Nolte Notes 7.12.21

July 12, 2021

“We’re all mad here, I’m mad. You’re mad.” And so down the rabbit hole we go! Just when you think you have it all figured out, the economy and/or the markets throw you a curveball. Maddening, sometimes. But we are in a deranged time where everyone is a bit crazy. We celebrate huge employment gains, yet at the recent pace, it will take another seven months to regain the old employment peak. Job openings continue to grow as companies of all stripes can not find willing workers. Many “consumer-facing” businesses have shortened hours due to a lack of employees. The Federal Reserve believes easy money can solve this problem, so they keep rates at historically low levels while pumping over $100B into the markets every month. “When you have a hammer…”Goods are having a tough time getting to market and prices for nearly everything are rising. Many believe this will work itself out over the next year as companies fully staff up and supply chains are working properly again. Some wonder if the economy is permanently damaged. The coming week will have inflation, retail sales and sentiment indices released. The madness is not likely to get resolved this week!

Worries about the Fed “starting to think about thinking about” cutting back their bond purchases knocked down stocks for a day, but the “buy the dip” crowd piled back in on Friday, pushing stocks to yet another record and 14th weekly gain in the last 19 weeks. Yes, there are some chinks in the armor, but the easy monetary policy is what rules the day. Over those 19 weeks, 90% of the stocks within the SP500 remain above their long-term average price, however the last few weeks, barely 50% are above their short-term average price. Meaning stocks have rallied so strongly that any short-term pullback has done little to dent the long-term picture. Within the S&P500 industry groups, all but telecom are above their long-term average, so until the market “technical” begin to break down in a more meaningful way, the path of least resistance looks to be higher. Growth has been the big winner over the past few weeks as interest rates have declined. Could the rate decline be warning the markets that the best/fastest economic growth has passed? Potentially, however, we would like to see a few more indicators pointing that way before beginning to worry about the next downturn.

The yield curve flattening is a warning sign of slower economic growth. However, without a signification push higher in the yield differential between junk and treasury bonds, long-term worries are not yet heightened. Earnings season gets started this week, and there will be plenty of commentary about what companies are seeing in their “end markets” and their capacity to fill demand. Finally, comments regarding pricing and inflationary pressures could also impact bond yields, pushing them back up if investors believe those pressures are more than just “transitory” as the Fed currently believes.

The quick rotation between “growth” and “value” has been driven by changes in interest rates. As interest rates rise, value does well. As rates fall, growth does well. Both are tied to the re-opening of the economy. If investors believe that the re-opening is going well and pricing pressures are building, value does well. If investors believe the best of the economic growth is now behind us and we are heading back to the recent average growth of 2%ish, then growth will do well. From a long-term perspective, growth is very overvalued, with various companies selling at their highest price to earnings multiples going back to 2000. While value is also expensive in absolute terms, relative to growth, it is about as cheap as it has been going back to the late 1990s. We believe that over the next few years, the overall market will struggle to provide meaningful gains, but that value should shine relative to growth as the economy slowly works its way back to “normal”.

Interest rates have been driving the markets as well as various parts of the markets for the past nine months and that is not likely to change. Hence, we will be watching yield differences between various asset classes for clues as to when markets are likely to make a significant shift. Not yet in the cards but watching closely!

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 6.2.21

June 1, 2021

What was Hollywood’s six-million-dollar man is now Washington’s six-billion-dollar man. Inflation impacts everything! The new budget rollout late on Friday will be the starting point for wrangling about deficits (do they matter?), spending programs (remember shovel ready?) and initiatives the current administration would like to put forward. An interesting provision is an increase in capital gains tax rates that would be retroactive to April. While many are wringing their hands about the proposals, what gets passed, should make for some interesting beach reading this summer. Back at the economy, the inflationary figures continue to run “hot” as the economy continues to lurch toward a full re-opening. Supplies channels are still not operating correctly and are unlikely to get back to normal before year end. Employment is getting better as the weekly jobless claims’ numbers fell again last week. The coming data dump for the first week of June will include the “official” jobs report that should see some improvement over last month’s disappointing figures.

The markets continue to chug along, even in the face of data that historically would have had the markets falling. Higher inflation and large job gains are generally a recipe for hiking interest rates. However, looking at the bond market, you would have to shake a few traders to get them to move. Ten-year treasury rates remain below their March peak, and “risky” high yield bonds have traded well. Investors are amazingly comfortable with a Federal Reserve that has been buying large quantities of Treasury securities every week. Along with a commitment to keep interest rates lower for longer, investors have little choice but to buy equities to get any kind of return. That has pushed valuations of the equity markets to extremely high levels, rivaling those of 1929 and 2000. What is currently missing is a reason to sell. Until the Fed begins to discuss withdrawing from their purchase program, or we begin to see investors move out of risky portions of the markets, the momentum is still on the bull’s side and stocks can get pricier still. The warm sun calls and living is easy…for now.

After a very rough first quarter, bond investors have been rewarded with “staying the course” as returns have been positive in each of the last two months. Bonds have even given stocks a run for their money since late April, providing essentially the same return without the daily swings. If there are concerns in the bond market, it is that the bond model has swung negative, indicating the direction for interest rates may be higher in the coming weeks. The model has been negative much of this year and even as rates have moderated, they really have not dropped too far from their March peaks. Commodity prices are likely to be the key driver for interest rates going forward.

The markets have been swinging back and forth between growth and value for much of the past six months, however value has been the “winner” overall, as it has been two steps forward, one step back for value stocks. These are the parts of the markets that will benefit from the continued opening of the economy as we go from virtual meetings to in person, from FaceTime to face-to-face. There have been and will be plenty of bumps along the way, however the differences in valuations between these two asset classes tends to favor value ahead of growth. Comparing technology’s performance vs. nearly every other S&P500 sector shows technology’s performance peaking in the third quarter of last year and underperforming since. Even comparing technology to international, shows a similar relationship. The rotation away from technology is hard for investors to do, as the allure of high growth keeps them from moving. However, the valuation on technology stocks in general is well ahead of their historical norms, while valuations of other sectors and asset classes remain near or below historical norms.

“Sell in May and go away” is a Wall Street adage that historically shows the markets doing poorly in the summer. However, the last few years it would be better to hold the stocks and just go away. Will this year be any different? Or will the Fed keep the good times rolling with as easy monetary policy? Stay tuned.

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 5.10.21

May 10, 2021

“Jobs, jobs everywhere and not one to be had”. With apologies to Samuel Coleridge, the jobs report on Friday was in stark contrast to the news earlier in the week of large drops in weekly jobless claims. Employment reports embedded in various survey data also indicated that payroll gains would be close to 1 million, not just a quarter of that guess. Given the huge whiff, it would not be a surprise to see stocks take a header and drop a few percentages. However, they rose nearly 1% as investors feel the monetary spigots will remain wide open, fueling further stock gains and potentially higher inflation along the way. Excuses for the miss abound, from lingering fears about covid while heading back to work, schools still in hybrid and parents needing to hang around the house while kids are home. Finally, some point to the generous unemployment programs that are keeping potential employees at home until at least September, when the benefits are set to expire. Of course, the weaker report emboldened others to push for even more benefits.

The economy is in a strange place. Manufacturing is running full out and having trouble finding “stuff” needed to make their “stuff” (hence the rising prices on various inputs like steel, copper, grains, etc.). Services are beginning to come online as restrictions ease. Yet they are having trouble finding workers and still have capacity restrictions and higher prices for their needs (like jet fuel and foodstuffs). Housing is booming as many are leaving the larger cities and heading to the ‘burbs. Lack of building (and higher lumber/copper prices) has pushed up home prices at a pace last seen in ’07. GDP growth was over 6%, yet the calls for more stimulus and keeping the Fed’s rate policy in place were heard following the report. The key question is whether the combination of the enormous stimulus package (as well as the one proposed) and higher input prices for all sorts of goods will indeed be “transitory” or much more lasting than is presently assumed. Inflation in the financial markets have been deemed a good thing, however now that it is spilling over into the “real economy”, it could pose problems for officials.

Bond investors cheered the poor employment report, as they believe the easy monetary policy will continue for longer than expected. Since hitting 1.74% in mid-March, the 10-year Treasury yield has eased to 1.60%, trading in a very narrow range. If the bond market is indeed worried about inflation, it is not yet showing up in yields. Even the spread between short and long-term bonds has contracted when it would be expected to expand as the economy heats up. Investors in low-grade corporate bonds are not worried either, as high yield rates are their closest to Treasury yields ever, meaning the margin of default risk has never been lower.

Even with the much lower-than-expected job growth last month, the “re-opening” trade in the market continues to lead the way. Small US stocks and large US value have been out in front much of the year and have regained their leadership roll over the past two weeks. The dollar has weakened as well, allowing international investments to lead their US counterparts. A concentrated portfolio of US technology stocks has been the big winner over the past decade, starting in the depths of the financial crises of 2008 and (likely) culminating with the rollout of the vaccine late last year. Investors are paying a hefty premium for growth, as the average price to earnings for growth is 30x, 50% higher than that for value stocks. Both are at historically high levels, but for those that need to always be fully invested, the near historical difference between the two would argue that investors should be buying value and selling growth. The “reversion to the mean” trade would help investors who have a diversified portfolio of large/small/international holdings perform better than the averages, which are still dominated by large growth names.

The circular argument of “why are stocks going up? Because people are buying. Why are they buying? Cause stocks are going up”, will come to an end at some point. There are not yet any hints that stocks are going to do much more than correct their torrid run this year. A large “wow” drop is not yet in the cards. Still scanning the horizon for signs though…

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 on Global Banking and Finance 4.6.21

Kingsview SVP Paul Nolte discusses employment, economically sensitive cyclicals and small caps.

Click here to read the interview

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Nolte Notes 3.22.21

March 22, 2021

The days are longer than the nights and the weather is beginning to warm up. Baseball starts in 10 days! Summer is just around the corner. The economic “issue” is that inflation is beginning to heat up as well. Getting lumber or copper for homebuilding or gas for your car is costing a whole lot more than a year ago. As a result, interest rates are rising and pushing the Fed to recognize that an ill wind that blows does nobody good. Inflation, in the words of the Fed, may be transitory, but for how long? Expectations are for an economy to be blowing hot during the summer as economies open around the world. With all the stimulus and people going back to work with extra money in their wallets, inflation may be around for something more than a transitory period. To be fair, the Fed has pulled the punch bowl from the party well ahead of things getting out of hand, but this time wants to wait until they start seeing the party really rolling before raising rates.

Last week’s economic data was less than stellar, but the key report will not be showing up until April’s jobs report. The weekly jobless data is stuck in low gear, without much change since Halloween. However, the continuing claims are about double that of early 2019 and about two-thirds of the peak in 2008/09. Other data points are indicating the economy is healing, albeit very slowly. The coming jobs report will be informative as to the type of jobs coming back. In early March, the jobs report showed a large pick-up in hospitality jobs, restaurant, hotel, and bars. The trend is expected to continue as various states are loosening the restrictions of the past six months or so. Commodity prices are beginning to roll over a bit, energy prices have dropped from their recent highs and agriculture prices are down for March. So, while inflation indices could continue to rise in the months ahead, some prices are beginning to decline. As vaccinations increase and economies open, the main debate is how much pent-up demand is out there. Many are hungry to get out, others remain cautious. Trying to guess human behavior after this year is a fool’s errand. We will watch how things unfold rather than trying to guess.

The direction of interest rates has been the focus of investors over the past month as rates on the 10-year bond is now at the highest level in over a year. However, looking back at the 10-year yield, rates have been in a range between 1.50% and 3% since mid-2011. Before collapsing to under 0.60% last summer, the yield on 10-year bonds was near 2%. The concern today is that inflation is going to spike, and the Fed will have to step in to raise rates. The Fed has stepped in early, anticipating the inflation that never came. Today, they want to see inflation before beginning to tighten rates. They should be on the sidelines until sometime in 2022.

The battle between growth and value continues to rage during March and has been dependent upon the direction of interest rates. When rates rise, growth stocks falter. When rates ease, growth races higher. Growth stocks are all about future expectations for earnings that get discounted back to a price today. As rates increase, that discount rate also increases, pushing today’s value lower. More cyclical stocks that are tied to economic growth benefit from a better economy. They tend to be very leveraged to economic growth, doing very well as the economy recovers and booms, and collapsing when the economy hits a recession. We have been concerned that growth stocks have “discounted” every possible bit of good news in their price, so any change could mean much lower prices if those expectations are not met. While not necessarily as egregiously priced as the tech bubble in 2000, many growth stocks are still priced for perfection and could fall dramatically if those expectations are not met. Meanwhile, little is expected of the consumer related stocks in the face of the pandemic. As the economy opens, many will do very well as consumers return and spend money. That rotation from growth to value is likely to continue in the weeks/months ahead as people start to feel better about mingling with others.

Interest rates are likely to continue to rise as economic growth should also rise dramatically over the summer months. While that growth may be temporary, investors will still fret about potentially higher inflation and a Fed that may begin to tighten monetary policy and push interest rates higher still.

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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