Nolte Notes 4.27.20

The market weirdness is still with us. Stocks rally as the economic news hits century lows, energy prices go negative for a day as storage facilities are near maxed out. The usual government response is to provide more funds for a variety of bailouts and to keep everyone indoors for longer. How could energy prices “go negative”? The US has been the global leader in oil production for the past two years and exporting some for the first time in decades. With global economies shutting down, our only major storage facilities in Cushing, OK and the strategic petroleum reserve facilities in Louisiana and Texas are both near capacity. Without a place to put the newly extracted oil, drillers were paying anyone to take it off their hands. There were also technical factors in the futures markets as the delivery of contracts were set for Tuesday before contracts started trading for June. Strange days indeed. The financial markets also reacted negatively to the news of Gilead’s Covid drug failure in trials. While the financial news is important to the markets, it is keeping an eye on the vaccine progress as well. The economy will progress as everyone gets comfortable moving about the country, which will take many months and not a few days.

Based upon the weekly jobless reports, it is expected that the unemployment rate will exceed 20%, getting close to the maximum 25% during the Depression. Of course, this time it was self-imposed rather than a “typical” recession. Earnings season is also in full swing, with companies reporting first-quarter results that take into count a portion of the economic shutdown. Many have pulled guidance due to a lack of business modeling for a situation such as today. The combination of no guidance from companies and the global pandemic leaves investors grasping for any bit of good news. That is coming in the way of additional government programs to help the unemployed, small businesses, and industries severely impacted by the economic stoppage. Working off the 2008/09 playbook, investors are figuring that much of the money, in addition to the Fed’s various programs, will eventually find its way into the financial markets. Remember that the economy performed poorly relative to the financial markets over the prior 10 years, much of it attributed to the easy money policies of the Fed.

It was another quiet week in the bond market as rates remain stuck at near-zero levels. Inflation fears have ground to a halt as companies cannot raise prices with basic materials from copper to oil continuing to fall in price. Even some of the typical “bond replacement” investments like utilities and REITs have suffered over the past week as investors return to the riskier holdings. This comes on the heels of the Fed essentially becoming the buyer of last resort for “fallen angels” and mortgage securities. To tread where the Fed will be buying, income investors are shunning the more traditional income investments.

Historically large market declines such as we have seen over the past two months tend to shift leadership on the recovery. Leading up to and through the tech bubble, small-cap, value, and REITs all began showing signs of leadership that continued into the next big market break – the financial crisis. Large-cap growth was beginning to assert itself in 2007/’08 and performed relatively well during the market collapse. Today there are no real signs just yet of a leadership shift. One to watch is gold, as it bottomed relative to stocks in 2018 and has been performing relatively well over the past two years. The gold miners have also done relatively well, but they have a history of poor management that has tended to destroy shareholder value than to create value.

The weekly decline came as the SP500 has hit the 50% retracement of the March market decline. Many investors attribute significance to those levels, so further strength will be needed to clear this hurdle. Stocks may instead take some time to digest the recent gains and watch the opening of various countries and US states to see what may happen to the number of virus incidents in those places. Ultimately it will be a medical victory that will give the stock market the “all-clear” signal for stocks to reclaim their February peak prices.

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

Nolte Notes 3.2.20

To quote Louis Rukeyser following the 1987 crash, “Let’s start with what’s important, it’s just your money, not your life. Those that loved you last week, love you today.” In one week, the markets have gone from all-time highs to more than a 10% decline in fears of the spread of the coronavirus. The virus has been in the news for the past few weeks, but investors didn’t seem to mind or care about it until last week, then everything mattered. Many more questions for doctors than economists last week and even today, we remain uncertain about the trajectory of the infections and any solutions or medicines to combat the virus. It is that uncertainty and fears about the virus coming to US shores that have investors skittish about the overall economy and whether we can avoid a recession. The economic data will still get published, but it will be looked as “pre” and “post” virus. The election season shifts into high gear in the US this week as well. The questions are never about how high the markets can go, but only how low can they go. Are the fears overblown? Will the global economy grind to a halt? Can the markets rise above the fray? All good questions that are not likely to get answered in a week or two.

The fastest from peak to 10% correction ever, the worst week since the Financial Crisis. Largest point loss in the Dow ever. The headlines did little to calm investor’s concerns last week. Save for the last few minutes rally on Friday that pushed at least the OTC market into positive territory, there was very little to put a smile on investor’s faces. It didn’t help that little economic data hit the wires last week, however, that will change this week with the employment report on Friday. We will also get various economic “health” indices, starting with China Monday and the rest of the world during the week. Safe to say, China will likely look very poor given the quarantines that have been in place for much of the past month. Given the heightened worries about the economic impact of the virus, it will likely be another month or two to see the full impact and another few months before we begin seeing how the world gets back to work.

The bright spot of the past week was the bond market, with treasury yields collapsing to fresh all-time lows. Calls for the Fed to act were also made and the markets now expect at least two and as much as four rate cuts by yearend. While lower interest rates are not going to cure the virus, many believe it will keep the economy going while the virus works through the global economy. Given how far rates have been pushed down, it may be time to reduce some of the bond exposure and take the quick profits that have built up over the last two weeks. One concern is that the flood of liquidity put into the economic system could spur inflation once the global economy gets back to “normal”. It may be difficult to close that barn door once the inflation horse has fled.

The very late rally on Friday gives us some hope that the selling may have finally dried up. The volatility is not likely to dissipate quickly, and further advances of the virus could see the selling resume. That said, we could see the markets put in at least a short-term bottom this week, pushing the averages up 3-5% in short order. That doesn’t mean the markets are out of the woods. It is possible that some selling resumes later in March or April and have the lows of last week tested again. Even with the decline of last week, valuations of the markets remain slightly above average. If earnings are reduced due to the global slowing, valuations could still be considered high. From purely a historical perspective, these types of shocks (think Pearl Harbor, 9/11, 1987 crash, etc.) saw the markets higher by 10%+ a year from the event. While this could indeed be different, the market decline is pricing in a worst-case scenario that may never come to pass. It is for that reason we are looking to put some of the cash that was raised earlier in February slowly back into the equity markets. We are looking out over the coming year, not just the next few weeks.

The drastic decline in stocks is providing a buying opportunity for the coming year, although maybe not for the next few weeks. Large US stocks as well as re-establishing emerging market positions over the coming weeks and months make sense currently. Bond investors have seen very large gains in a short time, and we will reduce the bond holdings some to capture those gains.

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 2.24.20

Yes, but on the other hand… so goes the analysis for stock investors. The coronavirus continues to grab headlines, especially when discussing earnings, economic growth or even estimates for the full year 2020. As a result, “safe haven” investments like the dollar, gold, and treasury bonds are all rallying. On the other hand, risk assets just hit all-time highs and stocks highlighting some of the hits to earnings also rose, like Deere, on expectations the virus impact will be short-term. The recent surge by Sen. Bernie Sanders worries Wall Street as a democratic socialist is seen as harmful to stocks. On the other hand, expectations are rising that Trump will have an easier time against Sanders, which Wall Street sees as bullish. Stocks like Tesla and Virgin Galactic have more than doubled already this year, with neither one showing a profit and still in cash-raising mode. On the other hand, utilities and REIT stocks are hitting all-time highs. Trying to make sense of the markets and economy today is enough to drive anyone crazy. On the other hand, some say it is crazy to be investing today.

The well above average reading from the Philadelphia Fed is feeding into expectations that the US manufacturing sector is improving. However, the IHS Markit flash index fell into contractionary territory, last seen in 2009. This week we’ll get national activity, housing, and confidence data, which all may be impacted by the recent news around the coronavirus. The uneven economic data creates an environment where depending upon one’s views, a bullish or bearish case can be made. Housing remains strong as low-interest rates and steady demand push prices higher. As mentioned above, manufacturing may be on the way back and employment remains very strong. The flipside is worries about the virus spreading, poor leading economic indicators and recent downgrades to earnings for the coming quarter. As a result, we would expect the markets to remain volatile as investors try to grasp the overall direction for the economy and the impact of the virus on earnings and global growth.

The beneficiary of the volatility in the equity markets continues to be bonds. Worries about a bond bubble and an inverted yield curve (where short-term rates are higher than long-term rates) are once again making the rounds. For those holding Treasury or high-quality bonds, they should see the return of their principal upon maturity, no matter the direction of interest rates. However, investments in lower-quality bonds, long-term bond mutual funds and various derivations of “bond-like” investments may have a harder time providing comfort when investors run to the safety of bonds if equities remain volatile. The inversion of the yield curve is a function of investors running into the safety of treasury bonds, especially long-term, pushing the yields below those on short- term treasuries.

For all the handwringing about the decline last week, stocks remain within a whisper of all-time highs. Many industry sectors are above long-term average prices, as do many of the broader stock averages. To be sure, stocks would need to fall about 10% to begin to threaten those long-term averages. The most vulnerable parts of the markets remain those that have risen the most over the past year, which are the odd couple of technology and utilities. Technology stocks have, so far, been immune to the virus news as they are viewed as safe places to get both earnings and revenue growth no matter the economic backdrop. Utilities have benefitted from the declining interest rate environment. As investors seek income in a world near zero, they have piled into the “safe” sector pushing up returns to close to that of tech stocks. It is not likely that both are correct. If rates fall, economic growth will be difficult to achieve, crimping the valuations and prices of technology names. On the other hand, if technology investors are correct, economic growth should be sustainable enough to allow interest rates to slowly rise, hurting the returns on utility names.

The markets are likely to be beholden to the virus news and impacts on global growth. If reports show spreading of the virus around the globe and not contained within China, expect stocks to fall in the weeks ahead. Bond investors should be the recipient of the “bad” virus news, as long as the bond quality remains high.

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 2.10.20

“Go away kid, you bother me”, delivered as only WC Fields could do, could also be used for the market’s reaction to the coronavirus news after two weeks. Once the Chinese markets opened after their Lunar celebration, the Chinese central bank injected $174 billion into their financial system. The global markets cheered by rising last week, with the US markets tacking on 3% from the prior Friday’s close. What changed? Sure, the economic data in the US was a bit better, with employment still at generational lows. The manufacturing and service indices improved from December’s levels. However, little truly changed over the course of a week the spurred the markets significantly higher, outside of the injection of money into the Chinese financial system. That money is now flowing around the world. The argument is not that the markets should be trading higher or lower, but the solution to every problem, whether the virus, modestly slower economic growth or low inflation, is to open the monetary flood gates. The only inflation that we are seeing is in the financial markets as they once again reach record highs. We’ll get a read on consumer inflation this coming week. Judging by the data from the employment report, inflation should remain modest. The impact of the slowing of the Chinese economy will likely be felt around the world through at least the summer months.

Leading the chargeback to all-time highs was once again the technology sector. Interesting in that technology companies rely upon China for components and is a huge end market for products and services. Slowing growth there is likely to impact technology companies when they report second and third quarter figures later this year. Outside of the SP500, the picture is a bit bleaker, but that could change if the markets continue to move higher. The net number of stocks rising vs. falling in both the tech-heavy Nasdaq and small-cap stocks. Until that gets resolved, which could happen with further advances, a warning flag is flying that the “recovery” rally is narrow in scope. The rally has been focused on the very large US stocks at the expense of many of the smaller companies. We have said the market was due for a breather, but a two-week decline that gets erased by the end of the third week hardly qualifies. Earnings have generally been coming in above expectations, but companies have been warning about lackluster growth going forward due to the virus outbreak and lingering issues around trade.

Checking out the futures markets for the Fed funds is a good way to guess what investors are expecting from the Fed later this year. Although they have said they are likely to be on the sidelines for much of the year, the futures markets are saying, with 80% certainty, that they will drop rates as much as twice before the end of the year. Our bond model tends to agree that the path of least resistance for interest rates is indeed lower. What makes this interesting is that the economy continues to generate jobs, and the rate of economic growth remains in the 2% range. Not tremendous, but in line with the past 10 years. Fed Chair Powell did refer to the possible impact of the virus and that central banks could react to an economic slowing. Monetary conditions remain very easy today, by a variety of measures. The yield curve is once again flattening, which could be a sign too that growth is already slowing. There will be lots to watch in the weeks ahead.

Not much has changed in the SP500 sectors, with technology leading the charge and the rest falling in line behind. One notable group that we have highlighted in the past is energy, which continues to struggle as oil prices have fallen from just over $60/bbl to $50/bbl. That decline has put pressure on many companies that have relied upon their ability to borrow in the public market, to keep the lights on. We saw a similar picture late in 2015, when energy prices dropped and the financial markets declined, worried about bankruptcies in the sector. The energy companies are also big players in the high yield bond market and could impact investors searching for yield in these markets.

Our optimism over the coming year is getting tempered a bit by the issues around the coronavirus. Economic growth will slow and the impact upon earnings is, today, unknown. This may be a period where bonds once again shine relative to 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 2.3.20

Another one bites the dust as the markets continue to march higher. The Dow crossed above the 29,000 level and is now just a few percentage points from 30,000 and may not be looking back. So far, the returns during January are like a pretty good quarter, just as last quarter’s returns contributed to a decent year. Historically, strong start begets more strength. When the markets are up over 2% in the first dozen trading days, the market continues higher the remainder of the year. The data from the economy continues to be supportive of higher stock prices. Two trade deals were signed last week, putting to bed the new North American Trade agreement. The deal with China continues to calm trade worries and encourages the thought that another trade deal will be coming soon. Housing is showing strength, inflation remains relatively low and earnings have started out well. What could possibly go wrong? There will be something, from out of the blue, but as we have seen with a variety of “worries”, the markets haven’t stayed down very long.

There are a few things that we try to keep in focus when looking at the financial markets. First, are jobs being created? Historically, job growth and growing markets have gone hand in hand. Check. Second is the “breadth” of the market, meaning are more stocks rising than falling. So far, the breadth has been positive and persistently rising, even as the markets showed some weakness late last summer. Check. Finally, is the number of stocks making new yearly highs. This has weakened since the markets took off a year ago. However, the number of stocks making new highs is now back at year ago levels, again indicating a broad market advance. Of course, there are always things to worry about, like the performance of equal weighted SP500 vs. the cap weighted. Instead of the biggest companies (largest market cap), the equal weight flattens out all 500 stocks to be roughly the same weight. Save for the market decline in late ’18, the largest stocks have been performing much better than the rest of the index. This has given rise to our regular comments that the bigger the stock, the better the performance. In order to assess when the markets may turn, keep an eye on the top 10-15 stocks within the SP500. When they turn down, the markets will as well.

Contrary to the recent cuts in rates by the Fed and standing pat for 2020, interest rates are moving up. This may be a bit confusing as the bond market tracks the direction of the Fed. However, since they have stepped back, we are seeing some strength in global economies, some higher prices for industrial metals and a still tight US job market. All of which should get inflation to pick up in a meaningful way, yet the inflation data out last week was low and commodity prices in general have turned lower. We are generally of the belief that the yields should remain in a range much of this year. This allows for the fluctuation in economic inputs like steel, iron and copper without getting too excited that long-term trends have changed in a meaningful fashion. If and until commodity prices can break their three year sideways movement, inflation should remain modest, keeping interest rates relatively low.

All the nice things about the markets commented upon above have already made their way into stock prices, as many industry groups are trading at very high “momentum” levels. While the trend is your friend, when stock prices race higher without a break, a market decline of at least modest amounts of price and time are ahead. For example, the last time stocks were this “extended” was last April, after which stocks dropped 5% over the course of May. This didn’t mean the end of the run higher, but just a breather in what has been a terrific run for stocks. When the economic and market conditions change and look dour, we could see a much better chance for significantly lower stock prices. Those components are not in force at this point.
The strong run by stocks early this year continues the pace from last quarter and is due for a bit of a break. Whether this week or next month, the decline should be relatively modest that shouldn’t change the bullish market dynamics.

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 1.21.20

Another one bites the dust as the markets continue to march higher. The Dow crossed above the 29,000 level and is now just a few percentage points from 30,000 and may not be looking back. So far, the returns during January are like a pretty good quarter, just as last quarter’s returns contributed to a decent year. Historically, strong start begets more strength. When the markets are up over 2% in the first dozen trading days, the market continues higher the remainder of the year. The data from the economy continues to be supportive of higher stock prices. Two trade deals were signed last week, putting to bed the new North American Trade agreement. The deal with China continues to calm trade worries and encourages the thought that another trade deal will be coming soon. Housing is showing strength, inflation remains relatively low and earnings have started out well. What could possibly go wrong? There will be something, from out of the blue, but as we have seen with a variety of “worries”, the markets haven’t stayed down very long.

There are a few things that we try to keep in focus when looking at the financial markets. First, are jobs being created? Historically, job growth and growing markets have gone hand in hand. Check. Second is the “breadth” of the market, meaning are more stocks rising than falling. So far, the breadth has been positive and persistently rising, even as the markets showed some weakness late last summer. Check. Finally, is the number of stocks making new yearly highs. This has weakened since the markets took off a year ago. However, the number of stocks making new highs is now back at year ago levels, again indicating a broad market advance. Of course, there are always things to worry about, like the performance of equal weighted SP500 vs. the cap weighted. Instead of the biggest companies (largest market cap), the equal weight flattens out all 500 stocks to be roughly the same weight. Save for the market decline in late ’18, the largest stocks have been performing much better than the rest of the index. This has given rise to our regular comments that the bigger the stock, the better the performance. In order to assess when the markets may turn, keep an eye on the top 10-15 stocks within the SP500. When they turn down, the markets will as well.

Contrary to the recent cuts in rates by the Fed and standing pat for 2020, interest rates are moving up. This may be a bit confusing as the bond market tracks the direction of the Fed. However, since they have stepped back, we are seeing some strength in global economies, some higher prices for industrial metals and a still tight US job market. All of which should get inflation to pick up in a meaningful way, yet the inflation data out last week was low and commodity prices in general have turned lower. We are generally of the belief that the yields should remain in a range much of this year. This allows for the fluctuation in economic inputs like steel, iron and copper without getting too excited that long-term trends have changed in a meaningful fashion. If and until commodity prices can break their three year sideways movement, inflation should remain modest, keeping interest rates relatively low.

All the nice things about the markets commented upon above have already made their way into stock prices, as many industry groups are trading at very high “momentum” levels. While the trend is your friend, when stock prices race higher without a break, a market decline of at least modest amounts of price and time are ahead. For example, the last time stocks were this “extended” was last April, after which stocks dropped 5% over the course of May. This didn’t mean the end of the run higher, but just a breather in what has been a terrific run for stocks. When the economic and market conditions change and look dour, we could see a much better chance for significantly lower stock prices. Those components are not in force at this point.
The strong run by stocks early this year continues the pace from last quarter and is due for a bit of a break. Whether this week or next month, the decline should be relatively modest that shouldn’t change the bullish market dynamics.

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 12.16.19

December 16th, 2019

The events of last week reminded me of Hanz and Franz, being played by Trump and Powell. They are here to pump you (the markets!) up. Whether through more balance sheet expansion to keep the overnight repurchase market from causing problems to the announcement of a trade “light” deal with China, the markets responded accordingly and rose on the week. It is estimated that by summer the Fed’s balance sheet will be as large as it has ever been since the crisis. Their buying of short-term securities should continue to push rates lower and keep the yield curve from inverting again. They are also likely to stay away from doing anything with rates in 2020 to keep away from looking political in an election year. The trade “deal” was interesting as the communications from each side didn’t quite match up as to what was agreed upon. Most of it centers on agriculture, but it opens the door for further negotiations and a potential cooling of tariffs hikes into the election year.

The economic numbers of the past week were good, but certainly not indicative of an economy on the mend. Retail sales disappointed some and the shorter Christmas shopping season is likely to make it look weak as well. A trade deal, even one with little meat as this one, could push up earnings estimates for next year as companies get more comfortable that the trade war is cooling. That said, the markets remain in a high valuation state that is likely to shrink returns going forward. For example, earnings were up modestly in 2019, but much of the 20%+ gains came from multiple expansion or paying more for the same earnings. As have been highlighted over the past few months, earnings since 2016 on the SP500 have been relatively flat, however, stock buybacks have boosted the earnings per share over that time. The low-interest-rate environment is allowing companies to borrow funds at very low rates and use the proceeds to buy back stock. It increases the leverage of a company and if/when the economy hits a rough patch, some companies will have a much tougher time paying interest costs and the principal of these loans. But that is a worry for another year. Today, things look rosy and bright with the Fed at investors’ backs and more room to buy back shares.

The start of QE “lite” has been a benefit to the bond market. Steepening the yield curve to a more “normal” curve has pushed short-term rates back down toward 1.50%. Intermediate and long-term bonds have moved a bit higher in yield. However, some of the bond-like securities, like utilities and REITs continue to benefit from the Fed’s beneficence. The one area that we are keeping a close eye on is the commodity market. Prices for a wide variety of commodities, from energy to steel, coffee to sugar are rising. It will take some time for the higher prices to work their way into the economy. They will also need to persist at higher prices and even go higher for the
Fed to begin to notice. The last time we saw higher year over year commodity prices, the Fed was hiking rates. Today, prices are above equal to year-ago levels.

As we have thought, a trade “deal” was announced last week by both China and the US, averting a rough yearend and higher tariffs. Whether that goodwill gesture lasts beyond the first of the year remains to be seen, but it comes with stock prices already discounting much of the good news. Technology and financials are showing the strongest momentum and could take a breather into yearend. The market as a whole has been rising persistently this quarter, falling only two of the eleven weeks. Now that the “good news” is here, what is next for stocks? This week should be the last week with any decent volume as investors head for home for Christmas and the New Year’s holiday. Slow volume should also mean modest moves in stocks, so investors should be able to sleep easy and dream of sugar plum fairies to close out a very good year. A buying of the rumor of a trade deal could mean a bit of selling now that one is supposedly in hand. The very easy monetary policy and cooling of the trade war should be good for stocks over the early months of the New Year. Politics will likely take hold after the first quarter when the primary season heats up around the US.

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 11.18.19

November 18, 2019

“’’Scuse me while I kiss the sky”, has been the mantra of the markets for the past six weeks. The drug of choice has been trade. As the agreement gets ever closer to the paper, the markets get more excited. What hasn’t been contemplated is whether the deal signed is worthy of the moon-shot by stocks. The economic data remains OK at best, with many more indicators coming in worse than expected than those beating expectations. Earnings have been beating estimates, but growth is merely 2% vs. a year ago. Of course, Wall Street is guessing earnings will rebound back to double-digit rates and all is good in the neighborhood. This all assumes that global growth picks up and that trade gets solved, not just part 1 of the thriller that is the art of the deal. A correction is looming that could shave 3-5% off stocks, putting the SP500 still around the 3000 level. “Lately, things don’t seem the same, acting funny, but I don’t know why.”

The six-week rally has more of the hallmarks of a locomotive pulling out of the station rather than an Indy car after the first turn. That said, many of the technical indicators are pointing to a correction of sorts over the next few weeks. As of yet, it doesn’t look to be more than the garden variety correction, like the market breathing rather than completely out of breath. Volume, what there has been, is heavily tilted to stocks rising. Over the past 25 trading days, more than 556% of the trading volume has been on the plus side. While that doesn’t seem like much, it typically ranges between 40-53% and gets “gassed” above 53%. This past week saw more stocks down than up for much of the week, even as the markets moved up. This is typical of a tired market that is getting pushed up by fewer stocks. Finally, the number of stocks making new all-time highs continues to contract, even as the SP500 makes new all-time highs. It shouldn’t come as a surprise, nor “scare” anyone out of stocks as we head into yearend. If timing the large market moves is difficult, trying to time the market bounces is impossible. For now, we are expecting nothing more than a normal correction.

Interest rates have moved up a bit over the past few weeks as the yield curve has normalized. The corporate bond indices along with utilities have declined over the past six weeks and commodity prices have moved up. Taken together, it is not a favorable environment for bond investors. The Fed has made it known that they are not likely to do much over the next few months unless there is a shock (good or bad) to the economy. This has provided the bond market a “release” for persistent betting on lower rates and yields are finding their new equilibrium. Investors have flocked to interest rate substitutes like utilities and REITs, which have been declining recently. Historically, the end of the year has been positive for interest rates, but things have been rather unusual of late, so to see yields rise may be the “new normal.”

As of yet, none of the industry groups has moved into the “overbought” territory, which would point to a multi month decline. The technology and telecom sector are getting within sniffing distance. Technology has been the star performer this year, beating the SP500 performance by over four percentage points. It is the largest sector within the SP500 and contains many of the largest stocks in the US, like Apple, Microsoft and even card payment companies Visa and Mastercard. It is hard to fathom that Apple today is larger than the entire energy sector. Apple and Microsoft are larger than the entire small-cap index. The SP500 has become one dominated by a few companies dominating the performance. Instead of diversification, the SP500 has become a concentrated “index” where 10% of the index is just three stocks, and the top 10 stocks account for over 22% of the index. The self fulfilling prophecy of “just buy the index” will eventually unravel and it will be important to own sectors and stocks that are not heavily weighted within the SP500.

The short-term looks grand as stocks continue to believe a trade deal will be inked soon and the economy will get back on track and generate 3-4% growth. While this may be true, we are not putting a heavy “bet” on that outcome, rather a slow-growth environment is likely with or without a trade deal. Yields may be rising over the short-term as they have been pushed too low by expectations for further Fed cuts.

The opinions expressed in the Investment Newsletter are those of the author and is 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 11.11.19

November 11, 2019

“As we express our gratitude, we must never forget that the highest appreciation is not to utter words, but to live by them” said John Kennedy just before his death in 1963. On this Veterans Day, we take the time to reflect, remember and be thankful for those who have fought for this country. The market’s tug of war is being won by the bullish camp, having pulled through with five consecutive weekly gains. There remains angst among investors though, from the never-ending trade news to the weaker economic data and decent earnings reports. We have maintained that a recession is not yet around the corner, but merely a very slow-growing environment, supported by the consumer and solid job growth. Christmas music already fills the air at the stores, as retailers get a jump on a shorter than usual shopping season. Market volume is already on the decline as investors start packing it in for the year. There are still plenty of trading days left and investors are getting their cheer on early this year.

Investor sentiment is not quite giddy, but certainly embracing the recent gains in the market. Sentiment readings are once again around the top 10% of their historical ranges. Combined with a market that is historically overvalued, at least a correction cannot be ruled out before yearend. It shouldn’t be anything like last year when the Fed was tightening and the markets were in free-fall ahead of Christmas. Monetary policy is very accommodating here and abroad, the bulk of stocks in the market are rising along with the tide which portends a short/shallow correction instead of a cliff dive. The only real fly in the ointment within the market is the number of stocks above their short-term average price. After peaking at the end of the first quarter, it has stair-stepped lower on each market rally toward or to market highs. It seems counter-intuitive with most stocks rising, but not above short-term averages. But on each market decline, some stocks hit air pockets, decline hard and never quite recover on the ensuing market rally. Right now, it is a minor concern, but worth watching as the end of the year approaches.

For just the second time since last Thanksgiving, the bond model has flipped negative, meaning rates are likely to rise from here. Even though the Fed just cut rates for the third time and indicated they’d be standing pat, interest rates have been increasing. The yield curve is no longer “inverted”, where short rates are higher than
long-term rates. Many of the more interest-rate sensitive parts of the equity markets, like utilities and REITs, are beginning to decline as investors shift toward the safety of higher-yielding debt instruments. The key component of the model is commodity prices, which have been in a trading range for much of the past three years. IF they can break that range higher, then the market dynamic for rates changes dramatically. Current prices are about 10% below that “break-out” level.

The change in the markets away from more interest rate sensitive sectors toward more “cyclical” (that do well when the economy does well) is an indication of higher risk appetite among investors. We are seeing it show up in better performance from international, emerging markets and industrial and technology sectors in the US. Even with the recent weakness in utilities, ten of the eleven SP500 sectors are trading above their long-term average price, showing broad participation as the market advances. There has been little change in the SP500 sector rankings as sectors that were strong six months ago are still among the strongest today. The one outlier has been energy, which has been the worst sector within the SP500 over the past 12 months. The higher commodity prices discussed above will need some help from energy to make a meaningful increase “stick” beyond a few weeks or so. Unfortunately, US production levels are very high, we are exporting oil and OPEC cannot quite get their act together to reduce their production. A good thing for US consumers as pump prices the same today than they were two years ago.

Investors don’t seem to be worried about a market decline anytime soon. We think a short and shallow correction is possible if the trade rhetoric heats up into yearend. That said, the bigger recessionary worries may be on the back burner well into 2020. Bond investors could be facing some rising rates in the weeks ahead, which would be good for reinvestment of maturing bonds into higher-yielding securities.

The opinions expressed in the Investment Newsletter are those of the author and is 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 11.4.19

November 4, 2019

The much anticipated Fed meeting came and went with nothing more than a yawn from Wall Street. They didn’t surprise anyone with another cut in interest rates and indicated they would be leaving rates where they are through the end of the year and potentially well into 2020. Fed Chief Powell laid out the circumstances where they would be making additional rate cuts and when they might have to hike rates, which is a bit of a deviation from prior Fed chiefs. The big news was the employment data, which was expected to print well below 100k in new jobs as the impact from the GM strike would shave over 40k from the final print. Surprisingly, payrolls grew by over 120k and the prior two months were revised higher by another 90k. This supports the Fed’s decision to keep rates at their current levels. It also further cements the US as the outlier in the global economy with higher economic growth, strong jobs market and rates still above those around the world. Of course, stocks loved it and pushed to new all-time highs.

There is plenty to like about the current state of the stock market. It continues to trade above its long-term average price, meaning the “bull market” is intact. After spending much of the past six months wandering below all-time highs, the breakout historically has generated double-digit returns over the coming year. The net number of
advancing to declining stocks also hit a new high, indicating the troops are following the generals in the market advance. Finally, many more stocks are beating their estimates for both revenue and earnings than was originally figured a month ago. There is always something to worry about though. Most of the gains in the SP500 have come from the very largest stocks within the index, meaning that while small stocks are rising, they are not keeping up with the largest stocks. The month-end price of the SP500 is 10% above the estimated price for a market trading at a rich 20x earnings, meaning valuations remain very high. Finally, while the employment report was very good, the bulk of the economic data has been coming in below estimates. Over the short run, stocks could continue their march higher, but over the long-term much of those gains could be fleeting.

For all the machinations within the bond market, the bond model has pointed to lower rates for 50 weeks. Low inflation, generally strong bond prices, even in the face of a Fed hiking cycle last year have kept bond investors “invested” even as everyone else was predicting higher rates. Now that rates are once again approaching multiyear lows, we are seeing some signs of a pickup in inflation and a utility sector that is likely gone too far on the upside. The model is comprised of utilities, commodities, short and long-term treasury rates and corporate bond yields. During periods of falling rates, the stock market has historically done reasonably well. Even accounting for the decline last December, the SP500 has averaged an 11% annual rate of return when the model is positive.

As much as the US markets have done rather well over the past year and we have highlighted the dominance of the largest stocks within the index, we are beginning to see signs of other asset classes performing well vs. the SP500. The most maligned asset class has been commodities, which on a year over year rate remain negative. Since the end of early September, however commodities have had a higher return than the SP500. The same is true of international stocks. Both emerging and developed countries have had higher returns than the SP500. The flipside is found in the interest rate-sensitive sectors, like treasuries, utilities and to a lesser extent REITs. Even the much-vaunted growth sector is losing out to the value stocks since the end of the last quarter. We have seen this movie before and it has not ended well for the upstart sectors. At some point, the ending will be different. The duration of the out performance of growth vs. value, international/emerging vs. US and interest rate sensitive will change and will likely last for a few years when it does. While the set-up is similar to a year ago, we are not yet calling for a cataclysmic ending to the year.

Central banks around the world are cutting rates, with the US just the most recent. Historically, lower rates have pushed stock prices higher, however not always for long periods. A shift toward a more diversified portfolio is welcomed, especially after a fairly narrow last 6-8 years. Bond investors, even with a cut by the Fed, maybe toward the end of the most recent “run” and higher rates may be possible over the months ahead.

The opinions expressed in the Investment Newsletter are those of the author and is 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.