Nolte Notes 6.29.2020

Nothing matters until it does. The focus on Wall Street has been on the opening of the state economies, the generosity of the Fed and the US government providing money to the financial and economic systems. The financial markets took off, well ahead of the economic data, and seemingly solely on the Fed largess until last week. Then the virus numbers started rising as people began going about their business as usual. The rise in cases worried investors that the second wave is upon us and the economy will have to once again shutter, meaning earnings will take that much longer to recover, additional resources will be spent and the “V” recovery becomes wishful thinking. The economic data does show the economy is recovering; however, the weekly jobless claims and continuing claims are not coming down as quickly as many were expecting. The holiday-shortened week will have the unemployment figures released ahead of the fourth of July and should provide plenty to chew on over the three-day weekend.

The markets have been holding up well in the face of persistently high virus numbers in the US, however, last week succumbed to selling pressure as worries about the second wave spread across the southern US. Most disconcerting has been how quickly many stocks “lost” their staying power above short-term average prices. After 90% of all stocks recently were trading above their 50-day average price, that figures have fallen below 60% and in jeopardy of getting below 50%. The story is worse when looking at long-term average prices, where the figure poked above 50% and today is below 25%. The net number of advancing to declining stocks is also rolling over, all of which paints a much more negative picture for stocks going forward. While the SP500 is barely trading above its average prices, many other broader indices have dipped below last week. Much like the reaction to the virus spread, the markets are taking a breather from the heady rally that nearly recovered all the losses in March.

The interest rate picture remains a bright spot for investors. As low as rates are today with the 10-year treasury at 0.66%, there remains room for yields to decline further if the recovery proves elusive. The Fed continues to buy bonds, supporting not only treasuries but also corporate bonds through their various programs. The yield curve, which steepened following the March bottom in stock prices, is once again flattening out. This is a warning sign that the economy remains tentative at best and could take longer than many expect in getting back to “normal”. As a result, bonds should be a good hiding place while stock investors figure out where to turn to next. Inflation should not (yet) be a concern for bond investors. Once the economy fully recovers, we should begin to see inflationary signs, but that date remains well in the future.

Technology continues to be the “safe” trade for investors. While we are working from home and ordering things online, these companies have been direct beneficiaries. As a result, technology is now gone into “overbought” territory, meaning a correction in prices or selling of technology and buying of other sectors or asset classes is likely at hand. The flattening of the yield curve and overall high valuations of the markets, in general, is beginning to give us pause about the sunny outlook for stocks. Within the SP500, there are now only three sectors that are trading above their average short-term prices, which was as high as eight of the ten in positive territory a month ago. While it may be sunny and warm poolside, storm clouds are beginning to gather over Wall Street. At this point, a correction in stock prices has been overdue but worries about the virus spread may provide fuel for more than a corrective selling phase for stocks.

At this point, we are taking off some of the “risk” in the portfolios, taking hefty gains in technology stocks, and increasing the bond exposure, especially treasuries. This may be a temporary shift, and actions by the government or the Fed for additional measures may allow us to reinstate a more bullish tilt. This is not a “bearish” call, but a realization that stocks, and investors, may be taking a summer holiday.

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

Nolte Notes 6.8.2020

The “game” of estimating economic numbers is rather humbling. There are so many variables, revisions and things not accounted for that hitting the actual estimate is a lesson in futility. Take the jobs report, in a “normal” month, the margin of error is usually 10-20,000 jobs. As states open slowly and get caught up on past filings for unemployment, it was estimated that jobs were still being lost in May. Payrolls actually expanded and the unemployment rate fell. The jobs report was much better than expected and created a surge in the stock market, capping the best three-week period since 2009. The employment report was one of many that were “better than expected” over the past two weeks. Many of the absolute numbers were awful, but vs. what was estimated, they were better. Wall Street operates in the world of recent data trends. If the trend is better, things are getting better and stocks should be rising. If the trend is getting worse, Wall Street looks around for the Fed to help by cutting interest rates and stocks rise. Heads they win, tails you lose. It does not make sense for those looking in from outside “the club”, but Wall Street has always moved to its own beat.

The last time we have seen the markets put together a two or even three-week run like this was coming off the 2009 bottom. Unusual in that the SP500 has already run higher by 40% over the past 50 trading days. Many are calling this a “blow-off” top that will reverse by August as everyone piles back into the markets. However, the rally is broadening out rather than getting narrow. The former leaders (technology and healthcare) are starting to take a back seat to the more cyclical portions of the market. Volume increased as the markets rose and the number of stocks rising vs. falling has been decidedly bullish. That does not mean stocks continue to race higher, but that any inevitable rest that may happen should be a good time to add to equity positions. It is crazy to think that the economy is contracting by over 5% and unemployment is likely to remain over 10% by yearend, yet the markets are within a stone’s throw of yearend or all-time highs. Such is the power of “free” money from the Fed.

Confirmation of the shift in the equity markets can be seen in the bond market. Even as the Fed has been regularly buying bonds and bond ETFs, interest rates are rising. The 10-year treasury is approaching 1%, which is not a big yield, but it was below 0.50% just a few weeks ago. Always worrying about something, investors may begin to be concerned that higher yields become competition for stocks as they can garner “safe” returns more than stocks. We are a long way away from that, but as the stock market rises and valuations get stretched, bonds will become a much more interesting asset class again. The Fed continues to hold the key and will be meeting this week to discuss interest rate changes (expect nothing), but may begin to explain what their expectations are for the remainder of the year, which will be very interesting to hear.

We saw signs of rotation to other parts of the markets two weeks ago and last week it came through in spades, with small-cap doubling the return of the SP500. International did very well as did the beaten-down financials and energy sectors within the SP500. The larger the stock, the worse the performance. It is this rotation that may provide some fuel for further gains. The largest stocks held up during the market decline in March and are now expensive relative to many other parts of the markets. The disparity between estimated returns of the largest US stocks (roughly 2%) and small stocks (over 10%) for the coming five years is at the widest it has been since 2000. That marked the beginning of a seven-year run for value, international and small stocks that then culminated in the financial crisis. These big market declines (Tech bubble, financial crisis, Covid) tend to be periods that mark a shift in market leadership. We may be in the early stages of that shift today.

So much for a market rest last week, as the SP500 jumped 5%. Still looking for a rest, but the longer-term outlook for stocks outside of the largest US stocks is brightening. Diversification away from large tech and growth names may allow for better performance in the months and years ahead. The Fed will be important to watch later this week about their plans to continue to support the financial markets.

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

Nolte Notes 6.1.2020

Spoken in the tones of Maxwell Smart: Would you believe the SP500 could get over 8000 by New Year’s Day? Including weekend and holidays, the markets have increased at a pace rivaling the one month decline from the February peak to the nadir in late March. A long, strange trip does not even begin to capture the events of the past three months. The trillions of dollars spent by Congress and the buying of bonds by the Fed has done more for Wall Street than Main Street and part of the reason for the disconnect between consumer confidence and investor sentiment. Earnings are not likely to recover nearly as quickly as expected as dislocations, broken supply chains and spending habits are not likely to snap back. Yes, states and many businesses are beginning to open, but with some new protocols that are not going to result in booming businesses like the end of 2019. An easy bet would be that the SP500 does not maintain the same pace of the past month and there will be some reconciliation between the generosity of the Fed and Congress and the daily reality of getting back to work. Heaven forbid there is a surge in cases or postponing of the economic opening. The financial markets will not react kindly.

The market has put together quite a run over the last two weeks. Both weeks saw a better than 4 to 1 ratio of advancing to declining stocks on the week. The volume of advancing stocks doubled that of declining stocks mid-week, showing a strong appetite for stocks by investors. While the markets have put on a show since the March bottom, much of the excitement has been contained within the first hour of trading. The Dow has increased nearly 7000 points from the bottom. Looking at the first hour of trading, the Dow added 6500 points just within that hour. In the final hour of the day, the Dow dropped 500 points. What that means is that stocks really did not move too much over the course of the trading day. If you were not in the market the night before, you missed that opening jump in stocks the following day. Healthy? No, as retail investors tend to be very active in the first hour, while the specialists (or smart money) tends to be more active at the end of the day.

As the economy begins to open, commodity prices are beginning to perk up as well. Still down significantly from a year ago, they have been moving gradually higher over the past month. Interest rates have perked up a bit from their very-low levels as the Treasury is issuing a ton of bonds to pay for all the stimulus. All of this is pushing the bond model toward the negative zone, meaning that interest rates could be rising in the months ahead. Since late 2018, there have been a few weeks that were negative as interest ultimately fell to near zero. This change does not mean rates are going to soar, but it means to be a bit more cautious about extrapolating the past well into the future. This means that the discussion about negative interest rates could be a bit premature.

There are some small signs that there is a rotation underway from technology and healthcare and towards some of the lagging groups like consumer discretionary and even financials. Smaller stocks, value, and international all bested the SP500 last week. Whether the rotation lasts more than a few weeks is yet to be seen, but these parts of the markets provide some of the better overall returns due to their poor relative performance to the large US growth stocks that we have been highlighting over the past few weeks. Since many of the technology names also are large contributors to the SP500 performance, it may be that the index takes a bit of a breather and allows some of the economic data to play some catch-up. It may be hard to believe but a few decades ago the kings of the markets included AT&T, Exxon, and IBM. Yep, dinosaurs. What will be said about this decade’s behemoths?

The markets have had a tremendous few weeks and are likely due for a rest. Whether that means some of the market leaders take a break while others jump to the fore or a retracement of some of the recent gains, we should get a feel for that the next few weeks. Bond investors could be seeing interest rates slowly rise in the months ahead as the Fed and government begin to back away from their intense support to the financial markets.

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 5.26.2020

A year ago we sat watching parades, fireworks displays and a concert in the park. The stock market was in roughly the same spot it is today, however, our lives are far from that “normal” we enjoyed a year ago. The most recent jobless claims numbers now show over 35 million people out of work and an economy that is contracting at a pace not seen since the Depression. Amongst all the bad news, there are glimmers of hope in various states opening their economies and a turn higher in many bits of economic data. While America honors those who have sacrificed their lives for our freedom, it also looks forward to better days ahead as we grapple with the containment of the virus. The holiday-shortened week will still have plenty of economic data points to assess the state of the economy. However, the financial markets, it is said, are forward-looking. Investors are banking on a “V” recovery once states open their doors wider and people get comfortable with the “new” normal. There will be plenty of people keeping an eye on the beaches and subsequent reports of changes in infection rates to determine the actual “letter” of recovery. The good news is that summer is here and hopes are high for easier living.

After May’s mid-month swoon, stocks recovered those losses and more by the close on Friday. Granted, much of the gains came right at the open last Monday, as the SP500 jumped nearly 3% in the first 30 minutes of trading. From there, the markets traded sideways much of the week. Last week was one of the first in a while that showed some participation from the broader markets. The smaller the stock, the better the performance. Technology and healthcare took a back seat to energy and industrials. International and commodities also performed better than the SP500. All that said, only one-third of the stocks within the SP500 are trading above their long-term average prices. It has been a slow grind higher over the past month as stocks, in general, begin discounting a recovery rather than the economic contraction we are experiencing. If more stocks can continue to best the popular index, we can see the recovery continuing well into the summer.

The fear of central bankers around the world is not rising prices, which they can handle, but falling prices, for which they have no tools to deal with in their toolkit. Deflation, or the general decline in prices across the economy, is a risk at this point with consumer and business spending slowed dramatically. The important issue for the Fed, and investors, is whether that price decline is temporary (disinflation) or a more permanent feature (deflation). If consumers believe that by waiting, they can get lower prices in the future, no amount of money or interest rate cuts will “create” the need to spend. As a result, we think the Fed is likely to keep interest rates at the zero level for quite some time. At least until we begin to see persistent pricing/inflationary pressures.

Thanks in large part to the performance of Amazon and Home Depot, the consumer cyclical sector has joined technology and healthcare above their long-term average prices. Looking at various asset classes, only the bonds can make that claim. The SP500 is between the long and short-term average price, and once it hurdles the long-term, many believe the next stop will be all-time highs from February. As has been the case for quite some time, the largest US stocks are the ones leading the markets. It is concentrated in the FAANG names (Facebook, Amazon, Apple, Netflix, Google, and Microsoft for good measure). All of them are higher on the year and have skewed overall market returns as well as earnings for the SP500. Without those names in the index, the markets would be closer to the 16% decline of the equal weight index year-to-date rather than the 7.50% for the SP500.

The markets are following the money coming from the Fed and the government. As long as interest rates remain near zero and the Fed is supportive of the financial markets, investors will feel comfortable taking the risks of investing. Whenever the Fed decides it is time to “normalize” rates, the financial markets will be throwing their usual hissy fit. But that time remains a long way off.

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 5.18.2020

Just when investors thought it was OK to put money back into the markets as various states begin the process of opening, trade issues with China once again rears its ugly head. President Trump tossed out a few comments in an interview about cutting off the whole relationship. That sent stocks lower on the week, even as sings of state openings were going reasonably well. The economic data continues to be poor, however, there are some early signs that we are beginning to pass the worst. High-frequency data points like driving, pollution, and even consumer spending are all showing signs of an increase in activity. Many of the data points remain at exceptionally low absolute levels, but they are “less-worse”, which is giving Wall Street hope that the worst is now in the rearview mirror. Some of the “soft” data points like surveys are showing sentiment is not nearly as bad as during the financial crisis or into the late 70s. Expectations are that as states begin to open, people will begin going back to work and increase overall spending. Whether the banter on China gets ramped up or just a political gambit, we should see in the coming weeks It is, however, a reminder that there remains plenty of “things” for investors to keep an eye on in the coming months.

For all the discussion about how fast stocks have jumped since the most recent bottom in March, the markets have been stuck in a range over the past month. Over that time, the number of stocks declining vs. rising has declined and there have been a couple of days where volume for declining stocks is over 8x that of rising stocks. All of which indicates that investors continue to focus upon the top stocks/sectors within the markets and that a broad-based advance is still not yet at hand. For the SP500, a break of 2800 could signal that investors are taking recent gains and opens the door to a potential retest of the March lows. By the same token, a push through 2950 could push the markets up and toward the all-time highs. We will be watching the sector winners, technology and healthcare, for signs of which way the markets will break. They have led stocks higher and continue to be a guide to the direction for stocks.

Federal Reserve Chair Powell had a wide-ranging discussion mid-week that put investors back on their heels. His warning of a prolonged recession contrasted with investors’ belief of a “V” recovery once states opened. He called for additional government spending that could result in a stronger recovery. Investors also believe that sometime next year, short-term interest rates would be below zero in the US. We have seen below zero interest rates around the world, however, it has not resulted in the booming growth economists had expected. Chair Powell tossed cold water on the idea. Much like the pointed comments toward China, the press conference was not well received on Wall Street, leading stocks lower for the week.

After nearly two months after the market bottom, little has really changed when looking at the various sectors within the SP500 and the broad asset classes. From a long-term view, only bonds are among the asset classes that are above their long-term average price. Within the SP500, it remains technology and healthcare. The longawaited rotation away from the large US stocks has yet to occur. While some of the market internals are deteriorating, the averages remain at a high level due to the very heavily weighted technology sector. If/when technology begins to fail, the markets could easily break their trading range, heading toward the March lows. The tech sector, a beneficiary of the “new normal” of working at home, continues to mask some of the underlying market weaknesses.

If the SP500 can remain in the sideways pattern of the past few weeks, it can give other parts of the market time to repair and regain their footing. Hopefully, at that time, it will allow the markets to breakout higher. Technology will be the key. Bond investors will be stuck with extremely low-interest rates for the next few years. While it may be appealing to reach for yield, that reach could be detrimental to the value of the bond portfolio.

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 5.11.2020

Ugly is the only description that can be made about the employment report. Going from generational lows at year-end to mid-teen unemployment in four months is all about how quickly and devastating the economic shut down has been. In a perverted twist, average hourly earnings jumped last month. How? The huge reduction in the lower-wage employees, primarily those in hospitality and restaurants, means those that were working last month were the higher wage earners. Economists warn next month’s employment report will be uglier, potentially surpassing 25% unemployment. Yet, the markets rose to their highest level in more than two months. Have the financial markets completely divorced themselves from reality? There are two likely reasons. The first is that government programs and the Fed cutting interest rates at a pace much quicker and more robust than during the financial crisis has provided fuel for stocks. The second is that some states are beginning to open, which will put people back on the payroll and that by July/August, the unemployment rate will begin falling. The period from late March to early May is likely to be the worst economic period and things will slowly improve going forward. As long as we do not see a resurgence of the virus and shut everything down again, investors believe things are improving and are willing to buy stocks.

Investors are buying the tried and true parts of the markets, which means primarily technology. The technology sector, by market capitalization, is now larger than the developed world markets, ex the US. We are seeing some cracks in various parts of the US markets, all outside of the tech sector. The technology stocks are back to their yearend prices, recovering everything lost during March. Instead of weighting the index by how large a company is and weighting them all equally, the index would be down over 16%. Looking at the smallest stocks, they are down nearly 20%. At some point, this will turn around, but investors are so confident in the long-term prospects for Amazon, Apple, etc., that the “mania” may continue longer than many believe possible. The recent race higher by these stocks are due for a rest, correcting some of the big gains from the March bottom. Whether investors get shaken out or just buy more, the coming two weeks should tell the tale.

The Fed will be keeping interest rates at or near zero for this year and likely much of next year. After trying to raise rates a couple of times since the financial crisis, investors fled the stock market, worried that higher bond yields would stifle economic growth. The most recent comments from the last Fed meeting indicate low rates are here to stay and investors are now betting below zero interest rates by next year. This means investors of all stripes do not have an alternative to earn a “safe return” that is today only marginally above zero. We continue to watch the action in the high yield market to determine the risk appetite of investors. So far, the appetite is healthy and indicates continued risk-taking by investors.

Nearly 80% of stocks are now trading above their short-term average price, while less than 30% are above their long-term average price. This dichotomy is an indication of the furious rally from the bottom with many stocks still not yet in “bull market” mode, as was described above. Only two sectors, healthcare and technology, are above their long-term average price. The longer investors rush to one side of the market, the more imbalanced the markets will get and the harder the decline for the once favored sectors when it comes. There are plenty of indicators that point to the overvalued nature of technology, but money continues to pour into the sector as the current “stay in place” points to additional technology needs and uses. It is hard to ignore, but be careful about holding on too tightly.

The SP500 has spent the last few weeks trading sideways and is currently perched near the top of the range. As investors are emboldened by some states loosening the reins, stocks could continue their march higher, especially the tech sector. However, based upon the lack of follow-through by the rest of the markets, a correction over the next few weeks would not be out of the question. How stocks act over the coming weeks will likely determine whether the summer smolders or is just a hot mess.

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 5.4.2020

There are over 30 million hitting the unemployment rolls and a 30% rise from the March market lows. Not quite the 30 for 30 sports fans are used to on ESPN, but such is the state of the markets today. Some would argue that the markets are forward-looking and anticipating better days ahead. Others would point out the economic data is the worst since the Depression and a 10-15% decline from the highs does not properly price in the decline in earnings. Still, others point to the Fed and government actions, pushing trillions of dollars into the economy, which will eventually wind up in the stock market. Finally, another group is worried that the virus will be with us well into the fall/winter and the markets are crazy at current levels. The reality is the economic data is and will be “the worst” since the Depression, the 70s, or WWII. The market is not the economy, but reflects the expectations for corporate earnings, revenue growth, and future opportunities. The arguments are strong, fair, and persuasive on each side. The arguments are one of the reasons for the continued large daily swings in the markets. Early morning rallies fade into the close, poor starts morph into strong afternoon gains. Welcome to the fickle financial markets! Much like Chicago weather, if you don’t like it now, just wait fifteen minutes.

Some of the more beleaguered parts of the markets sprung to life last week, from small-cap to international, only to crawl back into their respective holes by the end of the week. Once again, the market has been dominated by the largest US stocks, Apple, Microsoft, and Amazon making up 15% of the total index weight. If you want to know where the markets are headed, keep an eye on these three. Outside of these three, the markets look to be running on fumes. After their huge rally over the past month, many of the short-term indicators have swung to very-high levels that indicate at least a rest is in order. The SP500 is essentially the same place as of April 14th, with a 5% range on either side as investors continue to go back and forth about the virus and economic conditions over the summer. While still wild trading days, they are mere shadows of the March trading, when a 5% day was not unusual.

Overshadowed with all the excitement over some states opening and the ongoing concern of the virus, the Fed met and decided to keep rates unchanged. After instituting a variety of programs from extra liquidity, bond-buying, and the specter of buying corporate bonds, the meeting and press conference was relatively tame. The one key takeaway was Chair Powell’s version of former European Central Bank chief Mario Draghi “do whatever it takes” to support the economy and financial markets. In essence, backstopping the financial markets and risk-taking. It is little wonder some of the riskier parts of the bond markets have been jumping in price over the past month.

As the markets have rallied, the only constant has been the better performance from the technology and healthcare sectors. As of the weekend, they are also the only sectors above their long-term average prices. That said, they may also suffer if the markets decide to take a break from their recovery rally. As the markets backed away from key levels late last week, the money moved quickly from the better-performing groups as investors took profits that were quickly generated over the past 4-6 weeks. This may continue well through May as additional information comes out about spending, state openings, and tamping down of the virus. Medically, we are not yet out of the woods. While the markets may indeed anticipate the good news to come, it may come much later than anticipated.

The late-week decline in stocks could be the beginning of a correction to the recent rally. We may take some profits to rebuild cash balances, reallocating toward Treasury bonds temporarily to maintain value. Until we get more positive evidence of state reopenings without additional medical issues, the markets will continue to be volatile. The short and violent rally should correct, just as the short and violent decline into the end of March did. We see more risks on the downside over the short-term than opportunities for 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 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.