Most of you can start rejoicing now, as I say this is going to be an extremely quick and to the point update. Yes, I am in one of those very rare modes where I find myself cringing at the idea of writing anything. But this time, I am fully aware of the “why” behind the above statement…
I am guessing that I am not alone in my utter exhaustion with the current news cycle – with seemingly no exit ramp from the crazy on the horizon. And in my world, the current cycle has taken the “gamification” and “manipulation” of our purportedly free-market system – which I have opined on so many times before – to a whole new level of “I can’t even believe what I am witnessing with my own eyes”. To the point where I can’t even bring myself to an outline of what I would want to update you with – never mind a coherent analysis, complete with my feeble attempt at humor that you have all hopefully come to expect. I mean honestly – how would anyone attempt to coherently analyze the clown show we have all just lived since the beginning of this year?!
At the same time, and very conversely, I feel nothing but blessed. Blessed with our family, our friends, our health and with all of you reading this. And I feel even more blessed every time I hear from one of you about weddings, grandchildren, retirements, anniversaries, travel plans and on and on. Life is such a gift! So, I hope you can understand - and please pardon my French here – that I simply don’t feel like writing about all this never-ending bullshit. Especially when there is so much good in the world to focus on instead…
But alas, duty calls. And as much as I might rant and rave, and regardless of the perceived BS level present, I truly love my job. So, now that I have that out of my system, I shall dive in – while trying to keep it somewhat light and fluffy. Markets – including stocks, bonds and commodities – have been extremely volatile in the first quarter of this year, especially with recent “geopolitical events”. How is that for light and fluffy, award-winning analysis?!
More interesting and (slightly) more useful has been the rather schizophrenic nature of the volatility. Our good friend gold might be the best example of this, and has offered a perfect example of something we have highlighted previously. Gold is often cited as one of the best “hedges” against market unrest and/or inflation. Well, we just got a healthy dose of both once the Iran situation started – and gold immediately….plummeted. This was not overly surprising to us, as one only needed to look at what our “little yellow friend” (name the movie!) had done prior to the situation with Iran. That being, it was up. A lot.
Important to remember that when volatility hits, institutions “sell what they can”. Gold almost always fits that bill – even more so when you are sitting on 100%+ gains. And sell it they did. This is not at all inconsistent with previous “crises”, which is why we always push back against the adage of “you want to own gold when things get bad”. A much better adage, in our view, is that “you want to buy gold after the drop, when things get bad”. Which is one of the things we are pondering currently. Problem is, it’s tough to tell with any level of certainty if things are “bad” or not. More on that later.
Similarly, bonds have once again been challenging popular narratives. After 30-40 years of Fed intervention (manipulation), the investing population at large has come to believe that bonds are a hedge against stocks falling. If 2022 wasn’t enough evidence that this is not always the case – with long-term treasuries down some 50% peak to trough while stocks dropped – well, rates immediately shot up (bond prices down) with stocks falling again this time around. In fact, it should be noted that the last 30-40 years are more of an anomaly than a rule to live by when it comes to the perceived, inverse relationship between stocks and bonds. There is at least as much historical evidence – if not more - of bond prices being positively correlated to stocks (move in same direction) in periods of distress, than the other way around.
I cannot, or at least should not, dive much more into the bond situation today – given my indirectly stated intention to not let this update ruin either of our good mood. But let’s just say this: If bond (interest rate) markets are truly “free”, it would make sense for interest rates to rise along with inflation expectations. And try as they might, there is no one that is going to convince us that the ongoing, oligarchal temper tantrums are not inflationary risks. But, and this is a big “but”, we also know that our deficits are growing at unsustainable clips. And these unsustainable clips are pre-war, and we haven’t even yet had a recession – either of which would likely grow said deficits anywhere between “significantly” and “drastically”. So, if one puts two and two together, it becomes unlikely that our government (never mind economy) can afford significantly higher borrowing costs (interest rates). I will let you draw your own conclusions about what the oligarchs can and/or will do about this. I assure you, there are no dumb answers to that query…
Hopefully the above provides at least a base level of the chaos that we are dealing with at the moment. And believe me, I could so very easily turn this into one of those 30+ page analyses that everyone loves so much if I so chose. But for the sake of our collective sanity – along with the light and fluffy - I will not.
Of course, this update would not be complete if I didn’t at least mention everyone’s favorite asset class – that being Mr. Stock Market. For this discussion, I will summarize a very lengthy – and heated – discussion had between the three of us last week. Firmwide rule that any of the three of us can call for a mandatory group investment discussion at any time they deem necessary. Calling for one mandates clearing of all calendars for as long as it takes to hash through the topic at hand. After a couple of days (weeks) of not being able to clear my head, I decided to call one – the topic being basically “why do we own stocks (at all) right now?” Below is an abbreviated summary of the risk/reward exercise we did during this discussion.
Risks to Stocks (1-5 years)
- Valuations (obviously – as they are supposed to be what actually matters)
- Overall Debt (consumer)
- Corporate Debt (particularly private credit)
- Deficits (government ability to pump the economy)
- Interest Rates (as they affect 2-4 above)
- Inflation (as it affects 2-5 above)
- Geopolitics
- Employment (AI + margins + propping stock prices through buybacks)
- Recession (combination of 2-8 above)
Reward Potential for Stocks (1-5 years)
- “Stonks Only Go Up” / FOMO
- Economy / government can’t afford to ever let markets clear (be “free”)
- The Stock Market IS the Economy (see 2 above)
- Trump Tweets
- The Fed
- Earnings (supposed to be what actually matters)
Again, this is an abbreviated version – especially for the “risk” section unfortunately. Now, before you go on reading the paragraphs to follow, ask yourself two questions. First, do you largely agree or disagree with the assessment above? If you disagree, carry on reading – and I’d enjoy hearing your take. But if you largely agree, then ask yourself first what seems “different” when comparing the types of risks listed, versus the types of potential reward…
Here is my answer. The risks are “real”. In other words, the risks as presented are all consistent with what one would assume a functioning free-market system reacts to. However, for the potential rewards – at least until we get to number 6 – the same cannot be said. Yes, they are all “real” in a literal sense – but most of them would be (hysterically) laughed at in terms of a functional, free-market discussion. So, when you find yourself astounded at the perceived “disconnect between stock markets and reality” – especially thinking of the last 5 to 10 years - you now have a viable explanation for that feeling. And every single time you hear me make the claim that financial markets are now “more gambling than investing” – this is precisely what I am referring to.
It should also be noted that every single one of the risks listed on there are always risk considerations for markets. What makes this particular moment so amusing, for lack of a better word, is that almost all of the risks listed are already present. In other words, we are not pondering them as potential risks down the road. They are all here and right in our faces now, and in historically elevated fashion in most cases – inexplicably coupled with some of the highest stock valuations in recorded history. Resilient is an understatement for sure!
We should also touch on the one “real” – in this case defined by “actually supposed to matter” – potential upside (reward) in our list above. That being earnings potential for US companies. It is true that earnings overall have been remarkably resilient. I will also grant the very real possibility that they continue as such, especially as AI and other technological advancements benefit margins. But here is the inconvenient truth about valuations: even if collective earnings on the S&P 500 doubled in the next year – an outcome that no serious person is even considering – stocks would still be expensive using just about any valuation metric of your choosing…even at today’s prices! In other words, we would have to have earnings growth even greater than any serious person would ever project – while stock prices did nothing – just to get back to “reasonable” (NOT “cheap”) valuations. Why would one ever want to own stocks with that backdrop, especially when coupled with all of the very real risks already present? THAT was the sentiment I could not get out of my head, and the reason for calling the “anyone, anytime, any reason” meeting of the (feeble) minds…
So, what are we doing from here? I wish I could tell you that the meeting of the (feeble) minds last week brought additional clarity – at least for the author of this piece, who was also the one seeking it. Sadly, it did not. Generally speaking, we have not “trimmed risk” in the first quarter of this year. I cannot promise with any confidence that will still be the case by the time you receive this. Interestingly, and likely contrary to what you would have expected in reading so far, we have instead added to some existing positions along the way. Which brings up another oft-cited point that deserves revisiting today:
We always must play the hand we are dealt – not the hand that we want.
Yes, as I hope I have expressed well enough here today, we remain well and fully aware of the (growing) risks that are out there. At the same time, we are well and fully aware that the market has not cared about any of them – or valuations themselves – for a very, very long time now. And the economy, likely for that very reason, has remained “strong” (depending on who you ask of course). Do I think this can persist for much longer? I do not, and if I’m being honest, I haven’t felt this “uneasy” in a while. But it is so important to note, and as you are certainly aware by now, this is not the first time I have found myself feeling this way – especially since early 2020 and the arrival of Covid.
With that in mind, even with all of the noise that came with the first quarter of this year, we are choosing to play this “new hand” not markedly different from the last – at least as of this writing. That being from a conservative stance, with sharp focus on downside exposure (risk management) – due to our perception of risk vs reward as described. Still, and importantly, we are constantly looking for opportunities that may present themselves – either in the form of perceived long-term value (our preference), or sometimes even wandering onto the casino floor and “taking a shot” (technicals). Understand, particularly for the latter, this can take the form of either adding or reducing risk exposure.
Just keep playing the hands we are dealt - until we get one that we want…
I think this is long enough for today. In closing, please do not hesitate to reach out if you find yourself concerned with the news of the day, and what it might mean for your money. Many of you have done so recently, and I always appreciate and enjoy the conversations (more than you know). And of course, as always, we can never thank you enough for the confidence you have placed in us!
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.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major indices.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
The fast price swings in commodities will result in significant volatility in investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.
Any discussion regarding gold or commodities in general is referring solely to the asset class(s) themselves – we do not directly hold physical commodities or gold.
Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through HighPoint Advisor Group, LLC, a registered investment advisor. HighPoint Advisor Group, LLC and Round Hill Wealth Management are separate entities from LPL Financial.