I’m writing this with a gargantuan mandate in front of me. Accompanied with this update was a promise to once again make this update more concise, easier to read and to the point. For most reading this, at this stage of our relationship, you find yourself fully aware that none of the above-listed are strengths of mine. To make matters worse, this is not a normal quarterly update – but instead the outlook for the year ahead, where I will normally expand at length on all that has transpired, and our views on what may lie ahead. Still, a promise is a promise.
Most of what we have to say is not new – we’re tired of saying it, and you’re tired of hearing it. That should make it easier! But of course, there is always something new to talk about as the landscape evolves. So first, let’s take a quick dive into what we have already experienced this year…
The equity (stock) markets began the year with a seemingly insatiable thirst to move higher – a thirst that only grew greater as the year progressed, with very few interruptions along the way. Interest rates and bonds, on the other hand, proved almost schizophrenic in their behavior. What began with the hope of the glorious Federal Reserve coming back to save the day, morphed into interest rates seemingly intent on reminding the Fed that they better tread lightly. But all in all, financial markets were more than well behaved – and acted largely in accordance with what many had hoped and assumed for an election year.
The election itself – ignoring the outcome as it is not prudent to the point here – went much better than what many had feared. Instead of a drag out, lawyer riddled, riot in the streets battle between two parties refusing defeat – we instead got a surprisingly one-sided outcome, met with little resistance and virtually no claims (or evidence) of fraud. One could make the case that it was this fact – rather than the outcome itself – that led to the (now) short-lived rally in risk assets immediately following. Yet, as is very often the case, the equity markets quickly reversed course and currently sit largely where they were before election day. Interestingly, it has been interest rates that have remained stubbornly steadfast in their direction higher since we voted.
In short, stocks – and the politicians (oligarchs) who may or may not have influenced their direction – impressively defended their lofty valuations coming into the year. In fact, not only did they defend their valuations – they largely turned to us and said “you think that’s expensive?? Hold my beer…”. At the same time, interest rates rather unsuccessfully tried to chart their own direction - in the face of a myriad of head or tailwinds coming their way from the likes of the economy, the Fed or the politicians monkeying around both with deficits and the manner in which they would fund them. Finally, and thankfully, the election process itself proved stable in letting financial markets react simply to the outcome itself. That is your 2024 to date, as simply as we can describe it.
Now, we move to the more important part of this update. Mainly, a discussion of what may lie ahead for the economy and financial markets. As I mentioned in the email accompanying this update, we are intentionally sending this for your review before we talk individually. I would suspect, and almost guarantee, that each person reading from here will take something different from the data as presented.
As is always the case, we will not be making “predictions” for the year ahead. For our first broken record comment of the day – making specific predictions about what financial markets are going to do over any 12-month period is entertainment at best, very dangerous at worst. This time around, much of our discussion to follow is very intentionally designed to encourage each reader to draw their own conclusions – or at least their own point of view. And there is a very specific reason for this – which stems from the one and only conclusion we are willing to adamantly proclaim. That conclusion – which is not new, though definitely has strengthened over time– is this:
When it comes to equity (stock) markets – and to a lesser extent interest rate (bond) markets – as it stands today, the landscape remains much more suited for “gambling” than it does “investing”.
To be sure, and as mentioned many times before, we despise making the above comment. When you’ve spent your entire professional life espousing against such claims, you can understand the frustration and anger it provokes in having to say as much. I will also assure you that neither our compliance team nor the industry in which we work are particularly fond of us saying those words out loud – which is why the statement itself is as watered down as it is. And I’m going to guess that while there are quite a few reading that find themselves in agreement, it also isn’t giving anyone the “warm and fuzzies” hearing it…
Yet, and it is now time for broken record statement #2 – while that statement has a negative stigma in most people’s minds, it does not mean “doom and gloom” for one’s money. It also does not mean that the stock market is about to crash. It was “gambling” this year as well, and all is just fine! Finally, it does not mean that we should simply throw up our hands and assume there is nothing we can do. In fact, if anything, it means quite the opposite.
It does mean that we should all re-review our goals, timeframes and tolerance for risk. And importantly, it does mean that we should acknowledge the reality of the statement above when determining how we allocate our investments. Yes, we are going to call it a “reality” – rather than an “opinion” – because it is based on facts rather than projection, as we will expand on below. For more conservative investors – whether due to circumstance or by choice – this environment may remain a psychologically frustrating one for some, made more palatable by the continued availability of interest on more conservative investments. For more aggressive investors, no matter the reason for them being as much, the landscape will again prove a test of one’s resolve to weigh “FOMO” vs. the “fundamentals of investing”.
With that, let’s dive in. We shall begin our journey into what may lie ahead with a discussion around – you guessed it - valuations. Acknowledging again that you are surely as sick of hearing about them as we are of talking about them, a simple truth remains. If “valuation” – or alternatively – “an analysis of any investment’s cost vs its short and long-term earnings potential” is no longer a thing, then we can stop right here. We are then gambling, not investing. End of story. A couple of simple pictures to demonstrate where we stand today in terms of equity valuations – presented without comment:
Source: https://www.multpl.com/s-p-500-pe-ratio
Source: https://www.multpl.com/s-p-500-price-to-sales
We could go on and on, including “Uncle Warren’s” favorite market cap to GDP – or of course our own favorite, the Shiller PE. But we’ve shown it all before, and that is what I am trying to avoid here. Let’s put it this way, try as I might, I cannot find a valuation metric that shows otherwise. So, let’s all just agree that stocks are some level of “historically expensive”, and get on with it, shall we? But before we do, the most important reminder in this entire analysis for some – broken record statement #3:
Equity valuations do NOT – under any circumstances – tell us what markets are going to do in the short term. Instead, they give us clues as to what we might expect over the long-term…
If you are investing only for the coming days, weeks and months ahead – in other words you are a “trader” – the word “valuation” should never even enter your mind. Simply does not matter. However, if you are a long-term investor – or a retiree who relies on income from their investments – we would argue (as we have) that the word “valuation” trumps all else, with the exception of “risk management” for the latter group of investors.
Moving on.
I’m literally 3 weeks removed from an update for which the main thesis was that elections matter much less to markets than most want to believe. And I’m not here to argue against that now. BUT….
It is rare and rare indeed for a politician – certainly a presidential candidate – to follow through on much of what they campaigned on. But based on the current news cycle, it seems Trump has an agenda – love it or hate it – and he seemingly has every intention of following through in a manner that is catching more than a few (myself included) by surprise. With that, it at the very least bears discussion.
Mr. Trump seems hell bent on lowering taxes (especially corporate) and reducing regulation. It is tough to make an argument against those being anything but beneficial to earnings and stock prices. He also remains ever so adamant about wanting lower interest rates. As we have certainly seen by now, lower interest rates are welcomed by stocks, the economy and consumers alike. If we need rocket fuel to keep markets headed higher - even with the weight of valuations as discussed - well there you have it. Maybe…
On the other hand, his aggressive stance on so many different issues (financial or otherwise) could be a double-edged sword. As the old saying goes, the one thing markets hate more than anything is “uncertainty”. Well, his words – and now more importantly actions – do not exactly scream “status quo”. Furthermore – and completely contradicting my words in the last update – he has been talking incessantly of late about cutting government spending. God Speed Elon and Vivek! But as we will get into shortly, while common sense may want us to believe otherwise – reduced government spending is not a tailwind for stocks. Particularly when said stocks are already “priced for perfection”.
Now, I hate writing about “liquidity” – mainly because I know with certainty that I cannot define it, and I’m fairly certain no one else really can either. I might be wrong on the latter. At the same time, I am more and more convinced that “it” matters more to markets these days than just about anything else. Stanley Druckenmiller – in our view, the greatest investor of our lifetimes – talks about it often.
So I’m going to describe “liquidity” as some eclectic combination of government spending, government debt, just about anything the Fed does or doesn’t do, and maybe a hundred other things that I will not delve into here. Basically, we can think of liquidity as “how much money is floating around out there – and why…”. There is a myriad of data and analysis that might point to liquidity continuing to prop up asset prices (deficits, etc), with a similar amount possibly pointing to the opposite (interest rates, etc). But I will say this – we will be paying VERY close attention to not only government spending (deficits) going forward, as well as what J-Pow does or does not do in reaction to the assumed “fight” ahead with the new president.
Turning now to interest rates and bonds. We will first reiterate our stance from last year that the analysis of bonds is both more complicated – and arguably important – than anything related to stocks. Since investing in stocks (long-term) is supposed to be an analysis of cost vs. earnings, there is a ton of data one can use to make such determinations. Bonds, on the other hand, are almost entirely an analysis of the macro (do the MACRO – boogie, woogie, woogie) environment – and recently adding a dose of Fed/politician manipulation to boot.
On one hand, our government spending and debt has gotten so extreme it is drawing no longer so far-fetched comparisons with 3rd world countries. There is simply no economic principal that I know of – other than MMT – that says that it is sustainable. As we have stated before, it’s not the total debt number that everyone spends so much time talking about that is the problem. Politicians have been telling me literally my entire life that “our grandkids are going to pay the price for this debt”. I have seen zero evidence of this…yet.
That said, what IS different now, is the ongoing deficit – and the fact that there seems no credible way of meaningfully curbing it without touching social security and Medicare. And I will be beyond shocked if either party ever, ever touches either. It is political suicide. With that being the case, we “know” with near certainty that the growth rate on the debt will continue to explode – at the same time that the rest of the world seems increasingly uninterested in buying it. And to make matters even worse, interest rates are now forcing us to actually pay interest on all this debt – making the problem even worse. The proverbial “death spiral”…
We might view treasury bonds with the same supply/demand principles you would apply to any other asset (though it is definitely not that simple). If we “know” that there is a ton of supply coming, that should mean prices down – which means interest rates UP. Now add to that a decreasing foreign demand, and the problem gets worse. Finally, at some point, NO ONE would want to buy these bonds – as a culmination of all leads to a continued erosion of the purchasing power of the underlying asset (the dollar). If you are following along, it might lead us to assume that interest rates will be rising (and bond prices falling) significantly in the coming years. T-Bills please!
But then, what if the economy is ever actually allowed to slow again – without Fed manipulation – to clear all of the malinvestment created by Fed intervention(s) in the first place? What if the history we should actually be following is the one that says debt bubbles end with “economic chaos”? And at the same time, the stock market is then allowed to mean-revert, bringing valuations back to reality? In that scenario, (most) history might tell us that the ultimate conclusion is plummeting interest rates, along with significant declines in the economy and asset prices. See also, Japan in the 80s. Of course, such a scenario would require us to return to actual free-markets, vs. whatever it is one calls what we are doing now. But still, when you think of it this way, you’d find yourself wanting to forego all other assets and load up on government bonds with the longest duration one can find. T-Bills be damned!
Fascinating. Frustratingly complicated. Much more so than stocks in our view. But remember, unlike stocks, US Treasury bonds and the interest that they pay are fully guaranteed by the US Government. There ain’t no guarantee on (fill in the blank with your favorite tech name here) stock. So, while bonds may be more complicated in our view, the risk of “getting it wrong” is also much less dire. A win for more conservative investors in that regard. (Though inflation – which we are not tackling today – might have something to say about that)
Since we are on the topic of interest rates and bonds…
(Insert dramatic announcer voice here – in homage to Iron Mike re-entering the ring this week)
“Introducing, in the blue corner – accompanied by his merry band of minions! He and his predecessors have an unblemished record of blowing up asset bubbles, never letting markets clear, then stepping in to do it again! The Federal Reserve has on their resume all of ZIRP, QE 1-infinity, bank bailouts without repercussion, (illegally) purchasing corporate debt to again prevent market clearing, continuously failing to monitor the risk of the banks they are charged with overseeing, a second round of bank bailouts without repercussion and – most recently – claiming “success” for Americans after getting once-deemed (by them) “transitory” inflation under control, only after your cost of living rose by some 50% in only 3 years. And they’ve done all of this in just the last 30 years…
The man who was caught on hot-mic asking to “shut the f^%$ing door”. The King of the printing press. The keeper of the Oligarchy. Ladies and gentlemen, the Federal Reserve, led by Mr. Jaaaaaaaaaaaaaaaaaaaaaaaaaaaay-POW!!!!!!”
Hey, if I’m required to spend a whole weekend writing this – acknowledging that financial markets have been turned into glorified casinos – then I at the very least am allowed one paragraph to rip on the oligarchs who created as much. I thank you for obliging me as always…
Getting serious, we are not going to write 5 pages going through all of the reasons that the Federal Reserve (or oligarchs) might determine where financial markets go from here. The 36 trillion-dollar question of what happens if they cannot – or will not – sufficiently intervene “the next time” is of paramount importance. How much malinvestment is in the system that would need to be unwound? Just how much risk management has been ignored in light of never-ending Fed support and - until recently - zero interest rates? And what does it look like if/when we ever again are forced to learn the answers to those questions? You know, like a good ole fashioned end to a traditional economic cycle. Likely not good, but time will (might) tell.
The reality of all of it is that all investors – conservative or aggressive, young or retired – would all change their investment strategies if we knew with certainty the answer to the 36 trillion-dollar question above. Investors could allocate their monies based on the assumption that the Fed will always succesfully intervene. Risk management would become entirely moot. One could argue, and there of plenty of numbers to support this, that we have already reached that point with the investment community at large. And if you find yourself reading this, and thinking that you might want to take on more risk with your investments based on any of the above – then ask yourself this:
Are you investing, or are you gambling?
That might sound like a leading question, but it really is not meant to be. I am more excited about individual year-end discussions with clients than I have been in some time. The context that financial markets have provided in the past three years – one outsized “bad” and 2 outsized “good” – allows us to tackle the question above much more clearly and effectively. I will leave it at that as a teaser…
And with that, I hope that I have kept my promise of (more) concise and easy to read. But before we sign off, one interesting picture – presented without editing or comment…
If the above picture “speaks to you” in any way, I hope you will remember to share your thoughts!
With that, we want to wish you all the very best for Thanksgiving and the holidays to come. And while it might be a smidge early this year, wishing everyone an abundance of health and joy for the coming year!
And, as always, we can never thank you enough for the trust and confidence you have placed in Round Hill.
Sincerely,
The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Statements of forecast are for informational purposes and are not guaranteed to occur. Trends discussed are not guaranteed to continue in the future.
All performance referenced is historical and is no guarantee of future results. Investments mentioned may not be suitable for all investors.
Equity investing involves risk, including loss of principal. No strategy – including tactical allocation strategies - assures success or protects against loss.
Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. There is no guarantee that any investment will return to former valuation levels.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
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