Investing
Perform a simple google search and you can come up with no fewer than a dozen definitions on investing – each with parallels to the other, but with slight variations in specifics. At its core it’s the idea of making some form of a commitment (money, time, energy…) today with the expectation of getting an undefined positive payout in the future. It’s easy to lose sight of such a simple premise when things aren’t going your way. The Treasury market is enduring its largest bear market in history, commodity markets outside of gold are weak, and stocks have been in a relentless sell off since the end of July. Let this serve as a reminder that as fun as that period was back in late-2020 / early-2021 when asset prices did nothing but go up, that was the anomaly, not the norm. The key to investing success over the long-term is being able to navigate both the good times and the bad times. Not with surgical precision, but enough humility, prudence, and discipline to not allow your emotions to get the best of you at the least optimal points.
Controlling one’s emotions is likely more difficult today than it’s ever been given this era of information overload where every price tick is accessible at one’s fingertips. Every wiggle, rally, or sell-off is sensationalized to pull on one’s emotions. Be mindful of this – I’m not saying one should ignore emotions, they can be useful, but they can also be very detrimental to your long-term investing success. I intentionally started off this week’s missive with this pep talk because of the ongoing correction in all assets (except gold). Last week the S&P 500 and Nasdaq slipped 10% below their July highs with the Dow down about 9%. All three major averages have broken below key technical levels and the wall of worry confronting stocks at this moment looks quite daunting. The roughly 90 basis point rise in 10-yr Treasury yields since July has been relentless, financing rates are at their highest levels in a decade and a half, we have wars ongoing in two key regions of the world, geopolitical tension is high among major trading partners, inflation while moderating continues to pinch pocket books, fiscal deficits seem untenable, and elected officials appear to be less capable of governing with each passing day.
Yeah, it doesn’t take much of a nudge to jump on the bear band wagon at this juncture and you know what, you’d have plenty of company. But take it from an analyst that lacked a fair degree of optimism over the last six months, I find myself less pessimistic today. How could you be more bearish on the investment opportunity set today with yields in the fixed income market between 5 – 7% for investment grade credit (double digits in some areas of the high yield market) and the S&P 500 trading around the 4,100 level with P/E down to 16.5x forward estimates and a lot of stocks beaten up much more than the 10% slide in the major averages.
I see more opportunity today than was the case six months ago, and I suspect these opportunities might be even better over the next six months as the investment backdrop gets even more challenging. For someone interested in long-term investing success, these are the moments you look forward to. It’s by no means a back up the truck moment, but it is a time to turn over some rocks and think about an investment time horizon with a payoff period that extends beyond one’s nose. Without question things can get worse from here and while those 5% yields on short-term debt instruments are great today – they won’t be there tomorrow if/when things get worse. They’ll likely be much lower, and you may wish that you chose to take on some risk when the opportunity presented itself because being generally right rather than precisely wrong is an acceptable outcome.
Don’t get me wrong, I’m far from a raging bull and our work continues to suggest caution, but on a shorter-term basis we are nearing a point where things have been overdone to the downside:
As of Friday’s close, merely 23% of the S&P 500 was trading above their respective 200-day moving averages – marking the lowest reading in 2023 and a level in the 9th percentile over the last decade.
The Russell 2000 is down 33% from its lifetime peak seen in November 2021. It is at the same level it was in February 2020 – so it’s erased all its post-pandemic gains.
The internals within the equity market are awful with declining stocks outnumbering advancers by a three-to-one ratio on the NYSE to close out last week.
The number of stocks at 52-week lows is absolutely crushing the number of new highs.
The NAAIM Exposure Index has fallen to 24.82 from just over 100 at the end of July and its now approaching levels last seen at the October 2022 lows.
Investor sentiment via the various sentiment gauges has made a decisive turn to the bear camp. In the latest AAII Survey bullish sentiment, expectations that stock prices will rise over the next six months, decreased 4.8 percentage points to 29.3%. Optimism is below its historical average of 37.5% for the sixth time in seven weeks. Bearish sentiment, expectations that stock prices will fall over the next six months, increased 8.6 percentage points to 43.2%. Pessimism is now at an unusually high level and is above its historical average of 31.0% for the sixth time in eight weeks.
Lastly, the tightening in the GS financial conditions index since August has been equivalent to about 75 basis points of Fed hikes and we are approaching the point of peak restraint from last October. This to me suggests that the Fed doesn’t need to do more, nor should they do more if they don’t won’t to escalate the risk of ‘breaking things faster’.
Last week was another reminder that we still haven’t exited the era of ‘good news is bad news’ for markets and ‘bad news is good news’ which was a consequence of the nearly 15 years of unprecedented monetary policy support from the Fed following the GFC. We got the Q3 GDP report that ripped to +4.9% real growth and the tally for Q3 earnings season with 246 companies having reported coming in at +3.0% YoY (the first positive since the third quarter of 2022), and yet equities sold off. What was a nearly +20% year-to-date gain in the S&P 500 at the end of July has been pared to just +7% with fundamental data that has come in better than consensus expectations. Companies beating earnings estimates are not getting much of a pop with share gains average about +1% (an indication of crowd positioning in companies posting beats), whereas those missing EPS targets are getting punished to the tune of -5% on average (the norm is closer to -2.3%).
As for fixed income, I’m a buyer and it was nice to see the lengthy piece in this weekend’s Barron’s making the case for U.S. Treasuries, (It’s Time to Stop Crying About Bonds and Buy Them Instead).
The bond math just makes sense from current levels, especially if you have a view on the `economy that expects both growth and inflation to decelerate in 2024. Consider a 10-year Treasury bond with a 5% coupon and what happens to the return profile over a one-year holding period given various moves in interest rates:
For starters the 5% coupon provides you protection against another 60 basis point rise in in yields – a rise to ~5.6% in the 10-year Treasury yield would generate a 0% total return.
If 10-year yields increased to 5.5% the total return would be +1.0%. A 50 basis point decline in yields would generate a +8.5% total return.
If 10-year yields increased by +100 basis points to 6.0% the total return over a one-year holding period would be -2.6% versus a fall in yields of -100 basis points generating a total return of +12.7%.
The asymmetry given current yield levels as a starting point makes owning Treasuries with some duration exposure an enticing risk/reward opportunity in the current environment. Those interested in taking on some credit risk in addition to duration risk in the corporate credit market may be interested in the 5-6.5% yields in the investment grade space or the 9.6% yield for the FTSE High Yield Index. This yield level in the high yield space has only ever been seen one other time in the past two decades and that was during the GFC. Howard Marks, one of the most successful high credit investors of all-time, wrote about the opportunities in this area in his most recent memo – I’ve attached below a segment that I think is worth reading:
The week ahead is packed with central bank action (the Fed, Bank of England and BoJ all meet this week), quarterly bond sales plan from the U.S. Treasury Department, PMIs and unemployment releases for the Eurozone and the U.S., along with earnings releases from heavyweights like Apple. If you were inclined to pick a week to set the tone for the rest of the year, it would be this one where we’ll have the Fed meeting, the Q4 issuance schedule from the U.S. Treasury, a jobs report, and Apple earnings. Let’s see what happens and adapt from there.
The articles and opinions in "Capital Market Musings and Commentary" are for general information only, and not intended to provide specific investment advice. Performance, dividends and other figures have been obtained from sources believed reliable but have not been audited and cannot be guaranteed. Past performance does not ensure future results. Investing inherently contains risk including loss of principle. Advisory services offered through Casilio Leitch Investments, an SEC registered investment advisor.
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