The Carriage House Planning Blog - Carriage House Planning: Recent Episodes
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Fingers crossed, you had a great Independence Day (and you still have all of your fingers to cross). As we move into the middle of summer, there have been a series of major events occurring, some market related, some politically inspired, that have the investment markets feeling a bit “irritable” and perhaps have you feeling a bit uncertain. I felt that now is a great time to share some thoughts, observations, and expectations.
Historically, the summer months have been slow, quiet, and otherwise boring for capital markets. Once upon a time, most of the Wall Street banks and brokerages would slow down significantly while many of their lead decision makers would leave for vacation. Yet, as with so many other aspects of our lives this has changed dramatically as a result of our increasingly networked and connected world. This is not to say that markets are as active in the summer as they are in the rest of the year, but they are NOT nearly as quiet as they once were - a fact that cannot be ignored.
We seem to have reached a perfect “goldilocks” period in which the summer months are just active enough to foster in significant, pivotal, systemic changes but there also remains just enough belief that what was always will be. For this reason, these summer events have a disproportional impact on market conditions as those who are “on vacation” see these seismic moves after the fact then scramble to react, not being “ahead of the curve” as they may have been had it been any other time of year.
We first saw this summer phenomenon really materialize in 2015 with a massive currency event that took place in August. The Chinese government devalued their currency overnight in early August (August 11) but then more than a week later, on August 18th, the S&P 500 sold off for 6 days declining more than 11% in a week.
In June of 2022, many were of the mind the markets were “healing” after a very rough start to the year. This was also the first summer that many people finally were ready to travel again. However, as many began to step away from the office, the S&P 500 suffered a 12.5% decline over 9 days in mid-June.
Even last year, we saw the first wave of the “AI Frenzy” reach a head, resulting in a multi-month selloff from late July through October.
But it is not just market declines and selloffs that have been happening during the summer months. There have also been some rather statistically anomalous events occurring in the summer. In fact, this past Thursday (07/11/2024) presented a remarkably anomalous day for markets. However, this does not come as a surprise for us, as it confirms our assessment of market conditions and our expectation for the road ahead.
Many know just how “narrow” our markets have been over the past year and a half. I wrote about this in our last newsletter which has been subsequently published as a blog post here. I likened investing in 2023 to driving a minivan down the Autobahn while watching supercars fly past at breakneck speeds. The real nature of equity market performance in 2023 and 2024 is truly remarkable. Take for example the following which shows how many stocks in the S&P 500 are outperforming the index.
Put differently, look at how many of the S&P 500 stocks are even positive for the year. Would you have guessed this knowing the S&P 500 is up more than 15% for the year?
So what should we make of all of this? While the media is more than happy to play into your fear centers with headlines about an inevitable, impending crash, the reality is likely to be far more positive than it may seem. While anything is possible, the current evidence strongly suggests a significant likelihood of what I am referring to as a “Breadth Rally” that will play out as follows (this is overly simplified, and I am happy to explore in more detail if you would like. Let me know):
- Capital is anxious to exit these highly concentrated, extremely overvalued few stocks that are now radically overpriced and living on borrowed time. As this begins to happen, it will feel like markets are starting to crash because the headline indexes that everyone watches and views as a proxy for the “market” (S&P 500, Nasdaq 100) are cap-weighted meaning their performance is disproportionately impacted by these largest companies that will be experiencing capital-flight. The question is where this capital goes. (Hint: July 11th is your a clue)
- In our opinion, rather than flee to assets and asset classes that had previously been seen as “safe” or “risk-off” (bonds, T-bills, etc.), we believe it will be repositioned in the vast array of stocks that are significantly undervalued. This includes small cap companies (with the exception of regional banks, at first), value companies (consumer durables, staples, utilities, etc), and International companies.
- This will lead to a breadth rally that will in many ways go undetected as the headline indices will appear to be falling, triggering a sentiment collapse. This may, in turn, prove to be disinflationary, thereby allowing the Federal Reserve some leeway to slowly begin cutting rates. These rate cuts will then further bolster the small cap companies as their future success depends on their having access to easy (cheap) capital, a.k.a. lower interest rates.
- It will be at this point that capital will then begin to get nervous of equity (stocks). Historically, on first rate cuts, markets rally but that rally should be sold as inevitably, the rate cuts correlate with market and economic turmoil. Also, rate cuts will lead to the bond market to look far more appealing, so capital will begin to chase this. It is at this point we believe the real risk will begin to surface in the markets.
We have no interest in trying to predict what the future will hold. Instead, our analysis suggests this to be the most likely scenario based on current conditions. This does not mean it will happen. We will be monitoring and remain more than willing to change our minds if evidence necessitates. In the meantime, we hope you are having a great summer.
Respectfully,
Casey V. Fulp, CFP®️
(The following was a letter to clients featured in our end-of-year newsletter for 2023.)
As I reflect on 2023, so much comes to mind. This year has been full of surprises, but if we are honest with ourselves, what year hasn’t been? If I had to sum up 2023 in a simple analogy, it has been like driving a minivan on the Autobahn while en route to a family vacation in Europe. Bear with me, I’ll explain what I mean.
Imagine taking a vacation with your family to see the majestic beauty of Switzerland. Let’s say this represents your long-term financial goals. Unfortunately, your original flight was canceled due to bad weather and the only option was to book a flight to Munich, Germany. This may be equivalent to the broad market declines experienced by virtually every investor in 2022. As 2023 started, you may have felt a bit behind the intended schedule and not as close to your vacation destination as you may have liked but fortunately, you landed, all of your luggage made it, and you are now behind the wheel of a minivan driving on the historic German Autobahn. You chose this specific vehicle as it aligned with your needs and was most appropriate to help you reach your final destination. It is comfortable for the long drive ahead, roomy enough for everyone and all of the luggage, and is generally quite fuel efficient. It is also well-equipped to handle the bad weather that initially delayed the start of your vacation.
However, once you exit the city limits, there is famously no longer a speed limit on the Autobahn. A once comfortable 70 to 80 mph feels like a standstill as one after another, Mercedes, BMWs, and Porsches fly by you at 130+ mph.
Normally, you would feel cool, calm, and comfortable in your vehicle, yet as these flashes of German engineering whizz past you, a sense of envy and disdain might flood your soul. Suddenly the car that otherwise checked every box on your list of needs to deliver you to your destination feels mundane and pedestrian. It would be understandable if you started to feel envious of “everyone else” around you who seems to be able to enjoy the thrill of no speed limits. Also, you might normally be vigilant, or even hesitant, driving with inclement weather all around, but in this setting, it is easy to lose sight of these dangers. You may not even consider the implications of driving at 130 mph in bad weather on roads foreign to you. It would be so easy to instead fixate on the smile that would stretch from ear to ear if you were mashing the pedal into the floorboard of a brand new BMW M3, Porsche GT3, or Mercedes SLS AMG.
By now you have likely guessed that in this analogy, the minivan is your financial plan and investment portfolio. The investment market turmoil of 2022 is akin to the flight delays, hindering you from reaching your destination as quickly as you may have hoped. Inflationary pressures, Federal Reserve monetary policy, a looming recession risk, and geopolitical instability are akin to the bad weather all around. And those cars racing past you? Those cars are the S&P 500 and Nasdaq 100 indexes. More specifically, those cars are what have been dubbed the “Magnificent 7 stocks”, or “Mag7” for short. In reality, there are hundreds of other cars plodding down the road at your same pace, but they are easy to miss with these brightly colored, high-performance land missiles fly past you at the blink of an eye. As of this writing, the Mag 7 stocks are collectively up a mind-bending 115% for the year while the equally weighted S&P 500 is only up 12% for the year. The final quarter of the year has seen the broader stock market pick up, and your portfolio has participated to a high degree in this up move, but prior to November the true “stock market” was hardly attractive. It was these 7 stocks alone doing most, if not all of the legwork.
I know this year has been challenging. Last year was rough, but it was rough for virtually everyone. This year has been tougher to endure as the headline indexes seem to have just gone up. In the context of this vacation analogy, I do not blame anyone for feeling a bit of resentment towards your minivan as those high-performance cars fly past you. However, before getting too hung up on what the kids these days are calling “FOMO”, consider the following two questions:
1. Have your needs changed?****
Much like choosing to rent the minivan for its reliability, economy, and suitability for long distances, your financial plan was crafted with specific objectives and your portfolio is managed in alignment with your overall comfort with and ability to take excess risk. Our investment discipline and process is time-tested, and designed for long-term investing. Despite the market turbulence and “bad weather”, have your fundamental needs for long-term financial success altered?
2. Was the alternative appropriate at the time?****
Envy towards high-performance vehicles or headline-grabbing investments is natural, but when considering the past, reflect on the circumstances. Just as renting a high-performance car may be impractical for a family vacation, was concentrating solely on the S&P 500 or these “Mag 7” stocks the right choice amidst the uncertainties and risks prevalent at the beginning of 2023?
Recall that our objective is to achieve your long-term financial goals while also offsetting the deleterious effects of inflation and taxation. There have been and continue to be tremendous risks surrounding the investment environment AND there are also the persistent “unknown” threats that life may throw at each of us individually, which we can never fully anticipate or forecast. When we began our financial journey together, we assessed your tolerance for risk and volatility in your portfolio while also considering the goals that need to be met.
As we began 2023, the S&P 500 had just experienced a nearly 20% loss in the year before. We had a rare consensus view from surveyed economists that a recession was “imminent” in 2023. We had a continued war in Ukraine to which the United States was idiotically throwing dollar after dollar at. By just the end of the first quarter, the supposed “total banking collapse” or at a minimum a “regional banking collapse” was kicked off by the Silicon Valley Bank failure. Soon after we were hearing whispers of the Chinese Spy balloon that was sure to catalyze a war with China by way of the Taiwan conflict. All the while, we were still experiencing inflation rates in excess of 6-8%. Oh, and don’t forget about how ChatGPT was released (followed immediately by several other LLM artificial intelligence systems) all of which were sure to “completely unhinge labor markets and take all the jobs away”. Then there were the labor strikes from Hollywood to Detroit to railroad yards to coffee shops nationwide. Finally, just as the year began to wind down, we saw significant conflict in the Middle East once again erupted. And this was almost immediately followed by a surge in the 10 year treasury yield to 5%, which many news reports suggested spelled immediate disaster (I really do loathe the news media). I certainly don’t mean to trigger PTSD in anyone rehashing just a handful of the wild conditions we faced in 2023, it is important to remember all of the “bad weather” happening around us that presents a menagerie of risk which must be accounted for in order to be prudent, but successful, long term investors.
Then again, perhaps we should forget about all of the “bad weather” for a moment. You may be thinking, “There will always be a plethora of unknown factors and events,” and I agree, so instead let’s only consider the following: As of January 2023 the S&P 500 was trading at a Price to Earnings (P/E) ratio of 23, meaning the price of the S&P 500 was 23 times that of the collective earnings of the S&P 500 companies. To put that into context, even after suffering a 20% decline in 2022, the S&P 500 was still priced 44% more expensive than its historical average P/E of 16. Sure, markets can still outperform when priced at a steep premium to the historical average, but generally speaking, it’s not too crazy to suggest that most people would not rush to purchase anything that is 44% more expensive than it has been, on average, for more than one hundred years.
Ultimately, I know the past two years have been tough. However, I also know how important it is to put two years into the context of your bigger lifetime picture. Let's keep our eyes on the destination – your long-term financial goals. The road may be bumpy at times, but your investment plan is designed to weather uncertainties and deliver you to your destination securely.
So here’s to a prosperous, happy, and healthy New Year! I am looking very forward to continuing our journey together in the years ahead.
Table of Contents:
5:56 - Discussion around recent Federal Reserve decision and economic conditions
24:37 - Review of the fixed income market and significant moves in yields
37:46 - Deep dive into the broad domestic equity markets and recent strength in commodities
An overview of the Carriage House Asset Management Portfolios (CHAMP) Master Indicator.
Few words can describe the investment markets better than "Unpredictable".
While many profess to know what the future holds, rarely, if ever, has one individual correctly predicted the future with any level of measurable consistency. However, we do find great consistency in how investors routinely fall prey to the errant prognostications of those who have convinced themselves that they are some Cassandra or Nostradamus reincarnate.
At Carriage House Planning, rather than make haphazard and unfounded decisions on guesses about the future, we instead invest using a back-tested, emotionless, and regimented discipline. When it comes to your wealth and your financial freedom, we prefer to let the guesswork and luck benefit you at the roulette wheel on that Mediterranean Cruise you included in your financial plan. When it comes to the assets in your portfolio you have worked so diligently to save, we will rely on process and discipline.
In the first episode of a new video series titled "CHAMP Principles", Casey V. Fulp, CFP®️ breaks down the Carriage House Asset Management Portfolios (CHAMP) Master Indicator and explains the role it plays in our understanding of market conditions, and how we adjust portfolios based on the signals it provides. He also touches on the recent unconfirmed "Green Light" signal we have received and how this will govern portfolio decisions ahead.
[An article from the December 2022 issue of our client newsletter, The Lantern]
Isn’t it amazing just how much kids can teach us? It’s hard to believe that once upon a time, we were all so ignorant and yet so wise. Little did we know of the world around us, but unaware, we knew so much. We knew how to learn. As children, we have to know how to learn, it’s integral to our survival. Sitting back and watching an infant in awe at the world around him is truly inspiring. Toddlers are willing to try and fail and try again, often without anyone around to encourage them. They are so thirsty for knowledge, even if it comes with a bump or a bruise at times. But any parent who knows a thing or two about child development understands how crucial this is to their child’s development. As a matter of fact, it’s possible this specific skill is one of the most critical any of us could develop, while also being one we almost all but forget - learning how to fall.
While my youngest son, James, has his mind set on keeping up with his big brother and sister, I once again have the privilege and joy of watching him learn how to walk. Now that I am a bit more seasoned as a father, I find myself far less excited by his first steps than I am by watching James teach himself how to fall. I know that sounds terrible, but bear with me.
If you have ever watched kids on a playground, or if you have kids of your own, you know that they are naturally a bit more “elastic” let’s say, than we are as adults. They bounce. By the time your birthday cake sees 30 or so candles, you have to be careful just sneezing in fear of pulling a muscle in your neck; Meanwhile, kids can jump off the monkey bars, tumble, and pop right back up as if nothing happened. Then they go do it again. Yes, we know that kids are just more “durable”, a gift from nature allowing us all to make it through childhood more or less unscathed, but there is much more to it. In addition to being durable, kids learn how to fall. Generally, nobody teaches this. They learn this on their own, often with remarkable grace.
I remember the first time my daughter, Emmie, fell hard while learning to stand and walk. I was a new dad, she was my precious little baby girl. Let’s just say I was in pieces, scared to death. While she certainly shed a few tears, I was amazed at how soon she forgot about it… or so I thought. But here’s the thing, she didn’t forget. It wasn’t but a few minutes later, she pulled herself back up, started gingerly wobbling then fell gently back onto her cushy, cute, little butt. No harm, no tears. It took one big “ouchy” for her to realize this is how it goes. From that point, she seemed to have realized, “Hmm, I guess this will be part of getting where I want to be, so I had better learn how to fall ‘the right way’, a way that limits the pain and damage.” And that is exactly what she did, that is exactly what my son Jack did, and now I watch with so much joy and excitement as James is doing the very same.
So you may be thinking to yourself, “So what? Kids learn to fall, good for them.” Right? Sure, but I don’t remark on this casually as a doting father. As is so often the case, there is an amazing lesson we can all learn from our one-year-old selves. A lesson that most of us seem to forget somewhere along the way to adulthood - most of us need to (re)learn how to fall.
Babies want to learn to walk. They realize it is needed to keep up. They also desire independence and the ability to get to wherever their curiosity takes them or to whatever curious thing they want to explore next (even if it is a cabinet with child locks, sorry kiddo). They want to walk so they can get where they want to be more efficiently and quicker than crawling. Sounds an awful lot like any investor. We seek financial independence. We invest a portion of our hard-earned dollars to get where we want to be more efficiently and quicker than by saving, alone. While two-legged mobility is a liberating superpower for a baby, financial security is a superpower for just about any person.
There are many parallels that can be drawn between a baby’s journey toward ambulation and each of our journeys toward achieving financial freedom, but there is one major difference. The baby recognizes almost immediately how important it is to learn to fall as a part of the process. The baby quickly comes to understand that falling will happen, it is a certainty, but the severity and pain involved with the fall can be minimized if done properly. And as the baby matures into a toddler, taking more steps, faster steps, adding in a skip, a hop, or a jump, the child remembers how to fall. As more risks are taken, the falls may be harder and may result in more superficial scrapes and bruises, but that is a risk most kids accept as a part of the process. It’s the only way they will ever get to ride the scooter or bike or climb the tree, whatever the next objective may be. No matter the circumstances, the child never becomes rigid. They remain flexible. They do not land like a brick. They remain limber, flexible, and elastic.
This is where we all have a lesson to re-learn. Once upon a time we all learned and remembered how falling was going to be part of the journey. It was the only way to get there, wherever “there” was. Then we forgot. As we reflect on the past year, and peer into what the year ahead may hold, so many are lamenting the state of investment markets. There is anger and unease. Blame is being cast left and right. While I could add fuel to that fire, and easily point out many guilty parties who’s decisions led us to where we are, I also recognize that no matter who did what, this is part of the journey. As a function of nature, it is nearly impossible to find an example of anything that does not require ebbs and flows, gives and takes. The important thing to focus on is how you can strategically minimize how much you give and maximize how much you can take. This is the difference between falling flat on your face or gently falling back onto your soft rear-end. Falling is a given, how you fall is not.
Just as a forest fire clears the land, enriches the soil, and allows new budding trees to take root and bask in the warm, sweet glow of the sun’s light so, too, do bear markets clear the path for new market leadership and investment opportunities. While we may likely be witnessing a significant sea change that will define the characteristics of the investment regime in the years to come, the important thing to remember is that falling is part of walking. Opportunities will once again reveal themselves, but only if we get back up and continue putting one foot in front of the other. If we lay on the ground, crying and screaming, fighting the reality that falls are part of growth, we will never take that next step. Rather than convince ourselves that we are infallible or that markets only go up, we need to remember that falling is part of the journey. Falls should not be discouraging, they are necessary. The key is falling “the right way” whenever possible, just as we have in 2022.
The following notable changes were recently announced by the Social Security Administration (SSA), the Centers for Medicare & Medicaid Services (CMS), and the Internal Revenue Service (IRS), set to take place in 2023.
What does the evidence suggest should happen in equity markets over the coming weeks and months? While we have no crystal ball, we do have some interesting signals.
As a resident of the Tampa Bay Area for almost my entire life, I often looked at cities like New York, Boston, San Fransisco, and Montreal with a sense of wonderment. These cities all boast notable sports franchises with legacy status due to the numerous titles they have won. New York has the Yanks, Boston and their triple threat of the Pats, the Red Sox, and the Bruins, San Fransisco playing home to the Giants and the 49ers, and Montreal home to the Canadiens. Sure, Tampa has a couple of victories and a heck of a Cinderella story with the Rays in 2008, but none of our teams were able to stay on or near the top for more than a year.
I would often ruminate on what the fan experience must feel like having “your team” on the top for years at a time. You are passively riding along on the hard work, commitment, effort, and talents of a group of men or women. Undoubtedly you are emotionally invested, yet have no control over the outcome (despite your most superstitious efforts). I wondered if you are really able to enjoy it, or do you constantly fear what is presumed to be inevitable. You know what they say about being numero uno: There is nowhere to go but down.
In the unlikeliest turn of events, Tampa has managed to upend its own legacy as the redheaded stepchild of professional sports cities, clinching multiples titles, all within the past 18 months!
While this has been very exciting, I no longer wonder about what the sports fan feels. I have learned that this does come with a sense of fear about when the music may stop.
I suspect a very similar concern over when the music will stop is shared by a majority of investors right now, perhaps even yourself. The recent increase in market volatility has some scrambling for the exits, while others race in for the opportunity to find vacant seats, front-and-center. In keeping with the sports analogy, the question on so many minds is, “What period, inning, or quarter is it?”
Unfortunately, there is no Megatron clock showing a clear answer. This has many questioning if they should go ahead and leave to beat the traffic jam? Or is an overtime dual likely to take place? Could the game just be starting? We could try to predict blindly based on our gut feeling, or we can evaluate the evidence available to find clues that may help us better understand the probability of outcomes as we look ahead. For example, are the players drenched in sweat, showing fatigue? Is the field or ice far less pristine than it would be at the start of a game? Are the fans around us teetering to-and-fro, slurring their words as they scream like wild banshees at the ref? If so, this evidence would suggest the game has a higher likelihood of nearing the final whistle or buzzer. However, we may see some players sucking wind, while others are fresh as a spring daisy, and the fan sitting next to you is still gingerly nursing a beer with a fresh, whole hotdog in hand. There is no certainty in the matter, but one could surmise that much more game has yet to be played, and leaving now would not be favorable.
With this analogy in mind, I believe the following clues can offer a greater understanding of the probable direction for the broad investment markets.
Economic & Political Conditions“Flations” (not to be confused with flatulence)
So, which is it? Inflation, Deflation, Reflation, or Stagflation?
These four terms are being used somewhat excessively in news media and even in regular conversations between average Americans, but to little effect. A general misunderstanding of these terms exists, perpetuated by pundits and newspaper opinion articles that overcomplicate these concepts, manipulating their definitions to support the point they are trying to make. Instead, let’s just plainly define them for what they are:
- Inflation: Too much money chasing too little goods/services/products. Results in price increases.
- Deflation: Too many goods/services/products, but not enough money to buy them. Results in price decreases.
- Reflation: Fiscal (Congress) or Monetary (Central Bank) policies used to combat pressures or threat of Deflation.
- Stagflation: Slow or no economic growth, high unemployment, and Inflation all at the same time. (This one didn’t even exist until after the 1970s. Prior to that, economists insisted there was no way to have inflation and high unemployment at the same time, but then it did happen).
The Federal Reserve has been fairly assertive in its stance that inflation is transitory, or temporary, as a result of the pandemic-inspired government shutdown of economic activity. This belief has informed their decision to maintain artificially suppressed lending rates, as well as steadily increasing their balance sheet with an array of asset purchases, thereby “stimulating” the economy. The Federal Reserve has been in the Reflation camp for more than a year now, however, their tune has been changing month by month as they are finally realizing that Deflation was never the enemy on the battlefield. As you might imagine, when entire economies have been forced to shudder, there is not an excess of goods/services/products being manufactured. Simultaneously, when the Fed+Treasury is printing money and sending checks to Americans in exchange for zero economic output, there is little risk of there being too little money chasing too many products.
While the Federal Reserve has the loudest voice in shaping the “Flation” conversation, the astute American deafens their ear to the “assurances” coming from the Fed, focusing instead on the reality they live in every day. Doing so allows one to determine which “Flation” pressure is really at play. Then, adjustments can be made in financial planning assumptions and in portfolio decisions that are rooted in empirical evidence and truth, rather than the empty words of central bankers who have checkered pasts, at best.
We know that food and gas prices are higher now than they have been in recent memory, but these are not considered in the official calculation of inflation. However, one inarguable factor that ultimately impacts the cost of almost any good is shipping container rates. Shipping container rates remain at historical highs. While not directly indicative of anything, it is a great bellwether for how international trade has been, is, and will continue to be impacted by supply chain disruptions. Supply chain breakdowns, alone, (especially on a global scale) will stimulate inflation. Usually, they occur in a specific region of the globe, so broader inflationary pressures are not a concern, however, this is not the case in our current environment. The more reliance a country has on importing goods/services (raw or final), the more these inflationary pressures will impact that nation. The United States happens to be a country highly dependent on imports.
Additionally, it is worth looking at the current state of Consumer Price Indices (CPI). Below, we can see the aggressive ascent in the Consumer Price Index for all Urban Consumers in both all items EXCLUDING food and energy, as well as the cost of food. The bars at the bottom of each reflect the 21-week rate of change. So not only are these consumer prices going up, but they are going up by a greater degree each week.
Conclusion: 🛑 Extreme caution is warranted. At first inflationary conditions act as a tailwind to equity markets; However, this honeymoon period is typically less than 12 months, at which point selling pressures mount on fears of future cost increases. This can paralyze production and therefore future earnings begin to suffer. Generally, this type of environment is negative for markets over the forthcoming 12 months.
The Politicization of Health to Win Votes
Unfortunately, it has become apparent that a new trend is emerging in the politicization of Public Health. While not entirely new, the general bifurcation along party lines of public health policy has advanced drastically over the past few years in lockstep with the general polarization of many aspects of daily life. I’m old enough to remember when “Anti-Vaxxers” were earthy, hippy-dippy, “fight the man” progressives. Yet nowadays, this pejorative is pointed at anyone who does not have complete, unquestioning faith in unelected government officials, corporations with clear incentive models, or The Science™️. It also happens that these same people, regardless of their individual beliefs, are assumed to be a member of one specific political party. The line is thus drawn, and the politicians know it. Not only a shame, but this development has created a new risk on the economic spectrum.
Policymakers are incentivized by two major forces:
- Votes
- Lobbyists (a.k.a. The Creatures from the Dark Lagoon)
By drawing a party-line down the middle of public health, a direct conflict emerges: The focus is no longer on the health of the public and the policies that achieve this goal in the most appropriate and constitutional manner; Rather, the focus immediately shifts to determining the most effective means for achieving the votes of the next election cycle. The government has used the “You must fear this great health threat, but vote for us and we will make it better” to great effect while further diminishing the American Individuals’ right to assess risk/reward paradigms and make decisions for him/herself and that of their loved ones. This trend does not seem to be slowing, especially with mid-term elections soon to be forced into the public psyche.
This presents risks to markets and economic conditions as another government-mandated closure of businesses they decide are not “essential” remains a looming threat. While not directly impactful to some segments of the market (whichever the current government’s decision-makers deem “essential”), the economy as a whole will not likely weather another storm of this nature without catastrophic consequence. The potential impacts of this risk need to be accounted for as we look toward the future. Investing internationally as a hedge against domestic political risks presents one way to mitigate this threat.
Conclusion: ⚠️ A cautious and watchful eye should be trained on COVID-related policy decisions. Pfizer and Moderna are more than happy to see politicians scaring the pants off citizens, insisting they get a vaccine that remains in Emergency Use Authorization (EUA) status, technically not officially approved by the FDA for use. This has and will benefit their revenues, but generally, this uncertainty in future policymaking will be a burden on most companies. Some are choosing to mandate vaccination while others are not. This will lead to continued divergences, defining clear winners and clear losers. In other words, so long as this public health issue remains so politicized, there is no rising tide lifting all boats as we saw from March ’20 to April ’21. The tide will ebb and flow, without much rhyme or reason and will likely prove difficult to predict. Markets care much less about whether things are good or bad. Markets care if things are getting better or worse. Uncertainty is the market’s worst enemy.
Market ConditionsBreadth in a Funnel
When volatility in the major indices begins to appear as it did in July, we want to look at conditions like breadth to understand whether the ups and downs are being experienced by all stocks large and small, growth and value, or if the ups and downs are characteristic of some while not of others. In the case of the past month, the new highs reached by the S&P 500 and Nasdaq 100 can both be attributed to a small list of companies - those pesky big tech companies we have all been paying attention to for the past few years.
Monitoring indicators like the NYSE HiLo indicator and the NYSE Advance/Decline ratio evidence suggests the resilience experienced by the major indices has not been shared by the majority of stocks. Instead, it has been isolated to the largest companies, most of which are tech-focused.
Another way to visualize this is to look at the S&P 500 stocks trading above their 50-day moving average and 200-day moving averages. We know the S&P 500, itself is trading above these averages as it has recently reached new all-time highs, but how many of its constituents are sharing in that recent success? The chart below shows only 60% of the stocks in the S&P 500 are trading above their 50-day moving average while 86% remain priced above their 200-day moving average.
Conclusion: ⚠️ While this does not directly suggest anything positive or negative, it is generally less constructive to have a few stocks pulling the whole market. We did see this occur in the months following the shutdowns, as the big tech names lead the market up from the selling in March 2020, but this was bolstered by companies getting back to work as restrictions were lifted. We are now in a different environment, suggesting this lack of breadth is less than positive.
Historically Speaking: Market Strength Builds on Market Strength
On a more positive note as of July 30th, the S&P 500 has experienced six consecutive positive months. A study conducted by LPL Financial looked at the S&P’s performance following at least 6 positive consecutive months and the results are surprisingly positive. With the exception of a few negative periods, the subsequent 1, 3, 6, and 12 month periods are overwhelmingly positive.
While I do see this as a positive, the lawyers would not be happy if I failed to remind you that past performance is in no way indicative of future returns. I’d also like to bring your attention to the period outlined in yellow. Note that this period has the most significant negative performance in the subsequent 12 months following the period of strength. This is a notable period (especially for those who remember in the early ’80s) as this is when Fed Chair Paul Volkert was tasked with “breaking the back of inflation”. Hyperinflation had roiled global markets and extreme monetary tightening (raising the Federal Funds rate) was deemed necessary to pump the brakes. Not only did this set the stage for the longest bond bull market in history, but it also showed the negative impact of inflation when it overheats. It can be positive at first, but if it gets out of hand, hard choices have to be made, which may result in lending rates in the teens as well as less than desirable performance in the S&P. While not a certainty, this risk does exist and is being accounted for.
Conclusion: ✅ Generally positive, with the asterisk of inflation and monetary policy decision making.
Similarities between Chinese Markets and the Chinese Flag - Both are Red
Chinese markets have experienced bouts of selling over the past few weeks. After being up almost 6% for the year in February, the Shanghai Composite Index (SSE) has suffered a series of aggressive sell-offs now down for the year by a little over 1%. Most recently, the index declined by more than 6% over the course of 4 trading days in July. This weakness and volatility in Chinese markets presents a risk of catalyzing broader global selling as witnessed in 2015 and 2016. The following shows the extreme selling in the Shanghai Composite Index (red line) that started in June of 2015, followed shortly after by significant selling in the S&P 500 (blue line).
SPX & SSE 2015-2016
If we look at a comparison of the same two indices in the current market, we can see the aforementioned selling in the Chinese markets, however, our leading domestic index has not followed in its footsteps. A primary factor in the 2015-2016 selling had to do with a currency war, of sorts, waged by the Chinese on the US and other global market players. While this theme is not present on the surface, there are rumblings of speculation that such risks may present themselves.
SPX & SSE 2021
Conclusion: ⚠️ Weakness in Chinese stocks is a headwind for global markets and should be watched closely. The Chinese government has a history of intervening aggressively when volatile conditions persist. Emerging market funds will be most impacted and should therefore be analyzed closely for exposure to high-risk regions. Conditions are improving, however, recent reports of Coronavirus in major Chinese cities may further impact any recovery in their markets.
So, what period, inning, or quarter is it anyway?I’ll admit, I may have buried the lead a little. From the start, I have supplanted the idea that we should focus our attention on how long we might have left in the game but the truth is, this question is of little consequence. The real question that should matter to investors is how far along are we in the season? Games matter very little in the grand scheme for investors. Losses last only as long as the period between games UNLESS that loss comes at the end of the season or in the playoffs. I would liken the end of a season and the ensuing off-season to be equivalent to a 2008-2009 market, or even a February-March 2021 (a significantly short off-season, much like that of the Tampa Bay Lighting this past year).
At this point, there is little evidence to suggest we are at the end of the season or in the playoffs. There is, however, a good chance we will see a loss or two, maybe even a small losing streak over the coming months. The conditions we have discussed here, in addition to several others, present us with the reality that upside resistance is much stronger than downside support. That being said, one of the best qualities a market can exhibit after ascending for a prolonged period of time is a sideways consolidation - basically, if markets go up and down a little here and there, but don’t make any big moves in either direction, this can be very positive.
At this point, it would be prudent for investors to consider paring down some of their portfolio risk, but not advisable to exit markets entirely. Now that we are in August, major tax law legislation is not likely to be passed this year, so some capital gain harvesting could be in order. Additionally, with the Federal Reserve resuming their annual in-person meeting in Jackson Hole, WY later this month, we could see messaging emerge that proves volatile to short-term markets, yet bullish and far more sound for long-term economic conditions.
Wishing you happiness and prosperity,
Casey V. Fulp, CFP®️
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