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"Don't Believe the Hype?"

"Don't Believe the Hype?"

| June 06, 2023

Where are my fellow Public Enemy fans?  I sit here with one eye on the computer monitor in front of me, the other looking out the window at what is certainly the most gorgeous weather we are going to get all year.  Sun is out and not a cloud in the sky.  Temperatures in the upper 70s, without a trace of any real humidity.  I can think of no better weather for everyone to enjoy….another long-winded update from me about financial markets!

Nah, I wouldn’t do that to you – at least the long-winded part.  Partly due to the weather – and much more so due to some combination of popular demand/me not having much new to say (you might have noticed the lack of a 1Q update) – I’m going to keep this one brief, non-technical and to the point for everyone.  You will note that while I often begin these updates by promising as much, I dropped the word “try” from this one.

Slightly new format this time.  I’m going to propose various questions which we have been asked the most this year – as well as a few that I think should be asked – and simply give you my answers.  A question and answer of sorts, with me guessing at the preferred questions.  And off we go….

“What has changed since your last update?”

Not much, yet a lot – both at the same time.  Though that answer might be overly unsatisfying, even for the brevity warriors amongst you.  The biggest change that one might recognize is that we’ve had a rather pronounced reversal of what worked last year – largely not in our favor in terms of positioning, unfortunately.  Still, I’m happy to report that my blood pressure remains in better shape than the last time I wrote to you…

In short, it’s been the tech/growth/high-multiple stuff that has been rising (significantly in many cases) – while “value”, commodity-related (ex-gold) and many other sectors/strategies have lagged.  In fact, as of last week, the S&P 500 was up around 8% YTD.  But, if you had removed just 3 stocks from the index (which I will not mention for compliance purposes), said gains disappear almost entirely.  It should be noted, this is not traditionally associated with “healthy” markets – historically, we do not want to see a market being led by only a few names when hoping for sustained upside.

While we view that as the biggest change from our last update, there are a few other headlines that I am sure you have all seen in some form – each of which I will tackle separately below.  But the most interesting to us is that “long growth, long duration”, which was hit so hard in 2022, has come back in favor so far this year – though it still has quite a hill to climb to get back above water.  The question, of course, remains the same.  Is this short-term shift the real thing, or is it yet another head-fake along the way – designed to suck as many back in as possible before resuming its downward trend?  We still lean mostly toward the latter, but continue to look for evidence suggesting otherwise…

“What is going on with the banks – are they safe?”

Sent an e-mail out to clients on this already, so won’t spend a ton of time again here.  And breaking down the mechanics of what has caused the problems for smaller banks would cause me to violate my brevity promise.  I will just say this – it’s hard to discern fact from fiction when it comes to what the banks themselves say, or even those whose job it is to regulate them.  As such, I cannot answer that question with much confidence – and I remain fairly convinced that very few others (if any) can either.  That said, there is a difference between the safety of the banks themselves vs. the safety of your deposits with them.  I’m much more confident in the latter – mainly because the politicians in charge have told us as much, and even more so because everyone knows what carnage would result if millions of Americans were losing their deposits at the banks. 

In summary, I wouldn’t lose sleep over it…

“What is all this A.I. stuff I keep hearing about?”

First, A.I. = artificial intelligence.  We are not referring to alien life forms here, but rather the technology.  And I think many of you might be surprised with my answer.  While you by now have certainly grown accustomed to my somewhat skeptical view of “manias”, this is actually not one of them.  I happen to believe that A.I. has the potential to change the world as we know it, similar to the way the internet has.  In fact, we had listed A.I. in long-ago updates as one of the few “tailwinds” for stocks and the economy moving forward.  Does it scare me?  Yes, because I largely don’t trust the humans that will be in control of it.  Do I understand it?  Somewhat, though many of you tech-savvy readers likely understand it better than I do.

But you would be asking me this question from an investment standpoint, rather than a humanitarian one.  My guess is that there is going to be a ton of money made in and around the space in the years ahead.  Still, think through this with me for a moment.  Everyone remember the tech bubble which ultimately burst in 2000?  There is a reason it’s commonly referred to as the “dot com bubble”.  Investors started mindlessly throwing money at any stock that had anything to do with this “new internet thing”.  The “real” companies (ones with actual earnings) ended up with nosebleed valuations.  And then there were dozens if not hundreds of “new companies” – with no earnings or even business models in some cases – that also got bid to the moon.

What happened in the end?  Many (if not most) of the “new names” ultimately ended at zero.  The S&P itself – which contained all of the “real” companies - dropped over 50% from peak to trough.  This was because valuations (price of their stocks relative to the underlying earnings of the companies) in the tech space got way ahead of themselves in the mania.  Yet, we all now know that all of the hype over this “new internet thing” was definitely real – it completely changed the world as we know it.  And a lot of money has been made since.

In an instance of perfect timing, one of the three main beneficiaries of the A.I. craze this year (again will remain nameless) is up over 25% this morning after reporting earnings and providing forecasts.  This stock was already trading at 175x earnings before this move.  This is one of the examples I was referencing in our last update, comparing today with the environments we saw in different time periods before.  I’m not saying the analogy (in this case with the dot com era) fits perfect with today – they never do. That said, it sure as heck rhymes. 

So, while I do think there is going to be a lot of money to be made, I’m much less certain on the timing.  It feels awfully frothy out there from our view.  But stay tuned for sure…

“Biden/Republicans (or Trump - take your pick) are going to make us default on our debt!  Shouldn’t I be worried?”

On my currently long list of things to worry about while managing your money, this ranks at or near the bottom.  I’d say the risk of a “short-term circus” is large, while the risk of any “long-term consequence” is almost non-existent.  Even if they do not come to an agreement, and the treasury misses any interest/principal payments on treasury securities as a result, the chances of any real, long-term effects are minimal at best in our view.  The way we see it, the most likely scenario by far is that any investors in affected treasury securities would be made whole (both principal and interest) in very short-order as they come to an agreement.

Now, could it lead to short-term chaos and volatility in markets?  Sure.  But so could the dozens of other concerns I have previously laid out that rank much higher on my list of “real risks”.  As such, I would suggest losing zero sleep over this either, but view it instead as just another reason to err on the side of caution when it comes to one’s risk exposure.

“Anything else?”

Not really.  The summary through the first half of 2023 is hardly different than the outlook coming into the year.  I’m still in the camp that the most likely scenario moving forward is either a 70s style, volatile yet rangebound market with interest rates and inflation remaining elevated – or the economy and markets coming to a screeching halt quickly under the weight of the now much higher interest rates.  Either scenario presents both challenges and opportunities. 

The former allows for higher interest rates for longer – a huge benefit for most of you.  At the same time, it could mean an exhausting and frustratingly long experience for those more inclined to speculate (we are not those).  The latter comes with the fear and anxiety around an economy in free-fall – as well as the 5% interest we now enjoy on our treasury bills likely headed back to near-zero in response.  Yet this scenario would also most likely create an opportunity to - dare I say it - finally own growth assets at reasonable valuations for the long-term.

The scenario we continue to view as the least likely – though never impossible – is that the first 5 months of this year have been the beginning of a new bull market in stocks, and that we are headed to fresh and sustained all-time highs from here.  And the reasoning behind that statement hasn’t changed from the 27-page outlook we provided at the end of last year.  Again, it’s always possible – and I wish I had that ever-elusive crystal ball.

But if we are right, and while it might not sound as such, we are very comfortable (though somewhat frustrated at this very moment) with the environment as it currently stands.  On one hand, having 5% interest on short-term treasury securities – exempt from state income taxes to boot – is continued music to our ears, as it should be to yours.  On the other, if the proverbial “bottom falls out” of markets, it will create long-term opportunities that haven’t presented themselves in what feels like forever – even though those newfound and glorious interest rates likely disappear in the process.

The best, best-case scenario – unfortunately also one we find unlikely – is that stocks again become cheap because interest rates stay elevated.  That’s the best of both worlds from a long-term investor’s standpoint – assuming one has properly managed their risk upfront – as both stocks and bonds become attractive long-term investments simultaneously.  Basically, the exact opposite of what we experienced in the past 10 years or so.  And, just like my comment on the “new bull market scenario” – while we view it as unlikely, it is certainly not impossible.  Fingers crossed in this case!

So, I think I actually accomplished my stated goal for once.  Four pages, no charts, simply stated, and (hopefully) easy to read.  If not, or if you are one of the few who prefer the longer and more technical versions of these updates – please reach out

Otherwise, happy summer!  And, as always, we can never thank you enough for the trust and confidence you have placed in us.



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