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.

Nolte Notes 8.24.2020

Last week was the beach, this week is a bit of a hang-over from the sun and umbrella drinks, or so it seems on Wall Street. Yes, the economic data is heading in the right direction, if at a slower pace than many would like to see. Earnings season is “officially” over as the big retail companies reported huge earnings gains, which should come as little surprise since they were the only ones deemed “essential” and remained open during the various lockdowns. Too many “foo-foo” drinks may be impacting investors’ mental condition. Investor sentiment is getting very bullish as investors are getting comfortable with a Fed that has their back. Companies like Tesla are selling for gigantic multiples (Tesla is now on par with Wal-Mart in market value), many have yet to turn a profit. Two companies, Microsoft and Apple are now worth more than the entire financial services industry within the SP500. The five largest companies now account for nearly a quarter of the SP500, the greatest percentage in history. Yep, these companies have done well and benefit from the “shelter in place” mantra of the past few months, but they are selling like they will be the ONLY companies left standing in another decade. Time for another drink!

The various “high frequency” data points like restaurant reservations, gas usage, and airplane load factors have become the go-to for economists trying to determine not only if things are getting better (they are), but how quickly are they getting better (meh). The stock markets hitting all-time highs, recovering from the bear market in record time, is in stark contrast to the economy likely years away from achieving its own “record highs. The focus remains on Washington for another stimulus package. The last one was over $2 trillion; this one is likely to top $1 trillion. While the money is needed by those still out of work, without people feeling confident about being in larger groups (museums, ballpark, concerts, etc.) it will be very difficult, no matter the money, to get everyone back to where they were at the start of the year. Main street is NOT Wall Street as the past few months has aptly demonstrated.

All the money going out of Washington and the Fed must come from somewhere and that somewhere is from higher borrowing. The recent auction of Treasury bonds did not go well, and rates were pushed up a bit to entice buyers. This is normal, and some are fretting that buyers may not be able to absorb the huge amount of debt that the Treasury is borrowing. From the regular weekly auctions of short-term bills to the monthly auctions of long-dated maturities, the Treasury is borrowing $7-10 billion weekly in these various instruments. The appetite remains strong as US yields continue to be above zero (unlike other countries’ debt instruments) and it is the most liquid market in the world. Things may change, but for now, whatever gets issued is getting bought at a pretty brisk pace. Where is the tipping point? No one knows and so far, we seem to be far from it.

To say it was an odd week in the markets may be an understatement. The SP500 rose nearly 0.75% and the OTC markets by more than 2%, yet nearly twice as many stocks fell last week on the NYSE, while 50% more fell on the OTC market. Only Monday did more stocks trade higher than lower, yet the OTC market rose in three of the four remaining days of the week. It is a broken record; the largest stocks are having a large impact upon the “averages”. If the SP500 were weighted equally instead of by the biggest, it would still be down nearly 7% for the year. The smaller the stock, the worse the performance as the Russell 2000 is down nearly 9%. The time is ripe for at least a bit of a correction in the large names, as many of the smaller companies are or have already corrected their recent run-up from the March bottom. This does not mean the markets are going to decline by 30%+, but more along the lines of a 5-10% decline to reset investors’ expectations and put to bed the notion that stocks will forever climb to the sky.

Stocks should take a break from their weekly gains and “catch-up” to the economic data a bit. Bonds are struggling as well, as the difference between long-term and short rates widens. Widening yields has not happened this time around and may be signaling more worry in the bond market about a still-sluggish economy vs. the stock markets ebullience.

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 8.17.2020

Whether sitting on the dock of the bay or under the boardwalk, the next few weeks are when everyone hits the beach for one last bit of summer. Even Congress has packed up for the summer, returning to work after Labor Day. The lack of a stimulus package for the next few weeks has not taken Wall Street off its gradual rise to all-time highs. The economic data continues to surprise to the upside, leading some to wonder whether a package is really needed. Retail sales are robust and weekly jobless claims are finally under 1 million. While claims are still 50% above the worst historically, retail sales are nearly 5% higher than a year ago. Thanks in large part to the very generous stimulus package that has expired and now awaits Congress to return and vote on something. However, once past Labor Day, the focus will narrow on the November election, so both parties want to be the friend to the “regular guy” who is still likely unemployed. The next few weeks may be instructive, if the data continues relatively strong, there a call for additional fiscal support may not come to fruition until after the election. Stay cool and use plenty of sunscreen, it will continue to be hot and steamy in Washington.

As highlighted above, the two big pieces of data were the retail sales, indicating the consumer remains very willing to spend and weekly jobless claims. Both were above expectations. However, it is hard to pin down the variance in the estimates as economists really have no idea how the economy will or is supposed to recover from the March/April shutdown. So, when looking at the “surprise” index, which measures how far away from reality the estimates are, the index is off the top of the charts. This means all the surprises have been exceptionally good. Of course, economists wonder it this can continue with so many businesses shuttered (many permanently) and well over 15 million people unemployed, or 10% of the workforce. Add to that a Congress that is shuttered for the next three weeks. There will be one more employment report before Congress reconvenes and that should provide useful information on how quickly employment is returning to “normal”.

Just when interest rates were heading to somewhere south of zero, the combination of better economic data, Congress adjourning for the summer and a poor reception to treasury bond auction last week, has pushed the 10-year bond significantly higher. Commodity prices have firmed a bit and the difference between short and longterm rates has expanded, all indicating that the economy and overall activity is picking up. We have seen this show before as yields back up for a few months, only to decline as either inflation or economic activity comes in “too low”. The Fed has indicated they are happy to allow inflation to run above their 2% target rate for some time, however inflation has remained stubborn below that 2% threshold for quite some time. The large amount of debt taken on by the government as well as many corporations is the wet blanket that should keep the inflation fires from burning too hot.

Technology, for one week, has taken a back seat to other sectors. Joining technology were the utilities and communications as the only sectors declining last week. The shift to value from growth has been called for over the past couple of years, but outside of a good month or two, it has remained a growth story. If the economy can gain some traction, we should see many of the value sectors, like industrials, financials and even the beleaguered energy sector take the performance lead. Early June has been the demarcation line for value vs. growth as well as international/emerging markets vs. domestic. That one month run ended about the fourth of July and since that time, the old leaders have gained the floor. Valuations remains a concern, as earnings are likely to take a couple of years to regain all-time highs, the stock market is well ahead of those earnings and near their all-time highs. Something will have to give in the months ahead. There will be plenty of things to watch, Covid, economic data and the election. While the beach is warm, we will worry about that another time!

The path of least resistance remains higher for stocks. The easy monetary policy, low interest rates and better economic data have been the fuel pushing stocks ever higher. Many of the historical supports, like earnings and strong balance sheets do not matter today. The speculative fervor has investors in its grip.

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 8.10.2020

The much-anticipated employment report was released with a range of estimates large enough to drive a few trucks through. The weekly jobless claims released the day before was at a new low for this cycle, but still 50% higher than at the depths of the great recession. So, investors were nervous ahead of the release. The numbers were much better than expected, with the unemployment rate falling to just over 10%. Combined with the much better than expected manufacturing and service reports earlier in the week, it set a good overall tone for the market. For all the good news, there is a dark side. The wrangling in Washington for the next round of stimulus payments could get watered down with better overall economic data. The President used executive orders over the weekend to extend benefits and set the table for further gains. However, if the economy can heal relatively quickly, it means less of a need for government assistance that could wind up in the financial markets. At this point, good news remains good news and the markets are reacting accordingly.

The equity markets are once again within hailing distance of all-time highs, even as earnings continue to decline (estimated to bottom this quarter) and the economic data, although better, remains well below even the depths of the last recession. As stocks continue to rise as earnings decline, the valuations of the markets are once again heading toward historically high levels that essentially squeeze out future returns. Why are stocks still rising if the economy remains a long way from healthy? The data points are getting better, but the key has been the very low interest rates. The Fed has promised to keep rates at current levels for the foreseeable future and will allow inflation to run above 2% if it ever gets there. Earnings have been coming in above extremely low expectations with some companies beginning to provide estimates. All has been providing fuel for the continued stock rally. At some point earnings growth, rather than less bad, will have to carry the day.

As mentioned above, interest rates continue to be the key to higher stock prices. The Fed has been very active in the financial markets helping to maintain liquidity as well as keeping interest rates low. Over the past three recessions, the Fed involvement has ramped up. In 2000, the Fed cut rates aggressively to 1%. After the financial crises, they introduced zero interest rates and quantitative easing. This time, zero rates, QE and buying of corporate securities. Each time they have amped up their involvement, not always to provide trading liquidity, but to keep the financial markets propped up to provide the appearance of normalcy. As a result, the financial markets have not been standing on their own for quite some time. What will happen when the Fed pulls back from supporting the financial markets?

Earnings season is winding down this week, but the excitement about technology stocks and their potential growth over the coming years, due in large part to the virus hastening the use of technology. The markets began to rotate away from technology on Friday as signs of “better than expected” economic data is leading investors to begin looking at the more “cyclical” parts of the markets, including transportation, retail, and industrial companies. We have seen this movie before in late May, when value took the performance lead from growth only to give it up in mid-June. If the markets are going to make further headway, it will have to come from the other 70% of the market that is not technology related. During this time, the lower dollar is also making international investing “cool” again. It has also helped that the virus growth has moderated in many European and Asian countries that has allowed them to begin turning on the economic spigots.

A shift toward more value names and away from technology, rather than the end of the bull market, may be what the markets need to move into new all-time high territory. Bullishness should be moderated, though, as valuations are also near all-time highs, which should tamp down future returns from here.

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 8.3.2020

There are plenty of Wall Street aphorisms, from “sell in May and go away”, to “don’t fight the Fed” and “the trend is your friend”. The overarching theme for investors is not to fight the Fed. In last week’s comments, they indicated that interest rates are likely to remain at the zero level for the foreseeable future. The economic data, while generally better than expected, has been showing signs of leveling as Covid cases rise in various states. Whether looking at hotel occupancy or restaurant reservations or even credit card spending, all point to a moderation in economic growth. So, the Fed will continue with its extraordinary measures to make sure the economy does not backslide in the fall. Congress is trying to figure out their plan to soften the blow of still-high unemployment and businesses shuttering. All of this adds up to more dollars sloshing around, looking for a place to go to earn a return. That place seems to be the stock market, especially in the tech sector. If the trend is your friend, then technology is the place to be, until that trend changes.

The economic data point of the week was the overall contraction in the US economy during the second quarter. Falling by over 30%, the decline in GDP was the largest on record. Even so, that number was better than the 35% decline estimated by economists. Having never experienced a global economic shutdown, estimates for the decline and recovery will likely be nothing more precise than sticking a wet finger in the air to determine wind speed. The monthly jobless report will hit on Friday and likely show continued improvement in the labor market, but the more frequent weekly claims numbers are indicating a slowing in hiring. So, the trend is better, but at a less robust pace than just a month ago. That is giving both lawmakers and the Fed reasons to continue to support the economy and financial markets with additional stimulus. The economy is not likely to get “fixed” by tossing dollars at it, but only after people feel comfortable moving about doing their routine things.

The comments by the Fed about interest rates pushed yields even lower last week. Projections are for interest rates in the US to be below zero sometime next summer. One metric we keep a close eye on is the difference between two-year and ten-year yields. That difference collapsed last fall and signaled some problems within the US economy. It was only after the virus hit that we began to see “what” it was signaling. After expanding following the various stimulus packages, the yield difference is once again declining. It is above our “worry” threshold, however, another month or two of lousy economic data points could once again signal trouble on the horizon. As a result, we have increased our weighting toward treasury securities that should hold up well and have performed in line with the stock market since early June. As of today, the way is clear for further declines in interest rates in the weeks/months ahead. Until the recovery gains traction, rates are likely to remain at historic lows.

Not much has changed since the 4th of July with the sectors and asset classes. Technology reigns supreme, confirmed by excellent earnings reported on Thursday by the biggest companies. There are a variety of ways we can look at just how the markets have performed without the aid of Big Tech. Technology stocks now account for more of the SP500 than the next two sectors (Health and Discretionary) combined. The largest five stocks within the SP500 have gained as much as the other 495 names have lost this year. Finally, the tech-heavy OTC market is up nearly 24% for the year, while the average SP500 stock is down nearly 8%. How long can the winners run, and the losers suffer? Like the late 90s, much longer than many expect. One final note on the markets. Instead of selling in May and going away, we should be selling in July and fly somewhere. Historically the two worst months of the year are August and September with September as the worst month in the calendar. Enjoy the beach!

Outside of the daily reporting on Covid cases, the markets are looking a bit tired and due for a rest. Our larger concern is the slow contraction in yield differences between the 2/10-year treasuries. We are slowly taking some profits in the technology sector and allocating toward treasuries as a precaution at this point.

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 7.14.2020

“Ya know that tingly feeling when you love someone? It is common sense leaving your body”. So it is with investors falling over themselves, crazy in love with technology of all stripes. From the “mainstay” companies like Amazon, Microsoft, and Google to the new kids on the block, like Zoom and CrowdStrike. Even companies like Tesla are high on the “must own” list for investors. Many of these companies are selling at valuations well above 1999 levels with some at over 30 times revenue, not even earnings. The economic numbers remain OK, but the headlines continue to be clogged with reports of various virus hotspots in the US. The key to any recovery will be not going all the way back to March, when the economy was essentially closed. Investors are also interested in the extension of unemployment benefits, which should allow consumers to maintain spending, even if it is only online. A few months ago, we thought the summer could provide some clarity on the virus, the recovery, and potential treatments. Summer lovin’ for technology seem to be the only certainty this year.

Many of the high frequency data points, including Google searches, are indicating a flattening out of the “V” recovery. Now looking more like a square root sign, the economy will likely struggle going forward until the daily cases begin falling again. The weekly jobless claims figures are coming down, but at a much slower pace than a month ago, indicating hiring has slowed as businesses remain concerned about overall sales. As a result, inflation data remains extremely low. There are shortages of things in various places, but overall, it will be difficult for businesses to recoup losses by raising prices in the years ahead. The biggest fear of central bankers is lower prices as they do not have anything in their arsenal to combat general price declines. Interest rates will not be rising anytime soon, nor will the Fed be leaving their involvement in the bond market. While not strictly “price controls” it is certainly not a free market as defined by older economics books.

How low can bond yields go? Like the limbo, there should be a floor, but central banks around the world have had experience with interest rates below zero. Chief Powell has indicated he is not interested in dropping US rates below zero, but investors continue to push rates down as signs of inflation are nowhere to be seen and the pace of economic recovery remains uneven at best. What does that mean for bond investors? Just three years ago, a bond yielding 3% was deemed poor, but today looks pretty good. The 1-2% yields around today will look juicy in another few years. Investors are chasing much lower quality bonds to gain income, however many of those companies issuing bonds will have trouble selling new issues in the market to redeem those coming due. Bankruptcy will also be a problem in the bond market in the year ahead. Safer to stick to the Treasury or high-quality bonds that may not be yielding much but will provide the cushion when stocks fly off the rails.

It is still a technology world, with that sector rising over 5% on the week. The largest five stocks in the SP500 index are now a much higher percentage of the index than the top 5 were back in 2000. We have highlighted the large differences between the “cap weighted” index and “equal weight” index performance over the past few months. Even within the technology sector, there is a big difference between the cap weighted and equal weighted indices. Many investors now believe the large tech names are “defensive” and should always be owned/held. Valuations of the general markets are once again among the top 10% in history. Even within the tech sector, there are now nearly 40 stocks selling above 30 times revenue, compared to just 30 in 1999. Momentum is keeping the story going, but sometime in the future, investors will begin to shift their focus to the very inexpensive parts of the market and technology will flounder for a few years, not just a few weeks.

Earnings get started this week. We will be interested to see if companies begin providing guidance on future earnings. Those projections were pulled last quarter as companies had no idea what the economy would be looking like in a week, let alone in three months. Will companies confirm Wall Street expectations for the future or mirror the economic struggles as the virus continues to wander through the population? We have learned much over the past three months and we are certain to learn much more in the months to come.

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 7.6.2020

Here we are at the mid-year reset, otherwise known as the Fourth of July. The financial solution to the virus allowed the markets to contain the decline to roughly six weeks ending in March. However, the healthcare portion of the virus is the gift that keeps on giving. Cases are up from states trying to get back to “normal”. Some are backtracking on the speed of opening, others are continuing on course and asking citizens to wear masks. The
economic data is showing the economy is recovering, with many reports coming in well ahead of expectations. Such was the “big” employment report last Thursday, surprising to many that the unemployment rate fell to 11.1%. Released at the same time was the weekly jobless claims, which did not confirm the strength in the monthly report. Ongoing claims, or those getting benefits, has been flat over the past three weeks, indicating few are heading back to work. The generous benefits are set to expire at the end of July without action by Congress. Expect some action on unemployment benefits this month.

After taking a three-week rest to digest the April/May run higher, the SP500 is once again knocking on the door of the year-end price level and was spurred higher by talk of another aid package and better economic data. The coming week will be relatively quiet ahead of earnings season starting mid-month. There are some divergences setting up in the markets that could be a problem for stocks if not resolved in the weeks ahead. The number of advancing to declining stocks on the high-flying OTC markets are not keeping pace with the index. The number of stocks trading above their long-term average price has also flattened out. These could improve if stocks continue to march higher, but it could also be an early sign that the rally is narrowing. Finally, one indicator that remains positive for stocks is the difference (spread) between the yields on 2- and 10-year treasury bonds. If the spread continues to widen, stocks should be supported in the weeks ahead.

The aftermath of the market decline has seen the Fed introduce all sorts of programs to provide liquidity to the bond market. Some would argue that their direct buying of ETF and corporate bonds is well beyond their mandate of full employment and stable inflation. Bonds, outside of treasuries, continue to be priced for a higher level of risk in the year ahead. If the support of the Fed is successful, the returns on those bonds will be significant over the next year. Last quarter, near 10% returns have been achieved on these bonds as the Fed has supported pricing. The bond model remains positive, calling for lower interest rates in the week ahead. With a 10-year yield around 0.65%, how can lower be possible? Look at Europe and Japan for an answer where yields are negative for maturities out to 10 years. It is possible here with a highly active Federal Reserve.

Just when you think the markets are rotating into the asset classes that have been beaten down and away from those that have run higher, they revert to prior form. Technology came roaring back last week and remains top of the charts. However, there remain glimmers of hope for international and especially emerging markets. If there is indeed a “risk-on” attitude that is gripping investors, emerging markets should be a big winner in the years ahead. Valuations relative to the US markets are near all-time lows. That said, there are plenty of problems with the asset class. The stronger dollar makes their debt more difficult to pay back, as they borrow in US dollars, not
in their currency. Many countries still have serious problems following the virus global shutdown. All that said, the emerging market, over a 3-5-year time horizon should provide returns well ahead of US markets. However, that has been the case for the past three years, so that turning point could still be somewhere in the future.

Earnings season is around the corner and hopefully, companies will be providing more guidance than they did last quarter at the height of the virus shutdown. Investors remain very bullish as long as the Fed is an active participant in the market. Bond investors should enjoy above-average returns as spread continue to contract back toward normal levels 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.