Nolte Notes 4.18.22

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April 18, 2022

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

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

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

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

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

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

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Nolte Notes 4.4.22

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April 4, 2022

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

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

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

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

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

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

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Nolte Notes 3.14.22

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March 14, 2022

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

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

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

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

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

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

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Nolte Notes 12.6.21

December 6, 2021

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

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

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

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

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

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

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

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SVP Paul Nolte Interviewed By Reuters 2.19.21

Reuters interviews Paul Nolte, SVP & Sr. Portfolio Manager

Paul Nolte discusses what factors might shake the market, plus how a steeper yield curve is “the bond market’s way of telling everybody that the economy is recovering and getting healthy.”

Click here for the full article

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