of the market that have been beaten down to the point of providing good long-term value. Unfortunately, the geopolitical news will continue to dominate sentiment on Wall Street for the foreseeable future.

There are still some good hiding places to be invested while the storms of war and higher interest rates blow over. Some extra cash is not a bad thing, however selling everything and waiting until a “better time” may keep investors from recognizing the beginning of the next inevitable leg higher for stocks.

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 12.6.21

December 6, 2021

“Well, here’s another nice mess you’ve gotten (us) into.” In describing the current economic conditions, Fed Chair Powell admitted what everyone has known for some time, inflation is not transitory and may require a bit more aggressive Fed policy. From a quicker tapering of the bond purchases to maybe raising rates quicker in 2022, the markets are reacting negatively to the thought that the very easy monetary policy that has been in place for the past 20+ months is coming to an end. The employment report on Friday was the exclamation point on the strong economic data. While the total number of “jobs created” came in at half of what was expected, the employment rate dropped to the lowest levels since the start of the pandemic. Wage growth remains well above 5% annually. The coming week we’ll get a read on consumer prices as well as how many folks are quitting jobs. With the money that has been pushed out by the government over the past two years, many, especially older workers, have decided to leave the workforce entirely. It is a Covid effect on the job market that is likely to have an impact for many years to come.

The change in tone from Chair Powell coincides with the economic data coming in “hotter” than expected and a huge boost to GDP estimates. Based upon the Atlanta GDP model, estimates are for over 8% economic growth in the fourth quarter. Much of the supply chain problems can be attributed not to the lack of workers (yes that is part of the issue) but the huge jump in demand for goods. Looking at retail sales, historic growth has generally moved between 3-7% growth vs. year ago levels. Even coming out the recession in ’08, retail sales briefly touched 10% annual growth. Today that growth has been over 10% nearly the entire year with the most recent reading at almost 15%. With demand so far above historic trends, even accounting for the economic shutdown of a year ago, it is little wonder that prices are rising. This will be the Fed’s biggest challenge over the coming year or two; how to cool the economy without pushing it into another recession.

The number of stocks making new yearly lows has expanded to a level last seen during the depths of last March’s decline. Volume has increased with the market decline. On the NYSE, three consecutive days of declining volume exceeding advancing volume by at least three times has usually marked at least a short-term bottom in prices as investors bail on the market. Some of the measures of momentum and selling pressure are at levels usually seen around market bounces as well. So, just maybe the Santa rally is still in place. Worries about the Covid variant is also having some impact on stocks as investors fear reinstatement of some forms of economic restrictions. Hopefully lessons have been learned over the past year as we deal with the residual impacts from the virus and shutdowns.

The bond market is signaling a slowing of economic activity in 2022. Whether that is driven by the Fed or just the ending of various government support programs, the market move is unmistakable. So too is the change in difference between junk yields and government bonds. The change in the bond market is worth watching over the coming weeks to confirm the signal and by extension, a deeper reaction from the stock market.

The recent decline in stocks has impacted the growth part of the market more than value. Having been the darlings since last March’s bottom, growth stocks have been all the rage. The valuation differences between growth and value in the largest stocks hasn’t been seen since the late ‘90s. During the years following the market top in 2000, value, small and international stocks all did well in both absolute terms as well as relative to the broad market averages. Whether the coming years will be a 20+ year reprise of the tech wreck we’ll only see in a few years. But investors should do well to focus on the neglected parts of the market that still have solid fundamentals and underappreciated growth prospects.

The harsh decline in growth stocks over the past few weeks that has bled into the broader market may be setting up for the highly anticipated Santa Claus rally. If coal gets delivered, 2022 could be a tough year.

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 11.29.21

November 29, 2021

The “Nu” variant of the Covid virus is making the rounds in South Africa and has put the fear back into investors that we are once again heading for economic lock/shut down. Friday’s trading is usually very quiet with a few folks coming in to trade a bit and head back home to finish off the Thanksgiving leftovers. However, this year, trading was the worst in 70 years as investors sold anything that benefits from an open economy. Even energy prices fell 10%. The economic data from earlier in the week was solid, with the weekly jobless claims the lowest since 1969 and consumer spending still robust. That all got tossed out the window Friday. The weekend should provide some information that may help investors assess the economic and markets risks heading into December. As usual, technology did better, and bond prices rallied as investors warmed to working at home longer and a Fed that is not likely (now) to be raising rates. If the focus turns more toward the latest variant, then the economic data won’t matter as it will be considered “old news”.

The markets have been trading poorly over the last two weeks, with only one day showing more stocks rising than falling. Friday was the culmination of a bad string, with nine times more declining volume than advancing on the NYSE. The last occurrence was back in September, just before the markets bottomed, resulting in a big October run. At least in the short-term, the selling may have peaked. That doesn’t mean stocks trade higher but expect more ragged trading as we get deeper in the Christmas season. Much of the trading next week will likely center on the path of the new Covid variant. If it is determined to be relatively mild, stocks could regain much of the losses. However, if it poses more risks, then stocks could trade lower still. The employment figures will end the week. The report should be very good and could bolster the markets. Although stocks may be once again beholden to the path of the virus.

As stocks declined, bonds rallied, and interest rates declined. Investors are now expecting the Fed to slow down their pace of tapering their bond purchases and are willing to keep interest rates low. The yield curve has continued to flatten and is now the flattest in eight months. One other concern is the high yield spreads, which are widening. This combination, were it to continue for a few more weeks, could put additional pressure on stocks. For bond investors, treasuries will likely also be a safe port in a storm. The decline in interest rates is likely to continue as commodity prices are showing more signs of rolling over as well. If demand for goods and services wanes in the coming months, prices (and inflation) are likely to moderate.

Friday’s decline was across the board and left few parts of the market unscathed. As mentioned above, the bond market is beginning to signal that stocks could be facing some headwinds in the coming months. Historically, when we see the difference in yields between high yield bonds and treasuries widen out, the stock market runs into trouble down the road. The lead time is anywhere between three months to over a year, so it makes sense to begin watching the markets a bit more closely. The final part of the “market signal” is the flatter yield curve. When the difference between the two- and ten-year yields on treasuries begins to narrow, it is a sign that financial conditions are beginning to tighten. Again, this is not a call for the end of the bull market but is worth keeping an eye on in the coming months. Whenever the markets decide they have had enough, there are likely to be a few hiding places. Better parts of the market will likely be those that have not really participated over the past year, like value and international holdings.

Whether the new variant is at the center of the markets concern or a Fed that may be making a policy mistake, the markets are beginning to pay attention. If things begin getting rougher, treasuries will be a good hiding place.

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 9.20.21

September 20, 2021

It is way early to be getting ready for Halloween, but I’m hearing “I’ve got a spell on you” running around in my head when looking at the market action of the past few weeks. From monetary policy to fiscal policy, the continued rise in Covid cases and economic slowing as a result, the markets are struggling to figure out what to do next. This past week was the (now) much-anticipated consumer price index that came in below expectations. The higher product prices and lower consumer prices mean that corporate margins will likely be under some pressure in the coming quarters. Even as concerns over rising inflation show up near the top of consumer worry list, interest rates have remained very stable around current levels. This week we’ll hear from the Fed directly as they likely make their “ho-hum” announcement that their target for interest rates will not be changing. What will be more interesting is how Chair Powell discusses their plan to reduce the amount of bonds they are buying, which will also start the clock on when the Fed is likely to raise interest rates. Maybe less the spell and more the sound of silence.

We are smack in the middle of what has historically been the worst 12 weeks for the financial markets, yet the SP500 is slightly higher over the past six weeks. The economic data, as has been highlighted over the past month or so, has been coming in “worse than expected” and many attribute the weakness to the rise in the Delta variant. When checking out TSA daily “activity”, there is a noticeable decline in travel since early August vs. a “normal” 2019 that remained stable through the summer months. Consumer surveys are highlighting worries about rising inflation. Certainly, businesses are feeling the pinch. Many cannot get the stuff they need to sell to the end consumer or finish their products for sale. The reduced supply of goods is one of the key factors behind the higher inflation reports. Chair Powell will likely address some of those “transient” pieces at his press conference. However, supply chains do not look to be getting repaired soon and outages of various products will likely be a feature as we get closer to the holiday season.

The bond market is also under “the spell”, as it has moved very little over the past few weeks. The difference between short and long-term rates is also stuck. Worries about inflation, economic slowing, or robust growth do not show up in the bond market just yet. The bond model used to project interest rates over the short-term also indicates lower yields ahead with only commodity and utility prices showing up negative in the five-factor model. How much of the inflation fears are grounded in the transitory discussion or will be a long-term issue will not be known for at least the next six months, if not longer. By that time, we should have a better sense of what “transitory” really means.

The last few weeks of the third quarter should determine whether the broader market can regain its mojo. This quarter has been led by technology and surprisingly, utility companies, with the difference between large-cap growth and value, exceeding 5 percentage points. The “why” is likely due to the rising virus counts and overall weaker economic data that investors believe will be around for a while. If the economy struggles, technology has become the safe play. Valuations remain extremely high, however by themselves do not “make” the market decline. Once things get going on the downside, though, they are likely to end somewhere around “fair” value. Based upon today’s earnings, that would mean a 20-30% decline. That is not a “call” that the markets will do that over the next few weeks or even months, but something to watch for whenever the markets begin to unravel.

The short-term direction of the markets may be lower, but the Fed meeting this week should provide investors plenty to chew on as we start the fourth quarter soon. Bond should provide direction, so we will be watching their reaction to the press conference later this week.

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 9.6.21

September 6, 2021

In what may be considered “Delta Dawn”, the current variation of Covid is beginning to show up in the economic data. Friday’s huge miss on employment (250k vs est of 750k) caused barely a ripple in the financial markets. After much head scratching, investor’s figured that the Fed would continue to keep rates lower for longer as well as postponing their tapering of bond buying. Bad news is good news when it comes to the financial markets today. The surprises continue to occur on the downside, from employment to the various assessments of economic activity. Employment in the “customer facing” portions of the economy were essentially flat from the prior month. Manufacturing added jobs and the employment rate fell again, getting close to 5%, as the total workforce is contracting with more retiring all together. This week will be light on economic data, save for the produce price report on Friday. The next focus for the markets is inflation, as worries are beginning to surface that growth is slowing with inflation not being as transitory as the Fed expects.

The markets continue to grind higher, making 50+ new all-time highs this year and pushing the valuation levels of the market to all-time highs as well. Why? Investors are back to the belief that there is no alternative to stocks. Bond yields are very low, money market rates are essentially zero and the Fed continues to support “risk taking” by keeping rates low. How long can it last? Longer than many currently believe. Yes, a correction of 3-5% is long overdue, however a larger decline is not yet on the horizon. At some point the markets will have enough of the debt creation and decline, but so far, the signs of a larger decline are not evident. The market internals remain less than stellar, with stocks making new all-time highs still lower than their peak in June. The number of stocks above their long-term average price has been falling since March, another indication that investors are focused on the largest of the large US stocks. The markets have shifted back toward growth and away from the “re opening” trades, fearing that Covid will continue to make any economic recovery very uneven. If inflationary pressures continue to build and economic activity slows further, investors may indeed decide that the Fed will have no alternative but to raise rates. That could drop the curtain on the advance, but that may be months away.

The bond market has reversed course a bit over the last few weeks as the difference between short and intermediate term treasuries is getting larger. The difference between high yield and treasuries is also contracting. Both conditions have been supportive of risk taking in the markets and has led to the recent rally in stocks. Until the markets believe that the Fed will be raising rates to combat inflation, the interest rate environment should support stocks. Worries about a larger decline in stocks are usually preceded by a flatter Treasury curve and widening spread between high yield and Treasuries, which is not the case today. The tipping point will likely occur when investors begin to worry more about the likelihood that inflation is not transitory. The Fed’s favorite indicators of inflation are all well above their 2% target and rising. So far, the markets are buying the transitory label on inflation.

The song remains the same in the equity markets, the largest US stocks are doing well, while the rest of the markets suffer. International stocks gained some traction with the decline in the US dollar. The dollar has been relatively strong as the US economy has performed better than many of their international competitors. Looking over the longer term, the dollar has been bouncing within a range since last July. A break lower could indicate better strength internationally, higher would mean a stronger US relative to others. A declining dollar would also mean that international holdings would fare well as those gains buy more of an ever-cheaper dollar. The international markets, especially emerging markets, are among the best long-term estimated returns. However, that is predicated upon a more normal functioning global economy.

The long-term key to the markets may lie in strength of inflation and investor’s fears that it is more than transitory. That is not likely to show up in the next inflation report or two, but persistence into yearend may concern investors.

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 8.30.21

August 30, 2021

Everybody’s working for the weekend, or until Friday when Fed Chair Powell started his talk on policy. The Jackson Hole confab has been known to be a spot where new policies are rolled out, from the Bernanke tapering to Powell’s inflation target changes last year. Investors were concerned that another bombshell could be dropped. However, what was said was music to investors ears. Tapering but not raising rates for a looonngg time was the tune. Subsequently, Fridays “everything rally” put stocks again at new all-time highs and the delivered promise of lower rates for even longer. This could keep stocks rising. The economic data remains ok, while inflationary pressure continue to build. This time, however, inflation is due to supply problems that adjusting rates won’t fix. This week’s employment report comes ahead of a long weekend ending the summer doldrums. What happens next is likely to be driven by inflation and Covid, which is well out of the Fed’s purview. The markets have held up well during one of the poorer months in the calendar, but the next two historically have been just as poor.

Even after Friday’s rally, the markets are looking a bit ragged. The largest stocks are once again taking the performance lead. That in turn has meant the bulk of stocks are not following the indices to all-time highs. The shine has come off the “reopening” trade. The enthusiasm for a full economic recovery is following the slowdown in air travel and lower energy prices. The economic backdrop remains challenging as many locations are going back to masking mandates. Those steps “backwards” are keeping many companies from going back “full-time” and giving consumers pause before heading to the mall or other activities. The combination of stimulus rollback in a few weeks and increasing fear or the virus may put another kink in the road to recovery. The markets are not reacting to the economic data as much as to the still very easy monetary policy. The reason the markets rallied so strongly Friday was a clear indication that investors are hyper focused on the direction of monetary policy. Stocks are likely to continue to get bid for as long as the fed remains accommodative.

Chair Powell’s comments got the bond market going too. Unfortunately, there are more questions than answers. How long will tapering take? At what point do rates rise after tapering finishes? How will the path of the virus impact policy? Just how transitory is inflation? Will slowing economic data keep the fed involved in the financial markets longer than expected? The yield spread remains well below spring levels when it was anticipated the economy would be roaring back. Yet it has not collapsed to a point that would start investors worrying about a completely different set of outcomes. Investors also piled back into high yield bonds, supporting the dregs within the bond market world. Another indication of investor’s desire to take on risk, no matter the asset class.

The rotation back toward the largest companies also means a move toward technology. The momentum has been waning for the various sectors within the SP500 since May, with technology getting back up to the “very overbought” territory. Fridays everything rally may start a new leg higher for some forgotten parts of the market. Small and international stocks were among the big winners on Friday after underperforming the broad market for the last few months. From strictly a valuation perspective, companies outside of the US are much cheaper than similar ones inside the US. Better returns from international markets require better growth there vs. here and a weaker dollar to translate those returns to the dollar. The biggest knock-on international stocks are the lack of technology stocks. Domestic weights are around 30% and less than 20% overseas. After a decade of US dominance in the performance race, there should be a rotation to overseas, but until tech takes a back seat, it will remain a US-centric performance race.

The market continues to churn higher but is showing some signs of internal weakness that could (maybe?) push stocks lower over the next few months. At this point, nothing more than a much-needed rest/reset for investors. That said, even the 2+% decline of two weeks ago was seen as a buying opportunity. At some point the “buy the dip” will not be working as well as it has over the past 16 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 7.12.21

July 12, 2021

“We’re all mad here, I’m mad. You’re mad.” And so down the rabbit hole we go! Just when you think you have it all figured out, the economy and/or the markets throw you a curveball. Maddening, sometimes. But we are in a deranged time where everyone is a bit crazy. We celebrate huge employment gains, yet at the recent pace, it will take another seven months to regain the old employment peak. Job openings continue to grow as companies of all stripes can not find willing workers. Many “consumer-facing” businesses have shortened hours due to a lack of employees. The Federal Reserve believes easy money can solve this problem, so they keep rates at historically low levels while pumping over $100B into the markets every month. “When you have a hammer…”Goods are having a tough time getting to market and prices for nearly everything are rising. Many believe this will work itself out over the next year as companies fully staff up and supply chains are working properly again. Some wonder if the economy is permanently damaged. The coming week will have inflation, retail sales and sentiment indices released. The madness is not likely to get resolved this week!

Worries about the Fed “starting to think about thinking about” cutting back their bond purchases knocked down stocks for a day, but the “buy the dip” crowd piled back in on Friday, pushing stocks to yet another record and 14th weekly gain in the last 19 weeks. Yes, there are some chinks in the armor, but the easy monetary policy is what rules the day. Over those 19 weeks, 90% of the stocks within the SP500 remain above their long-term average price, however the last few weeks, barely 50% are above their short-term average price. Meaning stocks have rallied so strongly that any short-term pullback has done little to dent the long-term picture. Within the S&P500 industry groups, all but telecom are above their long-term average, so until the market “technical” begin to break down in a more meaningful way, the path of least resistance looks to be higher. Growth has been the big winner over the past few weeks as interest rates have declined. Could the rate decline be warning the markets that the best/fastest economic growth has passed? Potentially, however, we would like to see a few more indicators pointing that way before beginning to worry about the next downturn.

The yield curve flattening is a warning sign of slower economic growth. However, without a signification push higher in the yield differential between junk and treasury bonds, long-term worries are not yet heightened. Earnings season gets started this week, and there will be plenty of commentary about what companies are seeing in their “end markets” and their capacity to fill demand. Finally, comments regarding pricing and inflationary pressures could also impact bond yields, pushing them back up if investors believe those pressures are more than just “transitory” as the Fed currently believes.

The quick rotation between “growth” and “value” has been driven by changes in interest rates. As interest rates rise, value does well. As rates fall, growth does well. Both are tied to the re-opening of the economy. If investors believe that the re-opening is going well and pricing pressures are building, value does well. If investors believe the best of the economic growth is now behind us and we are heading back to the recent average growth of 2%ish, then growth will do well. From a long-term perspective, growth is very overvalued, with various companies selling at their highest price to earnings multiples going back to 2000. While value is also expensive in absolute terms, relative to growth, it is about as cheap as it has been going back to the late 1990s. We believe that over the next few years, the overall market will struggle to provide meaningful gains, but that value should shine relative to growth as the economy slowly works its way back to “normal”.

Interest rates have been driving the markets as well as various parts of the markets for the past nine months and that is not likely to change. Hence, we will be watching yield differences between various asset classes for clues as to when markets are likely to make a significant shift. Not yet in the cards but watching closely!

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 6.2.21

June 1, 2021

What was Hollywood’s six-million-dollar man is now Washington’s six-billion-dollar man. Inflation impacts everything! The new budget rollout late on Friday will be the starting point for wrangling about deficits (do they matter?), spending programs (remember shovel ready?) and initiatives the current administration would like to put forward. An interesting provision is an increase in capital gains tax rates that would be retroactive to April. While many are wringing their hands about the proposals, what gets passed, should make for some interesting beach reading this summer. Back at the economy, the inflationary figures continue to run “hot” as the economy continues to lurch toward a full re-opening. Supplies channels are still not operating correctly and are unlikely to get back to normal before year end. Employment is getting better as the weekly jobless claims’ numbers fell again last week. The coming data dump for the first week of June will include the “official” jobs report that should see some improvement over last month’s disappointing figures.

The markets continue to chug along, even in the face of data that historically would have had the markets falling. Higher inflation and large job gains are generally a recipe for hiking interest rates. However, looking at the bond market, you would have to shake a few traders to get them to move. Ten-year treasury rates remain below their March peak, and “risky” high yield bonds have traded well. Investors are amazingly comfortable with a Federal Reserve that has been buying large quantities of Treasury securities every week. Along with a commitment to keep interest rates lower for longer, investors have little choice but to buy equities to get any kind of return. That has pushed valuations of the equity markets to extremely high levels, rivaling those of 1929 and 2000. What is currently missing is a reason to sell. Until the Fed begins to discuss withdrawing from their purchase program, or we begin to see investors move out of risky portions of the markets, the momentum is still on the bull’s side and stocks can get pricier still. The warm sun calls and living is easy…for now.

After a very rough first quarter, bond investors have been rewarded with “staying the course” as returns have been positive in each of the last two months. Bonds have even given stocks a run for their money since late April, providing essentially the same return without the daily swings. If there are concerns in the bond market, it is that the bond model has swung negative, indicating the direction for interest rates may be higher in the coming weeks. The model has been negative much of this year and even as rates have moderated, they really have not dropped too far from their March peaks. Commodity prices are likely to be the key driver for interest rates going forward.

The markets have been swinging back and forth between growth and value for much of the past six months, however value has been the “winner” overall, as it has been two steps forward, one step back for value stocks. These are the parts of the markets that will benefit from the continued opening of the economy as we go from virtual meetings to in person, from FaceTime to face-to-face. There have been and will be plenty of bumps along the way, however the differences in valuations between these two asset classes tends to favor value ahead of growth. Comparing technology’s performance vs. nearly every other S&P500 sector shows technology’s performance peaking in the third quarter of last year and underperforming since. Even comparing technology to international, shows a similar relationship. The rotation away from technology is hard for investors to do, as the allure of high growth keeps them from moving. However, the valuation on technology stocks in general is well ahead of their historical norms, while valuations of other sectors and asset classes remain near or below historical norms.

“Sell in May and go away” is a Wall Street adage that historically shows the markets doing poorly in the summer. However, the last few years it would be better to hold the stocks and just go away. Will this year be any different? Or will the Fed keep the good times rolling with as easy monetary policy? Stay tuned.

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.