Nolte Notes 9.3.19

September 3, 2019

Everyone is looking for answers, asking good questions and the best the markets can do is “I dunno”. How’s the economy doing? Where is the market going? Should the Fed cut rates? When will the trade war end? Judging by the markets four periods of 3% or more drops during August, followed by three rallies of 3% or more, there is little consensus on Wall Street about anything today. Listening to the various Fed speakers ahead of their September meeting, they are sounding comfortable just hanging out for a few months and letting the chips fall where they may. The bond market, with its inverted yield curve (short rates above long-term rates), is screaming for a rate cut. Consumers seem pretty sanguine about things, as the consumer confidence polls are near all-time highs, retail sales are decent and jobless claims remain near generational lows. The confusion is not likely to end anytime soon, as the US will be imposing tariffs beginning 9/1 and China is sure to retaliate. Since we have seen this movie a few times, it is a pretty good bet stocks will decline early in the week. The good news is that one of the two worst months of the year is behind us. The bad news is September is here. What is likely to happen next? I really dunno.

The coming week, although shortened by the Labor Day holiday, will be loaded with economic reports, from manufacturing to services and employment on Friday. The Institute for Supply Management (ISM) follows the global Markit report on manufacturing. The US report has been getting weaker since March while the services have remained relatively strong. Based upon the Fed regional reports, it won’t be a surprise to see manufacturing get below 50, an indication of contraction within the sector. Services should stay above the magic 50 level. Friday’s job report should see 160k in new jobs, which is in line with the (new) recent reports on jobs. It is also above the number needed to keep the unemployment rate at current levels. Of course, any negative deviation will provide more fodder for calls of a recession.

The returns from the bond index, the Barclay’s Agg, was the best since late in 2008. The rally in bonds was due in part to a couple of things. First, inflation continues to be below forecast and that has a great influence on long-term rates. As inflation expectations fall, so does the yield on long-term bonds. Second, the on again off again of the trade war is taking its toll on economic growth. Bond investors are making the bet that a recession is close at hand and the Fed will have to drastically cut interest rates to help bolster the economy. Finally, since our yields are higher than most other government yields around the globe, international investors flock to buy US bonds to capture yields not available to them domestically. How low can yields get? Zero is not out of the question and many are starting to think US rates could eventually be negative.

Looking at the asset class battle of performance, the SP500 wins yet again. This time the winning pace was well ahead of the field. For August, the SP500 fell 1.67%, well ahead of small and mid-cap stocks that fell over 4%. Commodities fell by more than 4%, with only gold and silver shining last month, rising by more than 7%. International got close, falling just under 2%, but emerging markets dropped by 3.75%. It has been an SP500 show much of this year, as similar performance differences are exhibited on a year to date basis. This maintains the trend that has been in place, with a few annual exceptions, since the bottom in March 2009. The disparity between and within some asset classes are hitting historic spreads. For example, value stocks are now priced similarly to 2000, when they began an eight-year winning streak against growth. Small stocks, especially the very small are selling near levels last seen in 2009 before they went on a five-year winning streak. The very biggest US companies have done very well, but it has come at the expense of nearly every other asset class. There is a reversion to the mean on Wall Street. We’re just never sure when it will begin.

August was rather volatile, to say the least and September doesn’t look to start any differently. We continue to look at assets outside of the SP500 for the next “big thing” and plenty of areas of the markets are looking rather ripe to perform better than the SP500 names. Trade will continue to be the focus as we head into fall.

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 8.26.19

August 26th, 2019

Don’t quit on summer just yet…there is another week before the unofficial end over this Labor Day weekend. What should have been a relaxing week at the beach with a trashy novel was trashed on Friday by tweets that more tariffs could be expected as China upped the ante. Of course, not to be outdone, Trump indicated more tariffs would be announced in addition to an edict for companies to find other sources for goods/services than China. The economic news ahead of the latest salvos was mixed with the manufacturing sector showing the biggest impact of the trade war. Even the announced adjustment to the monthly employment report showing a cool 500k fewer jobs created did not worry investors. The economic data has been coming in a bit better than expected, but it is the headline news that is moving markets today. Unfortunately, the next headline is anyone’s guess. Remember Trump postponed additional tariffs until after Christmas, but announced additional tariffs after the Fed cut rates last month. The path forward is not at all certain and like hanging at the beach too long, investors could get burned by the next “surprise” announcement. Or a cool breeze could come up and all will be right with
the world. It truly is anyone’s best guess.

Shrouded in the shade from tariffs was the big powwow in Jackson Hole, where Fed officials met to discuss economic policies in a collegial environment. Looking at the economic data, arguments could be made for the Fed to stand pat. A few Fed governors argued as much. Some would argue cuts are needed to ensure the economy continues to grow in the face of weaker data due to tariffs. Again, a few made that argument. The coming week should clear up some of the economic questions as the calendar is loaded heading into the long weekend. From sentiment to personal spending and durable goods orders, the data is varied and hits many of the key parts of the economy that should help determine whether a recession is close or still a mirage in the summer heat. It will still be a week full of political posturing, regardless of the economic reports.

There is an increasingly loud group that argues the US could/should see zero or negative interest rates in the near future if only to match the yields available in other parts of the world. The 10-year rate of just over 1.5% doesn’t sound like much, but when other countries have their entire maturity schedule below zero, it sounds huge. Inflationary pressures remain modest at best, especially when using the commodity index as a proxy for inflation rates. Commodity prices are lower than a year ago levels and have been since Christmas. Combine that with slower economic growth and it easy to see why the Fed should be cutting interest rates. However, I have contended that interest rates, no matter the level, will not be a solution to the trade war. A solution to the trade war combined with fiscal policies promoting growth will provide enough ammunition for higher interest rates.

Very few asset classes and sectors within the SP500 are escaping the market tumult during August. Of course, Treasury securities of all stripes are providing a port in the storm. Combine the market decline with yields that are falling due to lower international rates and bonds have done extremely well this year, especially as everyone figured rates were rising at the end of 2018. A new entrant to the performance derby is gold. While not really an asset class (can you spend it? Does it earn anything?), many view it as an essential part of an investment portfolio. However, since 9/11, the precious metal has been anything but, declining steadily vs. the SP500 and in absolute terms until 2015. Bullion traded sideways for the next three years and only over the past month has it broken out of that range. Gold is not being bought as an inflation hedge (there really isn’t any), but as a hedge against a weaker dollar and/or chaos in the market. Chaos seems to reign supreme, but the dollar continues to hold up due in large part to the better yields available in the US. For the first time in a decade, we are beginning to add gold into investment portfolios.

Trade, trade, and trade seem to be the key features of the markets today. Until there is an agreement or the rhetoric calms down, the markets are likely to continue their large daily swings of 1-3%. We have been holding more cash and bonds over the past year, concerned that a trade resolution was not going to happen quickly. The pace of selling could provide a short-term bounce, especially if conciliatory comments are made from the White House.

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 8.19.19

August 19, 2019

It is now official: a recession in the US will be beginning next Tuesday at about 1:30 pm. The US yield curve inverted last Wednesday and the world freaked out. Every (save one) recession in the last 50 years has been preceded by an inversion of the yield curve. However, the lead time to the recession is less than exact. Equity market returns from the time of inversion to the actual recession have also been positive, up to 20% in some instances. So why is everyone worried the world is coming to an end? Fear sells; calm is just not that exciting. Things are indeed slowing globally, with Germany likely in a recession. The US too is also slowing, but some key parts of the economy remain relatively strong. With interest rates so low, refinancing activity has exploded and potentially could help retail sales later this year and into next. Retail sales remain solid. Inflation has ticked up a bit but is not in the danger zone. Jobless claims remain near generational lows indicating a still solid jobs market. As we highlighted a few weeks ago, this has been an unconventional recovery and the role of global central banks is likely to make the next recession just as unconventional.

Missed amid the handwringing about the yield curve was the relatively positive week for US economic data points. Retail sales, housing, and inflation all were better than expected. Some of the regional Fed data was also better than expected, indicating recessionary fears today are a bit misplaced. To be sure, some of the global data points are downright scary, hitting levels not seen since the bottom in 2008. The global economy, while hurting, is not in the same place as 2008, especially when comparing the headlines during the fall of 2008. Back in the US, the data has been beating expectations for the past few months. The next few weeks will be quiet on the economic front and hopefully from the equity markets as investors finish up their summer vacations ahead of the Labor Day three-day weekend in the US.

Yields are back down to historic lows and with the inversion last week, many penciled in a recession sometime ahead of the US election next fall. The larger, global concern is the total dollar amount of sovereign bonds that are yielding less than zero. Nine countries have bonds yielding less than zero for maturities out to 15 years, with four having negative yields out to 30 years. By contrast, the US sticks out like a sore thumb with “juicy” yields of 1.5% for 10 years. The negative yields “over there” may be forcing some of the funds into US Treasury bonds to garner additional yield. Foreign investors, after adjusting for currency hedging, can still net out a better return here than in their home country. Can negative rates wash ashore here? Former Fed Chief Greenspan thought it very possible. It could turn everything we think we know about investing upside down.

Since hitting a momentum peak at the end of the first quarter, stocks have treaded water, albeit in an interesting fashion! The decline we are experiencing is not much different than the one ending in June that pushed stocks back to the yearly high. The sentiment is getting bearish rather quickly as investors scoop up stocks that have a dividend and are considered “safe”, like utilities, REITs and some consumer staples. Technology has been hurt, more from the ongoing trade war than a slowdown in activity. One sector that has had its share of trouble over the past few years is energy. Since peaking in mid-’14 when prices at the pump were approaching $4/gal, the average price of an energy-related stock is back to the lows of early 2016, after prices collapsed. Even as crude prices have nearly doubled from the 2016 bottom, energy stocks can’t find love from investors. Many have dividend yields over 3%, rivaling many utilities along with decent earnings and cash flow. It is a sector that is interesting, but we’d like to see some better relative performance before jumping into the sector just yet.

While the short-term picture may have brightened some, the long-term outlook for stocks remains cloudy at best as earnings have struggled to rise over the past three years (and prices have risen) and debt becomes a larger piece of corporate balance sheets. Valuations are likely to remain a wet blanket on prices if/until a meaningful agreement is reached on trade. Trade is at the heart of the issue with stocks. Regular comments about trade, raising/postponing tariffs, close to a deal or calling off negotiations will continue to roil stocks.

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 7.29.19

July 29,2019

The hallmark of the past 10 years has been the unconventional nature of nearly everything economic. From pushing rates to zero (below in foreign countries) to fiscal easing at the end of the economic cycle, it should come as little surprise the Fed is talking about cutting rates. The rate cut is coming a week after the economy showed growth of 2.1%, consistently low jobless claims (indicating a strong jobs market) and decent corporate earnings. Yes, there is a weakness in the manufacturing sector, inflation remains stubbornly below their 2% target and tariffs are taking a toll on global growth. Unconventional tools have been employed by other central banks, from the holding of over 75% of all the ETFs in Japan to aggressive buying of corporate/sovereign debt in Europe. Will the US eventually succumb to those drastic measures? Can monetary policy alone get inflation above 2%? Can an “insurance” cut in rates solve the costs of the tariff war with China? These are some of the questions that may face Chair Powell after the Fed’s decision is made on the 31st. In the words of the great philosophical writer Jerry Garcia, “What a long strange trip it’s been!”

The financial markets once again tapped new all-time highs as investors embraced the thought of lower interest rates from the Fed. Sure, earnings did generally beat very low expectations, but that is like clearing a hurdle lying on the ground, not a feat to celebrate. We highlighted the lower number of stocks making new yearly highs, while those making new yearly lows are rising. This week we noticed that stocks trading above their short-term average price have been falling since the end of June. The flipside is that the net number of stocks rising to falling remains positive on the SP500, however, the broader common stock only net line has flattened out. After a significant rally from the May lows, it may once again be time for a rest for the markets, which may come with the announcement of a rate cut next week. It will be another “buy the rumor, sell the news” moment for the market.

Interest rates have taken a break from their steep drop this year. Long-term, 30-year yields touched 2.5% early in July and have added 10 basis points (bp) since then. Similarly, the 10-year got below 2% and is now nearly 2.1%. While not huge increases in yields, the correction is needed. We still don’t see reasons on the horizon for a large increase in yields as commodity prices remain relatively stable over the past year. Much of the past year, commodity prices have been falling. We use commodity prices as an early warning for higher inflation, as was the case during the 2002-08 period> In that period commodity prices were rising by 10-20% annually, arguing for rate increases to stem the rising inflation pressures. Since late ’11, commodity prices have spent most of the time falling, with only brief periods of prices above year-ago levels.

The momentum trade continues to rule the markets. What is going up, continues to go up while those things going down continue going down. For long-term investors looking for a reversion to long-term means, this has not been your year. One interesting change to the landscape has been the emergence of gold mining companies. Generally following gold prices, the mining companies have sales, earnings and in many cases pay dividends that can be analyzed. Unlike bullion, which has no cash flow, earnings, etc. For years, the mining companies ran their businesses very poorly, failing to invest in profitable projects and losing large amounts of money. Today, new management teams are beginning to turn that around. The price of bullion still factors into their profitability and just recently it stuck above $1400/oz, its highest price in 6 years. Mining stocks, relative to the SP500, bottomed early last October and again in late April and are now leading the SP500 this year. There have been plenty of false starts, with 2016 being the most recent big rally and big decline. Given the better corporate governance, maybe this time the mining companies can shine.

The markets will likely be very volatile around the Fed interest rate announcement and press conference on July 31st. They are expected to set the table for the remainder of the year. Current betting is more cuts to come, but if they cut and signal they are standing aside for a while, stocks could tumble. Friday is also when the employment report is released and watched very closely for signs of weakness.

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 7.22.19

July 22, 2019

Investors continue to guess the next Fed move-quarter or half-point cut in interest rates in ten days. What is clear is the unevenness of the economic data over the past week. Retail sales remain relatively strong, indicating the consumer remains “happy” with the economy and feels comfortable spending. The regional report from the Fed’s
New York district looked pretty rosy. Finally, the weekly jobless claims remain near generational lows. The leading economic index from the Conference Board was the only real black mark on the economic data. The earnings reported last week were generally uneven as companies within the same industry sector provided wildly different reports. From the bad of Netflix and CSX to the nearly great of Microsoft, IBM and Danaher, the reports were unbalanced This does cloud the “should we cut/hold interest rates” at the next meeting. The markets reflected that back and forth as well, losing some ground on the week, but in a very quiet, seemingly apathetic way. This week brings a dearth of economic data for investors to chew on, but plenty of company reports to review to glean any information on the health of the economy. It is not easy being a central banker these days!

There wasn’t anything alarming in last week’s decline, following six straight weeks of advances it was time for a rest. As investors wait for the Fed to send up their white cloud indicating a rate cut of the expected quarter- point, the markets are likely to flounder a bit. Once the deed is done, the markets may rally on the expectation for more rate cuts at future meetings. However, even as the averages push higher, the number of stocks making new highs vs. lows is disconcerting. A month ago, 10% of stocks on the NYSE made yearly highs. Today, the markets are straining to push 6% to new yearly highs. Meanwhile, those making new lows have consistently been above 2% stretching back to mid-May. A healthy market that is rising, should not be seeing as many stocks making new lows. This is a sign that there may be something wrong beneath the surface. This can be seen too with the smaller stock index lagging the more popular SP500, which we’ll discuss below.

The talk of cutting interest rates in what seemed to be a decent economic environment scared the bond market for a bit. Yields rose as bond investors feared inflationary pressures would surely show up as a result of such a silly move by the Fed. However, after a week of fretting, interest rates once again began to drop as inflation has yet to show up in any persistent way. Commodity prices backed off last week, pushing our bond model firmly in the “lower rates ahead” camp. The model has been calling for lower rates since late November when the 10-year bond yield was nearly a full percentage point higher. Little has changed since then as rates continue to surprise investors by heading lower. Until we see persistently higher inflation and/or economic growth above 3%, interest rates are likely to be stuck in low gear for the foreseeable future.

Wall Street must have heard us complain about the dominance of the SP500, as it took a back seat to bonds, emerging markets, and broad international indices. Value and even commodity prices did better last week. While we can cheer one week, like inflation or economic growth discussed above, the performance of other asset classes needs to be persistent. The case has been made by many that growth is well ahead of value and should revert toward the long-term mean. International, especially emerging markets continues to be valued extremely cheaply vs. the US markets. If the Fed goes through with a rate cut at their next meeting, we could see the dollar decline vs. other currencies, pushing international investments higher. We could also see a larger rush into “cheaper” stocks that provide good income possibilities for investors looking for more than a 2% yield from bonds. On the other hand, investors could continue to throw caution to the wind and buy the largest US stocks and hope that they continue to deliver on growth as the world economy slows down. At some point, there will be a rebalancing back to historical trends. Well….we’re waiting!

We expect the markets to remain quiet until the Fed meeting in 10 days. Individual companies will likely move based upon their own earnings reports this week. Bond investors should continue to do well as interest rates are likely to remain stable if not fall further in the weeks 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.

Nolte Notes 7.15.19

July 15, 2019

Plenty has come into focus over the past few weeks regarding the US economy. First, the jobs report reversed some of the weakness we saw in the May data. Combined with still steady wage growth, it was an indication that the US economy is not yet rolling over. Inflation data continues to come in weak, but the core rates were a bit higher than expected. While not yet enough to worry about, inflation remains below the Fed’s 2% target as it has for much of the recovery since 2009, so nothing new here. Manufacturing and service reports showed weakness as has the trade data. Finally, the global economy due in large part to the weakness in China is slowing and is showing signs of contraction. In a time long ago and seemingly far away, the Fed would be looking at those data points and likely hold steady. However, the Fed is also interested in keeping the financial markets happy (part of the unwritten third mandate!). The equity markets are demanding a quarter-point cut in rates at the end of the month with a still healthy possibility of a half-point. Europe stands to restart their bondbuying activities as well even with over $12 trillion dollars worth of bonds yielding less than zero. Central banks are once again forcing investors into the equity markets. Eventually, this charade will end, but when is still up in the air.

As the indices crossed over new high watermarks on Friday’s close, it also marked prices that have moved well above their long-term trends. Not yet parabolic, the persistent advance has investors flocking into the markets without regard of prices paid for stocks. Earnings season will be upon us starting this week with the banking sector in focus early in the week. It will be informative to see how companies characterize their earnings in light of the continued trade tariffs in place. For the banks, the inverted yield curve could garner some discussion as well. All that said, the markets look to move higher as momentum has taken hold and now it is more about the fear of missing out (FOMO) rather than fear of losing money. The risks are building, but the timing of any decline is a guess at best. As was said a month ago, the path of least resistance is to the upside, but returns over the coming few years are likely to be paltry from this starting point.

As Chair Powell did his best to indicate the Fed was going to cut rates without saying it so flatly in front of Congress, the markets certainly understood his meaning. What is interesting though is the reaction in the bond market. If rates are indeed cut, we’d expect bond prices to rise and yields to decline. However last week was exactly the opposite as bonds had their worst two weeks since April. Investors have bought up nearly everything that sports a yield above 2%, pushing valuations on utilities and other “safe” investments to near historically high levels. Commodity prices had their best six-week stretch since late 2017/early ’18. Inflation does not look to be returning with a vengeance. The better than 5% rise in commodity prices should be watched as an early signal that things are changing in the commodity world.

Just when we thought a diversified portfolio was the ticket this year, investors have moved back to the largest stocks within the markets. The second quarter saw over one-third of the returns in the SP500 come from the five largest stocks within the index. Large-cap tech has regained the performance lead from real estate and utilities. Going lower in the market cap world, the worse the performance and sending money overseas has also lagged the SP500. Once again, the SP500 reigns as the top asset class year to date. That is not to say the returns are terrible elsewhere. No one should sniff at a 10% gain after six months in the international markets, but compared to a 20% gain in the SP500, it pales by comparison. The same is true when looking at growth stocks vs. value stocks. We saw signs that value was finally(!) taking the performance mantle from growth at the end of 2018, but that has reversed at this point of 2019. Throwing caution to the wind seems to be the best way to invest these days. The markets seem to be bending the will of the Fed and maintaining historically low interest rates to keep the party going. The hangover will be a doozy whenever it hits.

The implication from the Fed cutting rates is that things are not well in the economy. Investors are certain a rate cut will solve the ills facing the economy. However, trade is something well outside of the Fed’s purview that cutting interest rates will solve. Keep an eye on trade discussions for the next direction in stocks.

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.