Chris Hyzy: This is Chris Hyzy, Chief Investment Officer, for the market update for October 3rd. Closing the quarter and stepping back, we’ve had one of the worst performing quarters in years and three straight down quarters of the S&P 500 for the first time since 2009. A diversified portfolio of say 60% stocks, 40% fixed income also having one of its worst periods to begin a year since data has been available according to Bloomberg since about the 1970s. Volatility as measured by the Chicago Board of Options Exchange, VIX Index, is now around 30. It’s been there hovering around that level for about six straight days but has yet to spike, believe it or not, to levels last seen in early part of 2022, in March of ‘22 to be exact, of around 35. Investor sentiment as measured by the American Association of Individual Investors’ weekly survey published last week indicated the weakest sentiment in many decades as well, but sentiment needs a visible catalyst to turn for the better. So, what is this catalyst? In our opinion, this catalyst first and foremost starts with visibly declining inflation, particularly in the preferred gauge that the Fed looks at which is the core personal consumption expenditure still elevated and has yet to visibly show a declining trend for at least three straight months. It’s coming down, but the Fed would like it to come down sharper. Number two, for us, it’s also the realization by the Fed that declining money growth, money supply that is, is causing a stronger dollar, financial pressures overseas as highlighted recently in the United Kingdom, and less liquidity in the treasury market overall which could create potentially more financial pressure. We expect volatility to remain elevated in the coming weeks, if not months. A wall of worry to remain overall as we close out this year, but we also expect bouts of rallies between now and year end. We also believe overall that we are in the process in which yields, at least longer dated yields, are actually peaking. Again, this is a process - a process of bottoming in the equity markets and risk assets overall and a process in which longer dated yields begin to peak. It’s also a process - one more time - that inflation ultimately visibly shows its real trend, which we believe is downward also in the coming months. Positioning for a peak in yields and stability in equities as the fed’s tone potentially changes in the next few months makes sense in our view overall. Have a plan ready. Be ready to rebalance in the coming months. That’ll do it for today. Thanks for listening.
Operator: Please see important disclosures provided on this page.
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Chris Hyzy: Thanks, everyone, for joining this week’s Street Talk Call for September 29th. If I had to think of a few words to describe the most recent market action - and I would even go as far as saying financial action if you consider what's been going on around the globe - it would be a few. It seems like the path of least resistance is down if you had to come up with a statement, but if you had to come up with one word, I would say outliers. The reason is many fold and we'll get into that in just a minute, but I first want to start off with from the top - the cycle. One of the reasons why there are so many outliers literally in this one year alone, in these nine months of 2022, has everything in my opinion - or at least a lot - to do with how where we came from. This is not a normal cycle. Normal cycles do not include the size of the expansion of the balance sheet and normal cycles do not include 40-year high inflation. They do not include situations where central banks around the world together are tightening aggressively to un-anchor the high inflation and re-anchor lower inflation. In some cases we've seen this story before, but it didn't come during a pandemic, at least didn't come even after a pandemic. There has been an extraordinary movement in the last two to three years as it relates to this cycle overall. What was built up in the cycle not just from a monetary policy perspective or a fiscal policy perspective, but think of the consumer spending dynamics that occurred, think of the job market, think of everything that has been altered in the last two plus given three years, and even before pre-pandemic we saw societal changes that were impacting how growth was produced or not around the world even in the United States. A lot of that had to do with things like supply chains, real time inventory, shifting to other types of operating efficiencies, and then ultimately we were in limbo as it relates to capex, capital expenditures, trying to increase productivity. There are labor supply issues and the pool of labor continues to be low relative to what is needed out in the corporate marketplace. So, from our perspective in the Chief Investment Office, one of the reasons why there are many head scratching elements day to day, week to week given this retest and reset period has a lot to do with how we got here and the fact that this cycle we call The Post Pandemic Cycle is producing a reset period largely speaking, half - if a little bit more than half - done. We have long said that this reset period is six to nine months. Why is it six to nine months? Because traditionally, reset periods are three to six months as it relates to valuation and then the earnings thereafter and then ultimately, you can tip into a recession or not and that ultimately determines how far earnings goes. This time around there's a lot of debate as to type of recession, mild versus hard, when's it going to happen? What drives us there? Ultimately, how quickly could we pick ourselves back up from that? Markets are extremely volatile right now, and not just in risk assets, but also in bonds. I want to highlight a few things that we've seen recently. First and foremost, six down days in a row before yesterday. A handful of times this has happened since the 1950s. Traditionally, according to Bloomberg data and the data that we've examined, the next 12 months after this has happened has, on average, been positive developments in equities. In other words, a positive performance year, the 12 months after six down days have occurred since the 1950s. That is not a catalyst to all of a sudden warm up to being overweight equities in our opinion, but it's certainly something to point to as to sentiment. Another thing about sentiment is this - according to the American Association of Individual Investors Weekly Survey, you can argue that we are now sitting on the foot bed of the highest number of bear percentages ever and the difference between bulls and bears has dropped down to a next low that we saw back in the first quarter of 2009. So, sentiment is very, very poor. Even if you look at technicals on a shorter-term basis, you're also witnessing that but again, these are not tailwinds all of a sudden or catalyst to turn the market. The market needs an oasis. We’ll get into that in a second. As it relates to where we stand right now, we're on guard. We’re defensive. We think there are equal risks to the downside and upside when you're broadly speaking about the markets, and that's because nobody knows the exact bell that's going to ring when the Federal Reserve ultimately says, “We're done.” We can point to a number of gauges, and there's widely sought after gauges out there whether it's inflation, whether it's the bond market, in some cases valuation readings in the equity markets, real yields, the dollar, leading economic indicators, purchasing managers indices. There's a number of indicators that you could point to to ultimately say when are we at the end of the reset period and still looming over all this is whether or not you dip into a harder than expected recession. So, let's start with what we know. Right now, yields have gone from what we would consider to be deeply negative real yields to attractively positive real yields in one of the sharpest, quickest amount of times ever. That magnitude is right at the top of one of our outlier lists. A lot of this has to do with the hawkishness by the Fed and other central banks, but it also has to do with the quick and balance sheet removal that has now begun as it relates to what the Federal Reserve is doing. So overall, if you put that at the top of your list, the magnitude and change of negative real yields to positive real yields. Number two is the strength of the dollar. The dollar relative to the pound is at a record low, Pound Sterling at a record low to the dollar give or take. Same thing with the offshore China’s yuan and the yen relative to the dollar is at a 2.5 decade low. When you get bond market volatility in the magnitude of switch from negative real yields to positive real yields and you get a huge move in what we have witnessed in the two-year yield which tracks the expectations of the Federal Reserve, you can get currency instability and that's what we're using right now, currency instability. We saw that over the last couple of well 48 hours or so. The Bank of England stepped in and what they did was they looked away from inflation instability and they started to think about financial stability. That is a major switch and when you do that, that is a flare gun that goes up to investors around the world that says, “Who is next to do that?” So, we'll talk about that in just a second but the Bank of England, another outlier, stepped in during high inflation and actually bought bonds to stabilize the bond market. A lot of reasons for that, but the biggest change has been that reversal of removing assets from the balance sheet. They had to add them to create stability in the bond market. What is the contagion around that? It's a stronger dollar and it's further real yields in the United States. Let's move over to another outlier. Let's take a look overall at the quick move down in valuations. Not a big outlier, it's a small outlier, but we've gone from you could argue 22 times, in some cases down to about 17 times trailing, and is there more room to go as it relates to down to 16 which is traditionally an average multiple over many decades? In our belief, yes, but having said all that, that would also dovetail with slight drift higher and yields which we also expect. Then at that point, 16 times on a trailing basis, we believe the market gets to what we would say is fair value with the laundry list of concerns that are still out there. That's generally because markets around the turn of the year, at least in our belief or early in the first quarter, we believe investors and markets in general will begin to discount the Fed’s next move and that's where we get into a few things here that I want to mention. Some of the outliers first are an extended war in Ukraine and energy squeeze in Europe, which happens to be a little bit better right now than expected if the winter is not colder than expected. Then another outlier that we haven't mentioned recently is what is going on in the initial public offering market. We haven't seen this dry of an IPO market since the onset really of the 2000s. So overall, two-year yields. Another outlier at 2007 levels 15 years ago and last but not least, what we're now starting to see across the board is what commodities are telling us. This brings me to my next point. What is inflation’s next move? There’s an over focus on every data point. It's one of the reasons why the market is down today on September 29th and removing some of the large gains that happened yesterday is due to the personal consumption expenditure reading, CPI, and other inflation gauges that are suggesting that perhaps inflation is not coming down. We think differently. We have to think forward. Commodities are way down from not only their peaks or median levels of the year across the board including oil. Gold prices are down. Gold prices in our opinion wouldn't be down as much as they are if inflation wasn't about to come down. Again, real yields went from negative to positive. That is doing its job. The housing market is now turning and going the other way. Yes, some aspects of housing are looking backward and show some robustness, but overall, the level of prices and what we're witnessing for the first time in the rental market in September - rents actually declined. Is this a trend yet? No, but it's a start. So overall, we think in the next three months inflation will show its true colors and start to come down. That brings me to my final point here which has to do overall in combination with valuation. Real yields going positive and the strongest of all – dollars - in our opinion is the fact that the money supply continues to drop. If money supply is dropping and commodities are telling us a particular story, what we need is time. We need to assess the length of time that it takes for inflation to begin to adjust the mindset of the central banks around the world. We believe again, that's around the turn of the year. So, do we have some more downside? We could always have more downside, but what's the upside in terms of the equity markets in the next 12 to 18 months? We think it's at least equal to the next three to six months in the equity markets. If we think out on a tactical basis 12 to 18 months, we think neutral still makes sense. Having said all that, the oasis. Every desert needs an oasis at least from our perspective. What is the oasis as it relates to the financial desert that's hot and dry with blowing winds? From what we believe is the water and vegetation in the oasis is two things when you get down to it. First and foremost, when two year yields peak and when the dollar peaks, the combination of those twin peaks, if you will, ultimately in our opinion, is an oasis that the market needs to suggest that ultimately the Fed pauses and ends their tightening campaign, not necessarily pivoting and going all the way towards easing, but simply pausing. At that point perhaps that pause is equivalent to yesteryears’ lifeline in which the shed put - in other words, the lifeline of trying to stabilize markets was what was needed back then. Simply we ask the question, “What's needed now? Is it simply a Fed pause?” We will know more in time, but our belief is that inflation in the next three months will show more of the colors that we expect, which is to the downside. Ultimately, the question will come is when does the Fed pause? Doesn't mean pivot. Doesn't mean easing. From our perspective, it's when do all these high magnitude increases in interest rates and balance sheet removal begin to bite and begin to bite visibly? As that happens and money supply continues to contract, we believe the market’s discount some subtle downside from here. Therefore, we stay on guard, we stay neutral, and we look for opportunities between now and the end of the first quarter to rebalance portfolios for the long-term investor that can take advantage of better prices. That'll do it for today. Thanks for listening.
Operator: Please see important disclosures provided on this page.
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Chris Hyzy: This is Chris Hyzy, Chief Investment Officer, for the market update for September 26th. Global financial markets have experienced significant downside pressure last week, continuing the trend from late August. Recently however, the downside momentum has gathered speed as central banks around the world led by the Federal Reserve have raised rates together and have expressed a move towards higher rates for longer than expected. In addition, currency volatility has also picked up as the Pound goes to many decade lows and the Yen at about two and a half decade lows versus the dollar. In addition, the equities and bonds selling off. Gold and oil prices have also declined, signaling that investors are moving towards an ultra-defensive tone. We remain on guard with a defensive tone as well. We believe markets are in a reset phase still, trying to price in a higher rates structure, a stronger dollar structure, lower overall economic growth and earnings, and heightened geopolitical risk all at the same time. This takes time and we expect choppy markets and overall action in this regard to last into year end. We emphasize diversification across and within assert allocation and look for opportunities in spades in the next three to six months plus to rebalance portfolios in order to take advantage of the turndown in inflation eventually. The ultimate pause by the fed, which we expect somewhere around year end, and not necessarily pausing overall rates, but at least in terms of their verbiage, we also expect a peak in the dollar early next year and finally, the stabilization in corporate earnings. This rebalancing also includes considering an increase in duration in fixed income portfolios primarily through exposure to long term government bonds. At that point we believe long term investors would benefit from a resumption of the long-term uptrend in the US profit cycle, a move lower in long term bond yields, and equity markets in general. For now, the reset continues, consolidation continues apace across most financial markets including stocks and bonds, currencies, gold, and oil. In the next three to six months we have high conviction that long term
investors will have opportunities to rebalance portfolios in a more meaningful way up in equities if you’re below your tactical targets. For now, we continue to be on guard. Thanks for listening.
Operator: Please see important disclosures provided on this page.
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