Managers Reports - Ethical Offshore Investments

Don’t Try and Pick ‘Tops or Bottoms’

Stephen Strowger — Tue, 06 Aug 2024 05:57:25 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

The purpose of publishing these newsletters on the Ethical Offshore website is to provide investors some simple, easy to understand technical details on why the US markets are behaving the way they are at the moment, what has occurred to get them where they are, and what actions may influence where they end up in the near future.

The way Adrian Tout explains all this, in simple terms, I believe is good reading for any investor to get a better understanding of what is happening within the financial markets, what risks to be aware of and how to take advantage of these market conditions for your medium to longer term investment journey.

Lesson: Don’t Try and Pick ‘Tops or Bottoms’

Two lessons on what not to do from TV’s most famous stock picker
Did Buffett just ring the bell on Apple at 32x forward earnings..?
A Framework to help assess whether buying (or selling) is a

Yesterday’s post talked about how I don’t try and pick a top or bottom in a stock. I don’t believe it’s something you can do consistently well.

Now and again it happens – however I attribute that to luck more than skill.

When I sold the bulk of my large-cap tech holdings a few months ago – it was not the top in these names. Most of them continued to add further gains.

However, when I sold, I felt were trading at the “greed” point in the cycle below (“d”)

On the other side of the coin – when there is outright fear (“g”) – I don’t pretend to know where the bottom might be. Therefore, my approach is to wade into a stock in halves.

For example, my first half position is typically around “f” – when I sense valuations are below the mean (blue line).

Quite often the stock won’t plummet to oversold levels … where it finds a base and continues to rally.

For example, stocks spend most of their time just either side of the mean between “not too bad” and “not terrible” (i.e., points b, c, e and f)

However, when there is genuine fear in the market – I will often look to establish a full position.

For clarity, in my case, a full position will vary anywhere from 2% of my total investable capital (for a more speculative position); and as much as 20% (not more than) for a very high quality stock.

For example, earlier this year Google constituted ~16% of my total holdings (it’s less now)

But on average – my full positions are typically in the realm of 4-5% of my total investable capital.

This is what works for me and how I manage risk – it may not work for you.

Today I want to share two examples from a ‘market expert’ on the dangers of:

• Calling a bottom in a stock; and

• Capitulating when fear is greatest (when you should be buying)

And in my conclusion – I’ll share a timely example of what one of the greatest investors of all time did with his Apple position last quarter.

Spoiler alert: “be fearful when others are greedy; and be greedy when they are fearful”

To our first lesson…

Lesson #1: Calling a Bottom (or Top)

Bottoms are always very easy to see in hindsight. A stock eventually finds the lowest level someone is willing to sell – it proceeds to catch a bid – and from there it rallies.

We look back and say “well that was the bottom”.

Hindsight Capital Inc. always produces astounding returns!

As investors, we don’t have the luxury of knowing what the future holds. All we have are probabilities.

In most cases, the price will go lower than what you paid for it; and/or continue to rally after you sold it.

That’s the case for me at least.

And this is precisely what happened to financial media personality Jim Cramer this week.

But a quick preface before I continue…

Cramer is an entertainer first and foremost. He hosts a program on CNBC’s known as “Mad Money”. His job is two-fold:

• Deliver entertaining (financial) content to lure eyeballs; and

• Enable his employer – UniversalNBC – to sell more advertising.

Part of Jim’s entertainment are regular stock tips.

But a word of caution… he’s an entertainer first and a stock picker second (as I will demonstrate)

Therefore, if you are acting on a Cramer tip – be sure to do a lot of independent work.

Earlier this week (Monday – July 29) Cramer “called the bottom” for popular cybersecurity company CrowdStrike (CRWD)

After a 35% plunge in the stock’s price following the largest IT outage in history – Cramer felt this was enough.

Whilst not the focus of this post (but to demonstrate the severity) – Delta estimate they lost in the realm of $350M to $500M – forcing them to deal with 176,000 refunds after cancelling some 7,000 flights as a result of CrowdStrike’s negligence.

If Delta are successful with their lawsuit (and I don’t see why they won’t be) – one wonders at what precedent this could set?

Are Commodities Telling US Something..??

Stephen Strowger — Tue, 07 May 2024 07:22:24 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

May 6, 2024 – Adrian Tout

Are Commodities Telling Us Something…??

Why I expect lower commodity prices in the second half
If true, then expect inflation to fall and the Fed to cut
And why the narrative will pivot from inflation risks to the dreaded ‘R” word

Forecasting things like (not limited to) GDP growth, unemployment and inflation is tricky business.

Very few get it consistently right (especially policy makers).

And whilst macro forecasting is generally a fool’s errand – there are things we can observe to improve our probabilities of success (or at least reduce our risk).

Consider inflation…

Whilst not perfect – there are a set of reasonably strong correlations which exist over extended periods.

And it’s these types of correlations we can use to our advantage.

As I will demonstrate shortly – over the past five decades (after the US dollar removed its peg to gold in 1971) – inflation levels have largely correlated to what we see with commodity prices.

And this makes sense – as commodities comprise the input cost of almost everything we consume (e.g. from energy to food to basic materials etc).

It follows that every inflationary spike we’ve seen has come with (short-term) spikes in commodity prices.

Here’s another way of framing it:

We’ve never experienced a surge in inflation without a rise in commodities.

And whilst the financial media (and specifically central planners) appear ‘wrapped around the axle’ on things like “Supercore PCE services” – is this the right metric when looking ahead?

Let’s take a look.

Where You Go… I Go

Let’s start with a long-term chart…

Below is the 20-year correlation between the Global Commodities Price Index vs Consumer Price Inflation (CPI)

May 6 2024

At first glance, we can see that the correlation is not perfect, however more than consistent.

For clarity:

The orange line is YoY % change with consumer price inflation (CPI) – currently running around 3.5% (as of April 10)

The light blue line shows what we see with the YoY % change with the global commodities price index.

It’s fair to suggest that commodities represent a “foundational layer” for inflationary events (e.g., note the corresponding peaks and troughs)

But consider what we’ve seen of late…

For the first few months of 2024 0 commodity prices on the whole (especially oil) moved higher.

Naturally, this added to inflation (cited by the Fed).

(n.b., read this post where I called the possible ‘oil problem’ for the Fed in March)

Now compare this to what we saw last year with commodity prices…

Here we saw rapidly declining prices for energy, agricultural and metals products (with inflation following suit)

Therefore, perhaps the right question to ask is where do we think commodity prices are potentially headed?

This is a very difficult question to answer.

But we can take a look at history (and specific ratios) to hazard a guess…

What Can We Learn?

Whilst things like services are adding to inflationary pressures (due to higher wages) – it’s worth asking whether they will continue to be the most impactful driver of higher prices?

My guess is potentially no…. especially if we continue to see the labor market weaken (which I think will be the case)

As an aside, the latest labor report showed more chinks in the employment armor.

From mine, commodities are arguably a more reliable long-term source of inflationary pressure.

And if the Fed are to get back to levels of 2% Core and Headline (PCE and/or CPI) – they will need to see lower commodity prices.

Period.

To that end, much lower commodities will play a major role in determining the Fed’s next step on (possibly easing) monetary policy.

And from there, we can hazard a guess as to what we see with speculative assets (which I will touch on in my conclusion).

Now over the past three years – the Fed has been forced to be restrictive with monetary policy.

Due to artificially suppressing rates well below market – this lead to excess money chasing too few goods (the very definition of inflation)

But what has eluded most investors (for now) has been the “long and variable” impacts of tighter monetary policy.

Look no further than massive amounts of fiscal spending (which I will talk to below).

From my lens, it would appear that the Fed’s restrictive policies could finally be playing catch up (and perhaps why Jay Powell & Co. are so confident in their inflation outlook)

Another chart (and coming back to fiscal spend):

The chart above plots the global commodity price index (blue) vs the fiscal deficit as a function of GDP (orange and inverted).

Again, it’s far from perfect… but it could be helpful with identifying what potentially lies ahead for inflation.

Now when the federal deficit-to-GDP ratio rises, the deficit shrinks, and fiscal stimulus becomes less accommodative.

The opposite also holds true; i.e., when the deficit expands (as we saw recently at a level not seen since WWII), this is both accommodative and inflationary.

For example, looking back, we saw this ratio rise with massive fiscal deficits – sending commodities (and inflation) higher.

To that end, one could argue the government was an opposing force to the Fed in their fight to squash inflation (and hence the delayed impact of monetary ‘long and variable’ lags.

(Note – Powell told us as much in this interview with 60-Minutes early Feb).

The “good news” is the government has started to moderate their post COVID spendathon (slightly)

For example, the federal deficit/GDP ratio has come down about 2.4% since last June (see below)

Now if our earlier correlation holds true (bearing in mind it operates with a lag) – this should result in decline in commodity prices towards year end.

For clarity, this is not to say it will, but all things being equal this is what we should expect (i.e., it’s a higher probability outcome)

So what sort of decline could we expect?

Well for that I will refer to the tape…

Today the GSCI commodity price index trades around 577 (according to tradingeconomics.com)

The chart below (which also plots the price of Crude Oil) suggests we could see this index ~16% lower by years end (i.e. the previous support level of ~$470)

And if that were to transpire – this would be disinflationary – giving the Fed scope to cut.

Put together, a reduced fiscal deficit as a function of GDP will likely see softer commodity prices.

And if that’s true – it follows that inflation heads lower – given the Fed latitude.

But what about bond yields?

Lower Bond Yields

Finally, the correlation between long-term bond yields and commodities is worth observing.

Again, this isn’t perfect, and what’s more suffers an ~2 year lag.

For example, two years ago the 10-year was trading ~3.0% (relatively accommodative)

This is helped push commodities higher…

However, as the 10-year continued to sustain a level well above 4.0% – the rally in commodities stalled.

And it makes sense…

Investment cycles tend to decline as the cost of money increases (e.g., which we saw with private investment in the latest Q1 GDP report)

Now consider the following 20 year chart:

May 6 2024

Commodities are yet to fully react to the 2.0% gain in rates over the past two years.

However, you can see it’s starting to bite. Commodity prices are stalling.

Given the historical two-year lag between the two – it’s my guess commodity prices will soon ease.

And if that happens – the conversation will quickly shift from ‘inflation concerns’ to that of economic growth.

And from there, we usher in Fed rate cuts.

It Starts with Falling Commodities

To help dimension the above shift, from mid-2022 to mid-2023 the GSCI commodity price index plunged 35%.

Given what we now know – the saw CPI decline from 9% to about 3%.

However, the dreaded “R” word also dominated the narrative.

Commodity prices are not only our cue for lower inflation but recessionary fears.

My expectation is commodities will suffer a large drawdown in the second half – giving the Fed more scope to cut.

Will we enter a recession?

That’s very difficult to answer… but it remains something we can’t rule out.

I think the answer to that will depend on what we see with employment.

For example, if we see the unemployment jump to levels of 4.50% over the coming few months, then I would be confident in calling for a recession.

But first, let’s see what happens to commodity prices…

If we see a 10% to 15% fall in the coming 6 months with the GSCI… that’s where the conversation will shift.

And no-one will be talking about unwanted inflation.

Putting it All Together

My argument is Powell has an itchy trigger finger when it comes to rate cuts.

A sharp fall in commodity prices (e.g. to the tune of 15%) would be just the tonic.

What’s more, I also believe Powell wants to ensure he “sticks the so-called landing”

He knows that a sharp decline in commodities will be a leading indicator of slowing demand and growth.

However, cutting rates at that point might be too late.

Meanwhile he has a US President election to contend with….

If Powell is successful in avoiding recession (and he might be with a lot of luck) – then equities will advance during the rate cut cycle.

If not – down they go.

From a risk management perspective, exposure to bonds looks very attractive in a disinflationary environment.

For example, if the 10-year is to fall from today’s 4.50% to levels closer to 3.50%, that will be a boon for anyone buying bonds today.

And in terms of equities – your tilt should be towards defensives over cyclical sectors.

Cyclicals do better during the early cycle… not late cycle (which we are in now).

But there’s a lot of water to pass under the bridge between now and then… keep an eye on commodity prices.

If they continue to decline… expect inflationary pressures to ease.

Regards
Adrian Tout

The post Are Commodities Telling US Something..?? first appeared on Ethical Offshore Investments.

The post Are Commodities Telling US Something..?? appeared first on Ethical Offshore Investments.

How About Zero Rate Cuts this Year..??

Stephen Strowger — Thu, 11 Apr 2024 05:01:03 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

April 7, 2024 – Adrian Tout

How About Zero Rate Cuts This Year…??

Markets see a 2% chance of no rate cuts this year
Several reasons the Fed can afford to ‘wait & see”
Still expecting a buyable pullback

At the time of writing, the market is pricing in three rate cuts for 2024.

But is this realistic?

My argument is no.

Let’s frame the discussion with the latest ‘dot plot’ following the March FOMC meeting:

With respect to this year – there is slight division among members. For example:

9 see 2 rate cuts;
9 see 3 rate cuts; and
1 envisages 4 cuts

As I wrote last Friday – if just one of the members forecasting three cuts becomes two (e.g. due to stronger than expected employment and/or inflation) – then two cuts will be the scenario.

However, what if zero rate cuts become a possibility?

This post attempts to explore reasons why that outcome should be considered.

Probability of No Rate Cuts

The probability of the Fed maintaining rates where they are is not something which is priced in.

For example, following last month’s “strong” employment data, the market sees this as a small 2.1% probability.

From the CME’s FedWatch Tool:

The column on the far right hand side suggests a 2.1% probability that rates stay the same (i.e., 525 to 550 bps).

However, that probability was just 0.2% one month ago.

Three rate cuts (a target rate of 450 to 475 bps) is still the favoured outcome.

But my feeling is 2% underestimates the possibility of the Fed taking a wait and see approach through the second half of the year.

And there are a few reasons for that…

The Wealth Effect

Outside of more common cited metrics such as employment and inflation – there are other factors which will weigh on the Fed’s decision to ease.

For example, one is the huge “wealth effect” from risk assets in recent months (which in itself is inflationary)

Let’s start with the stock market…

Since November 1 last year – the market is up around 25% or ~$10 Trillion Dollars

April 7, 2024

This 25% surge now finds the S&P 500 with a total market capitalization of ~$43 Trillion.

Naturally, investors have seen their wealth accelerate – whether it be their 401Ks or other investments.

Now let’s consider housing…

Property has also enjoyed stellar gains (thanks to record low levels of inventory) – up an incredible 46% the past four years – a CAGR of around 10% per year.

Below is the Case-Shiller House Price Index – a leading measure of U.S. residential real estate prices, tracking changes in the value of residential real estate nationally.

The table below shows the changes over the past few months, year-to-date and past 3 years (where gains are ~9.50% annualized on a national basis).

Rising property values are also another major source of the ‘wealth effect’

But there’s one more asset class we might be forgetting…

Here I’m talking about the $2.64 Trillion market that is “crypto”

Consider the most prominent coin – Bitcoin.

It has rallied from ~$15K at the start of 2023 to ~$70K at the time of writing.

Who knows…. Bitcoin could be “$80K” or more by the time you read this (or maybe less than $50K!)

So here’s the thing:

The leading cryptocurrency by market value has gained over 50% in 2024 – extending last year’s 155% surge.

April 7, 2024

There is little doubt this too has played a significant role in (some) investors feeling ‘wealthier’.

In fact, there is research to support this.

Consider this article from CoinDesk – who cite research from Harvard Business School on crypto’s wealth effect (especially with younger investors who have a higher propensity to spend):

A 2023 paper by Harvard Business School’s Marco Di Maggio and his team of economists estimated that the marginal propensity to consume – the amount spent on consumption for each additional dollar earned – out of unrealized crypto market gains is double that of stocks.

That means a sharp rally in crypto prices, like the current one, can lead to a wealth effect that injects inflation into the economy by creating extra demand.

“The rise in bitcoin and ETH and alts is inflationary as it creates more money-like assets and a strong wealth effect for young people with a high marginal propensity to spend,” Brent Donelly, president of Spectra Markets, said on X.

The wealth effect is a behavioral economics concept that says that individuals, households and businesses spend more when the value of their financial assets rises. That increased spending is financed, essentially, by wealth created out of thin air – asset price gains. However, it adds to demand-side forces in the economy, putting upward pressure on prices.

Therefore, when you consider the sharp rises we’ve seen in risk assets across the board (e.g., stocks, housing and crypto) — it’s not reasonable to think this is “injecting” further inflation into the economy.

Credit Spreads also Tightening

Something else which tells me the Fed are likely to hold are what we see with credit spreads.

They are starting to tighten.

For those less familiar – credit spread compression happens when the yield differences between Treasuries and other bonds (e.g. corporate debt) that share the same maturity shrink.

In recent months, the compression of credit spreads has proved beneficial for high-yield, bank loans, emerging markets, and corporate bonds.

As Treasury prices fall and their yields rise, investors generally move into other debt instruments.

This typically happens when the economic environment is positive or improving, causing narrower spreads.

On the other hand, when the economic environment turns negative (e.g., odds of recession increase) – then investors sell out of riskier investments like corporate bonds in favor of the safety of Treasuries.

This, in turn, causes the spread to widen.

Therefore, if we’re to experience a so-called “soft landing” (which the market anticipates) – expect spreads to narrow further.

April 7, 2024

Now if we were to see unease in credit markets – with spreads widening – it could support the case for rate cuts.

But this is not what we find.

Easing Financial Conditions

Last but not least – consider what we see with financial conditions.

I offered this Fed chart recently – asking why central banks believe financial conditions are “restrictive”?

Again, if conditions were considered tight, then it might support the case for the Fed to ease.

However, conditions are as “easy” as we’ve seen in 2+ years.

There’s no headwind here.

Tailwinds

Each of the above are all tailwinds for the economy.

What’s more, each of them are inflationary as they increase demand and consumption.

But what about the so-called lag effect of monetary tightening you might ask?

Well so far we have not seen it…

Typically the long and variable lag effect of rate rises will come into play up to 18 to 24 months after the Fed first hikes rates (March 2022)

But here we are two years later and it’s been negligible.

There was been a small impact with the unemployment rate moving from a very low 3.4% to 3.8% – but certainly not the “economic pain” Jay Powell told us to brace for.

From mind, there have been 4 major tailwinds which have effectively offset tighter monetary policy:

Cumulative $2T in excess consumer savings (which is now gone);
~$6 Trillion in fiscal spending;
70% of US home borrowers securing 30-year mortgages below 4% (minimizing the impact of rate rises); and
The wealth effect from appreciable gains in stocks, houses and crypto currency.

Each has culminated to keep the economy out of recession.

And when you also consider the record amount of immigration in the US (legal and illegal) – this has meaningfully added to the labor force (as I wrote last week).

For example, according to the CBO, the tightness in the labor market is likely to persist due to immigration.

“Using the new CBO estimates of net immigration released in January 2024, we estimate that the labor market in 2023 could have sustainably accommodated employment growth of 160,000 to 230,000. That is still below the actual monthly increases in employment in 2023, but far less so than previously estimated.

Similarly, for 2024 we estimate sustainable employment growth will be between 160,000 and 200,000, approximately double the sustainable level that would have occurred in absence of the pickup in immigration according to the pre-pandemic projections from CBO, BLS, and SSA”

They also add “…the unexpectedly high level of immigration also explains some of the surprising strength in consumer spending and overall economic growth since 2022. Moreover, we expect immigration flows to further boost economic growth in 2024″

All Reasons Not to Cut

Given all of the above – why would the Fed choose to cut rates three times before the end of the year?

This has been my question all year… even when the market was pricing in six rate cuts.

From mine, there is ample demand and inflationary forces at play for the Fed to “wait and see”

Last week’s employment result may force a few Fed members to moderate their dovish views.

And pending what we see this week with CPI – those who were thinking three cuts – may shift to just two.

As it stands right now – I think there is at least a 50% probability the Fed doesn’t cut at all this year.

That’s a long way from the 2% which is priced in….

What am I missing?

Putting it All Together

With respect to the S&P 500 – don’t be surprised to see further profit taking from current levels.

And if we are fortunate enough to see a correction in the realm of 7-10% – but that will be an opportunity to buy.

As an aside, in a non-recessionary environment, the average pullback in any one year is around 13%

There are some years where this doesn’t happen – but it’s unusual.

However, given how far stocks have come, I personally think the probabilities for a buyable pullback are high.

For clarity, I don’t think stocks are going to crash into some abyss this year.

For that to happen, we would need to see a material change to the unemployment picture (e.g. moving towards 4.50%)

However, if that were to happen, then we will see the Fed move aggressively.

But as things stands, I’m finding it hard to make the case for rate cuts.

Regards
Adrian Tout

The post How About Zero Rate Cuts this Year..?? first appeared on Ethical Offshore Investments.

The post How About Zero Rate Cuts this Year..?? appeared first on Ethical Offshore Investments.

Trade the Tape – Three Cheers for 5,000!

Stephen Strowger — Mon, 12 Feb 2024 10:32:27 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

February 8, 2024 – Adrian Tout

Three cheers for 5,000….

How much further can this epic rally go..?
Monthly time frame offers useful perspective
Q4 earnings show only 2.9% YoY…. Good…. but not great

This week the S&P 500 closed above 5,000 for the first time.

Golf clap.

Another milestone as we climb the infamous wall of worry.

Over the past 100+ years the S&P 500 has averaged capital gains of ~8.5% per year plus dividends of ~2.0%

That’s a total return of close to 10.5% (on average)

If you compound 10.5% per year over 20 years – that’s a 637% increase.

But as we know, the pathway is rarely smooth.

For example, some years the market may “add 20%” and others it could give back a similar margin (or worse).

And we saw this happen recently.

However over the long run – markets will rise more often than they fall. Therefore, the percentage play is always from the long side.

One of the best charts offering perspective is this (which I shared last year):

This shows how the market has continually navigated numerous headwinds.

From World Wars to depression to recessions to numerous financial crises.

That market finds a way through…

In more recent times (post 2000) – we’ve experienced two pullbacks of around 50%.

I’ve traded through both.

The first one hurt a great deal. The second one less so.

I’m willing to bet we will experience a similar 50% drawdown before 2030.

And guess what – it’s something to look forward to.

Experience has taught me these events are (rare) opportunities… not reasons to panic.

Great returns are created from buying low.

Something else to take away from this chart – U.S. stocks have typically outperformed all other asset classes over time (a conversation I love to have with people – especially those ‘married’ to real-estate or gold).

Whether the asset class is property, gold, bonds or overseas markets – U.S. stocks reign supreme.

And that’s certainly been the case the past few years – as gains in U.S. equities dwarf those of the UK, Europe, China, Australia and most other countries.

But let’s take a look at this current market rally.

S&P 500 Closes Above 5,000

The equity rally from late October 2023 has been nothing short of extraordinary.

I doubt if anyone forecast the S&P 500 trading above 5,000 by early Feb.

I certainly didn’t. Not even close.

From example, the average S&P 500 end of year forecast in the first week of January was just below 4800.

I shared this table of 18 bank / analyst forecasts:

At this week’s close of 5026 – and ~6 weeks into the year – we’re already above most analyst’s EOY predictions.

Let’s start with a look at the weekly chart (followed by the monthly):

Feb 9 2024

A couple of observations:

First, there has only been one red candle (the first week of the year) since the week ending October 23.

That’s not typical. Generally stocks will pause for a breath over 6 months.

It’s little wonder we find the weekly Relative Strength Index (RSI) well in overbought territory.

The last time things were this (technically) extended was early 2022.

But as I remind traders – an overbought RSI is not a sell signal in isolation. The market can remain overbought for several weeks (if not months). For example, look at the period between May and September 2021.

However, typically sharp sell-offs occur from this zone.

Second, we’re around 25% higher than the 200-week exponential moving average.

And whilst this is less than what we saw in early 2022 – it’s also rare markets get this extended in this timeframe.

Bottom line – trade with caution – it’s difficult to say (with any conviction) there’s much left in this rally.

Let’s now shift our horizon using the monthly lens – as it paints a slightly different picture.

Feb 9 2024

Using this horizon – we are not yet overbought (as we were in both 2018 and late 2021)

However, things are looking extended in terms of distance from the 35-month EMA (which is similar to the 200-week EMA)

Two other observations:

61.8% to 76.4% outside the retracement from October last year is around 5,050 – where we are trading now. This zone could act as an area of resistance; and
We have seen 5 pull backs of at least 10.5% since 2016. In each case we traded down to the 35-month EMA (or slightly below) where it found support. That level is currently 4191

From mine, this is the zone where you would look to start adding exposure (more on this in a moment when I assess the forward PE based on Q4 earnings).

For example, pending what we see with the U.S. election, the tensions in the Middle East, Chinese slowdown, oil prices, monetary policy, bond yields and Q1 earnings – it would not surprise me to see us test this area.

Speaking of earnings…

Q4 Earnings Good… Not Great

Factset furnished us with the latest update on Q4 earnings this week.

In short, earnings have improved this week. However, the growth in earnings does not equate to the surge we have seen in equities.

The blended earnings growth rate for the 67% of S&P 500 companies who have reported fourth quarter is 2.9% YoY.

The good news is that’s up from 1.6% last week and an earnings growth rate of 1.5% at the end of the fourth quarter (December 31).

Looking ahead, analysts expect YoY earnings growth of 4.0% for Q1 2024 and 9.1% for Q2 2024.

That’s a rapid ascent higher which will require a robust (spending) consumer.

For the full year 2024, analysts are calling for YoY earnings growth of 10.9% (slightly down from the 12% a few weeks ago)

Factset also tell us the forward 12-month P/E ratio is 20.3, which is above the 5-year average (18.9x) and above the 10-year average (17.7x).

Echoing Leon Cooperman the other day – that’s too rich for my blood.

It’s worth noting that a 17.7x forward PE puts us around 4159 (i.e. the 35-month EMA zone shared earlier) – which implies a (potential) correction of ~18%

Putting it All Together

One thing I’ve learned over the past 25+ years in this game is markets will often go further than what you thought was possible (in both directions)

When you think they can’t go higher – they do. And when you think the selling is finished – it’s generally not.

For example, if you asked me whether the S&P 500 would be trading above 5,000 in early February late last year – I would have said it’s less than a 20% probability (a bet I would not take).

But here we are…

Fortunately I have long exposure (which I’ve since pared) – and did not put on any short positions.

So far that bet has been prudent.

Traders taking short positions on the basis the market is overbought have been crushed (in turn forcing them to cover – helping to drive up prices).

What’s more, it’s possible that zero-dated options (a relatively new phenomenon) is playing a role. Steve Sosnick – Chief Strategist at Interactive Brokers – wrote about this recently:

Last year, we saw exchanges list so-called “zero-dated” or “0DTE” options listed in a range of key indices and ETFs. They have proven immensely popular, with cumulative options volume setting a record last Thursday (the day after the FOMC meeting).

For better or worse, they have made speculation incredibly easy. It is likely that these products exacerbated December’s decline, and it is almost certain that they have accelerated this year’s rally.

Most traders are more comfortable trading from the long side rather than the short side, which explains the recent pops in volume on up days.… it would not be surprising if these ultra-short-term options lead to microbursts of volatility and the occasional spurious move

Who knows for certain – but I’m sure they are playing some part in this euphoria.

Trade safe. Stay patient. This is a long game.

Regards
Adrian Tout

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Trade the Tape – Will the Bond Vigilantes Strike Back

Stephen Strowger — Fri, 09 Feb 2024 07:00:33 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

February 8, 2024 – Adrian Tout

Will the Bond Vigilantes Strike Back..??

US Government’s insatiable appetite for even more debt
Record Treasury auction this week – $42B in 10-Year Notes
Building the case for higher yields in the years ahead

Today the US federal government sold a record $42B of 10-year notes:

This was a closely watched bond auction – with the potential to push bond yields higher if there was a lack of demand.

But this wasn’t the case… it was well bid… fetching a yield of 4.093%

Markets exhaled.

Of particular note – international demand was at 71% versus a six-month average of 66.4%.

Makes sense…

The US is arguably one of the safer (or economically stronger) markets to put money to work.

For example, China is in the midst of debt-deflation spiral – with ratings agencies putting them on notice (following the imminent collapse of Evergrande – with the debts in excess of ~$300B)

Europe is in and out of recession – with the UK not much better.

From that lens, the US looks like a decent alternative.

The US Treasury said last week that it plans to continue gradually raising coupon auction sizes through April.

A $54 billion sale of three-year notes saw solid demand on Tuesday. The Treasury will also sell $25 billion in 30-year bonds on Thursday.

Why record debt issuance you ask?

Simple: widening budget deficits.

And that’s a problem.

Powell’s Warning

Last weekend Fed Chair Jay Powell gave a rare interview with 60 Minutes.

Not only did Powell tell people to expect rates higher for longer – he also sent less than subtle warnings to Congress. I quote:

“It’s probably time, or past time, to get back to an adult conversation among elected officials about getting the federal government back on a sustainable fiscal path”

Amen.

But good luck with that Jay.

When asked if this was an urgent problem – Powell said “…sooner is better than later. You could say that it was urgent, yes.”

I might be wrong – however I suspect the Chairmen is looking at this chart – where federal debt continues to outpace real GDP (i.e. output).

Another way to interpret this chart: it’s costing greater amounts of debt (at higher rates) to maintain the same rate of growth.

This is not a sustainable path.

Bloomberg reported that former Fed Chair – Janet Yellen – since taking the position in Treasury – has consistently said that the right metric to look at is real net interest as a share of GDP — in other words, the inflation-adjusted interest rate that the government is paying for its total debt, compared with the size of the economy.

However, this week she highlighted that the Biden Administration’s budget proposal last year would have kept that rate at around 1%, an “historically normal” rate, in coming years.

Originally the budget was said to include $2.5 trillion of proposed deficit reduction – however Congress failed to act.

There were no cuts… just increased borrowing and spending.

Efforts to reduce spending were blocked.

This has put Yellen in a bind.

When pressed on the ‘urgent issue’ of widening deficits (and increased debt) she said recently: “I don’t want to express a view – the jury’s still out”

This was in stark contrast to a year ago.

Powell explained the basic math to 60 Minutes (echoing my chart).

He said… “federal debt is growing faster than the economy. So, it is unsustainable.”

This isn’t rocket science.

As an aside, renowned investor Paul Tudor Jones, told CNBC this week that he agreed with Powell in thinking that the federal government is on an unsustainable fiscal path.

Someone want to tell Congress?

The Case for Higher Rates

With inflation coming down and the prospects of maybe two or three central bank rate cuts later this year – bond yields have retreated from their recent highs.

For example, the 10-year peaked just above 5.0% to trade almost 100 basis lower this month.

And from mine, this has been a large catalyst for the massive equity rally the past few months – especially longer-duration assets (e.g. tech)

But here’s the thing:

Given the troubling fiscal situation – there’s no guarantee the bond vigilantes won’t return with vigor.

In other words, they will demand higher compensation for buying US debt.

On this subject, I caught this CNBC interview with billionaire investor and hedge fund manager Leon Cooperman.

Cooperman is Chairman and CEO of Omega Advisors, a New York-based investment advisory firm managing over $3.3 billion AUM – the majority consisting of his personal wealth.

He echoes much of my sentiment:

Investors are too optimistic about the number of rate cuts the Federal Reserve will enact this year; and
The S&P 500 is now trading at 21 times forward earnings, which seems unsustainable.

As a complete aside, when I find too many people who agree with my thesis, I start to ask what I could be missing?

Here’s Cooperman:

“Everybody came into 2023 with a very negative view, and the market went up quite a bit. Everybody is now positive, and so my guess is that by the end of the year, maybe we will go down”

“I think the Fed will cut short rates, maybe two or three times.

Forget the six times that the market was discounting, but I think the long end will go up.

The 10-year at 4%, 5% or higher would not be a big surprise.

… And when you see the market multiple 21 times… it seems too rich to me

Too rich for me too Leon!

On the subject of unsustainable deficits and debt – he said this is a reason we could see much higher rates.

The U.S. government ran up another half a trillion dollars in red ink in the first quarter of its fiscal year.

The jump in the deficit pushed total government debt past $34 trillion for the first time (see my earlier chart)

“Given the amount of debt that we’re creating in the system, I wouldn’t be a buyer of government bonds at these levels”

Put another way, Cooperman does not feel a 10-year note yielding around 4.0% is adequate compensation.

If he (and Tudor Jones) are right – it could spell trouble for equities should bond vigilantes wake up.

Putting it All Together

From mine, this is a potential blind spot for equity investors.

They are paying a very high multiple to own stocks (e.g. 21x forward) and are pricing in as many as six rate cuts.

As Cooperman says – this is a risky bet.

Powell essentially ruled out a rate cut in March (as part of this 60 Minutes interview) – whilst stressing the urgency of the worsening US fiscal situation.

And from mine, Yellen’s unwillingness to answer the question of fiscal responsibility this week spoke volumes.

What happened to the $2.5 Trillion in planned spending cuts?

From mine, it’s unlikely Congress is going to find any agreement to aggressively cut spending.

However it needs to be done…

Which raises a question: who is going to vote for austerity measures?

Cutting spending is never popular.

But at some point, you don’t get a choice. Your hand will be forced.

Keep an eye on bond yields.

Regards
Adrian Tout

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Trade the Tape – 4 Ways to invest in Bonds

Stephen Strowger — Mon, 30 Oct 2023 06:55:40 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

October 29, 2023 – Adrian Tout

4 Ways to invest in Bonds

A myriad of ways to invest in Bonds
Evaluating the risk / reward of each pathway
Compelling reason to increase exposure to fixed income

If you’ve been following my posts the past few weeks – I’ve suggested it’s a good time to start increasing your exposure to bonds.

As part of these missives – I’ve also had many reader emails asking me how?

Good question!

This missive will offer you a guide on some of the simple ways you can increase your exposure.

But let me offer a caveat… bonds are not risk free (nothing is)

As with equity investing – you should always consider your own risk profile and financial position.

What works for me may not work for you.

But first let’s set the scene as to why. And from there, I will follow with the what and the how.

Why Bonds Look More Compelling

Over the past three years – fixed income investors have been crushed.

In short, the prices of bonds decrease when interest rates rise.

Given we have seen the Fed funds rate go up more than 500 basis points over the past 18 months (the fastest increase in 40 years) – it’s caused widespread losses in bond markets.

It arguably caused three banks to collapse (due to forced (premature) sales of bonds which were underwater).

For example, consider the widely-held long-term (20+ year) treasury bond ETF TLT

October 29 2023

This $40B Bond ETF has lost the equivalent of 17% per year for three years.

And whilst these are a proxy for long-duration – the 50%+ price correction is indicative of what we’ve seen across the fixed income market.

The devastation is not unlike what we saw with equities in 2001 and 2008.

But I will go one further…

This is the worst three-year period for bonds since the 1780’s.

George Washington was President – where the fledgling U.S. was trying to figure out how it was going to pay its debts.

Over 200 years later and it’s still trying to figure out how to pay its debt!

I digress…

Now at some point (e.g., when the supply / demand equation shifts) – these assets will catch a strong bid.

But we are not there yet…

That’s when investors will decide the value is just too compelling.

Now we’re starting to see a sentiment shift in 2-year bonds – as these yields stabilize (i.e. there are buyers)

And should economic growth slow next year (my expectation) – it follows that yields will fall.

Put another way, buying will start to extend along the curve.

If correct, the price of bond ETFs like TLT will rise.

To give you an idea of the potential capital appreciation in bonds:

If 10-year yields fall ~0.5% (back to 4.50%) – the respective bond price would gain ~13%

You can read more about my thinking on bonds here.

Now you know the basics of “why” – let’s talk about the “what” and “how”.

How to Invest in Bonds

There are a number of ways investors can play the fixed income market.

I will explain at least four ways – starting with US treasury debt.

#1 – US Treasury Bonds

Perhaps the most direct way to own U.S. government debt is via the Treasury’s own website.

Alternatively, you can also do this via most leading banks and/or brokers.

But my personal preference is through exchange traded funds (ETFs)

If choosing an ETF – you can find any duration you wish.

For example, iShares offer the following three types of duration exposure:

This list is intentionally not exhaustive. There are many similar bond funds available.

For example, for long-term exposure, I’ve started accumulating Vanguard’s ETF EDV – which has a lower expense ratio than TLT.

But an important point to note is the concept of duration risk when choosing the fund.

For example, there’s far less duration risk in the SHY (1-3 Year) vs say the TLT (20+ Year)

I explained this concept in a recent post:

The good news is we’re now seeing safety in the front-end of the curve (e.g., what we see with the 2-year yield).

The 2-year has been fairly steady of late despite the action in the “10s” – in turn causing the un-inversion of the 10-2 yield curve (which bond investor Bill Gross said will likely turn positive this year)

For example, up until the last couple of months, there has been an argument that even the 2’s were not safe. I say that because there was uncertainty around where the terminal rate was for the Fed. In other words, how many more hikes were there to come?

That’s now changed. The 2’s are now seen as a much safer place to be and it’s attracting buyers… which is keeping yields steady.

Now to be clear, we don’t see this in the 10’s just yet – but it will come. And if the Fed is more or less done (and I think they’re close) – then it’s safer to start buying 2’s.

Let’s now turn to another form of government bond – however this one offers added tax advantages.

#2. Muni Bond Market

Muni bonds are perhaps the most popular market for individuals due to their compelling tax benefits.

Similar to treasuries – these are also looking very attractive at current yields.

For example, you can get 5.0% long-term returns on Munis with the added tax benefits that Treasuries do not offer.

Some ETFs to consider include (not limited to):

Now the tax equivalent yields on these bonds are getting closer to matching equity like returns (almost 8% in some cases).

I think these also warrant a place in your portfolio.

#3. High Yield Market

Let’s say you are less interested in the tax advantages of a Muni bond – and you’re seeking yields closer to 8% or 9%.

As Howard Marks’ of Oaktree pointed out in his latest memo – these yields are almost competing with the 100-year average annualized return of the S&P 500 (which is around 10.5% inclusive of dividends).

Naturally, with yields in this range, it comes with higher risk (not unlike equities)

For example, corporate bankruptcies are as high as they have been since 2010 – up something like 30% on last year.

Expect these to increase as yields remain high.

But that’s why you can demand a yield in the realm of 7-9% or more.

For example, when credit conditions were more favourable – the returns were closer to 4-5% for high-yield debt.

That doesn’t add up – you were better off owning the equity.

That said, there are “safer ways” to play high yielding corporate debt (but they are certainly not risk free)

For example, ETFs in this category include (not limited to):

An important point of difference here:

OSTIX is an actively managed fund; vs
HYG and JNK are Indexed based (and lower cost)

You should inspect each of these ETFs to see exactly the companies, quantity and concentration of debt they’re holding.

I’ve recently started adding exposure to HYG.

#4 Investment Grade Corporate Debt

The last approach I want to share is investment grade corporate debt.

The returns here are higher than government debt (due to the risk); however less risky than high-yield.

In this instance, yields are in the realm of around 6% (where debt includes the likes of say Apple, Google, Microsoft, Coke and other quality names)

An ETFs to consider here is iShares iBoxx Investment Grade Corp – LQD

As an aside, when we were at the peak of the pandemic – the Fed said they were willing to step up and buy LQD.

As soon as this was announced – its price rocketed higher.

Note: an alternative to LQD is iShares AGG – however AGG also includes a blend of treasury debt (about 42%)

Putting it All Together

In “Rethinking Asset Allocation” – I explained why I felt the longer-term risk/reward for bonds was now starting to make more sense.

Three reasons (perhaps not limited to):

Longer duration bonds are getting to a point where the value is just too compelling. When we consider 5-year, 5-year forward inflation expectations are 2.5% – this tells me the 10-year at 5.00% is value. Typically the difference between the 10-year and inflation expectations is closer to 1.0% to 1.5%
If Real GDP growth is to trend back to levels of 2.0% (or less) next year (which I expect) – and you’re getting the 10-year at 5.00% – that’s a great deal. Over time, the 10-year yield will track real GDP.
If you’re of the view inflation is trending lower (meaning the Fed will move back to easing within ~12 months) – bond investors will see capital appreciation

For example, when the US 10-year traded at 4.00% and below – you were arguably better off in equities.

And when these yields were below 3.0% – you really had to question your exposure to this debt.

Not now.

These yields are closer to 5.0% and could easily trade higher (given the current supply / demand imbalance in the market)

But at a guaranteed 5.0% – with the prospect of capital appreciation – this is starting to make a more compelling argument (especially in a slower growth environment)

If you are new to bonds – I consider starting at the shorter-end with the 2-year.

They do not carry the same duration risk as the 10+ year.

I highly doubt you will lose money (given you have the buffer of a guaranteed 5% return).

However, if you have a longer-term (3+ year) lens – you can start accumulating longer-term duration.

There’s no need to be too aggressive yet.

For example, if we see the 10-year yield inch higher (e.g., 5.25%) – consider adding more.

I don’t think anyone will be able to predict the top in yields.

In any case, you have a number of different bond vehicles to choose from.

Each has their own risk profile and none are risk free.

Typically if it’s a higher return – it implies far higher risk.

Please carefully choose what’s best for you and your own financial position.

Regards
Adrian Tout

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Trade the Tape – Have Jobs Slowed Enough for the Fed to Pause?

Stephen Strowger — Wed, 13 Sep 2023 07:14:44 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

September 2, 2023 – Adrian Tout

Have Jobs Slowed Enough for the Fed to Pause?

Unemployment rate moves up to 3.8%
Job picture is slowing – but enough for the Ted to pause..??
Oil prices above $85/b – how does that bring down inflation..??

Another August is now in the Trader’s Almanac.

Its reputation as a negative month lived up to its name – with the market giving back ground.

That said, we’re not too far off the highs, with the S&P 500 only retracing around 1%

September however boasts the worst record of all the calendar months – so don’t be surprised to see volatility pick up.

Last week offered plenty of macro data for traders (and the Fed) to consider.

For example:

Core PCE at 4.2% YoY – higher than June’s 4.1%
ADP private sector payrolls report shows gains of 177K – much less than expected
The BLS monthly payrolls (for all jobs) showed gains of 187K – also less than expected (where previous months were also revised lower)
The total unemployment rate ticked higher to 3.8% (up from 3.5%)

With the unemployment rate at 3.8% (mostly due to higher participation in the work force) – this has some believing the Fed is done.

But can we make that call?

I don’t think so… not yet

Fed Still Has Grounds to Raise

Popular opinion on Wall Street is the Fed is now finished raising rates.

For them, the labor report this week sealed the deal.

Take widely followed blogger Barry Ritholz…

It’s “unimaginable” the Fed will raise rates says Barry…

Really? Why?

Below I will offer a few reasons why I think it’s more than imaginable.

But it requires a bit of grey matter being put to use…

To start…

A total unemployment rate of 3.8% is essentially full employment.

And whilst it’s up from last month’s 3.5% – it’s still exceptionally strong (which can be inflationary).

Second – consider JOLTS (Job Openings and Labor Turnover)

The popular narrative is because this dropped to ~8.8M openings from a high of 12M a year ago – the job market has gone “cold”

But is it?

Below is the 20 year trend:

Sept 2 2023

Prior to the pandemic JOLTS were just above 7M.

And that was considered very strong.

We are still above that level but off the post-pandemic high (which is to be expected).

But this is not a weak labor market – not with over 8.8M unfilled job openings.

Finally, consider wage growth.

Based on the Atlanta’s Feds wage growth tracker, the three-month moving average of median wage growth is still above 5%

The good news is it’s below the 6.7% average pace of one year ago…

So yes – wages are gradually coming down.

But similar to what we find with JOLTS – wage growth is still historically very high.

Powell has said he would like to see this at levels closer to 3.0%

If I put these three things together:

Total unemployment at 3.8% (anything below 4.0% is considered full employment)
JOLTS at 8.8M (still well above the pre-pandemic peak); and
Wage growth above 5.0% (three month average)

What (if anything) suggests these are where the Fed needs them to be?

Sure, these trends might continue but at what velocity?

Core PCE Ticks Higher

For now let’s assume folks like (not limited to) “Barry Ritholz” are correct with their thesis that employment has cooled enough for the Fed to quit hiking rates.

And that might be right…

However, we still have a situation where the Core PCE rate sits at 4.2% – higher than last month’s print

Sept 2 2023

From mine, this is problematic.

Prior to the Core PCE print this week – my guess was this was still likely to come in with a 4-handle – more than enough to cause concern for the Fed.

But there’s something else we should be mindful of…

And that’s what we see with energy.

Take a look at the price of WTI Crude of late – it’s now back above $85/b

Sept 2 2023

Now before I explain why this will feed into higher inflation – take a look at this post from April earlier this year.

I argued that there was a good chance that WTI crude would find support around $65 and rally back towards $100 a barrel.

Here’s the chart I offered:

April 4 2023

My logic was simply enough – we were more likely to experience a supply shock (given the policies of the current administration on fossil fuels)

But here’s the chart that matters for Powell (and rates)

Sept 2 2023

The purple line shows the price action for WTI Crude (right axis)

The orange line shows the year-on-year change for consumer price inflation (left axis)

Since the last CPI print – the price of crude has moved from well below US$70/b to over $85/b.

This is yet to show in the rear-view CPI numbers.

So what happens if we also see another bounce in CPI?

As anside, the gas price in California (San Francisco) is back above US$6.00 for 1 gallon (where there are ~3.8 litres p/gallon).

With the Aussie dollar trading ~64.5c against the USD – that’s the equivalent of ~AU$2.45 p/litre (similar to the pump prices in Sydney)

Now whilst Core PCE excludes food and energy – the price of energy permeates through to everything that’s in the Core PCE calculation.

Essentially Core PCE is what you pay for goods and services.

And as we know, almost everything we consume requires energy to manufacture (specifically crude).

In summary, if we continue to see WTI Crude trade well above US$70/b (which appears likely due to supply constraints) – this does not bode well for inflation.

S&P 500 Recovers the 10-week EMA

Whilst the month ended lower – stocks made up some lost ground on the perceived ‘softer’ labor print.

Echoing Ritholz etc – the perception is 3.8% unemployment equals “no more Fed”

Maybe. But I’m less convinced.

However, this perception was enough to also drive yields lower – in turn giving a boost to stocks.

Again, this all comes back to bond yields.

Let’s take a look using the weekly chart:

Sep 2 2023

Technically it was a good win for the bulls this week by reclaiming the 10-week EMA (red-line)

The close below this moving average last week looked ominous.

Looking at the chart, I think there’s every possibility that the market now continues to grind higher.

For example, we could challenge the 4600 made late July.

And this is why you should maintain some exposure to the market.

I personally think it’s a mistake to be either:

overly long the market; and equally
hold onto too much cash (e.g., more than 50%).

For me, my exposure is 65% long with no short positions (or long puts).

My year-to-date performance is ~13.1%

I’ve underperformed the S&P 500 YTD due to sitting in ~35% cash.

That said, this was also the reason I outperformed last year by ~19%

For example, when the market dropped sharply the past few weeks – my downside was limited by comparison.

And as I’ve shared recently – I think the risks to the downside still meaningfully outweigh any potential upside gains.

Therefore, at this stage I’m not putting any new cash to work.

And if I did – it would be more in value (lower PE names) – which have trailed the market.

Putting it All Together

For me the economic data was certainly mixed.

My assumption is the lower JOLTS number (to “only” 8.8M openings) was a catalyst for lower bond yields.

Lower bond yields typically translate into stocks (especially tech) catching a bid.

Add to that a softer than expected nonfarm payrolls report and away we went.

But I ask the question of whether this is really a soft labor market that will bring down inflation?

3.8% unemployment is full employment. And 8.8M job openings exceed that of pre-pandemic levels.

However for me the big number is Core PCE at 4.2%

That’s still a long way above the Fed’s target of 2.0%.

And with oil prices rising of late – I think this will only add to any inflationary pressure.

Therefore, I can’t follow the likes of Ritholz (and most others) making a call of “3.8% unemployment equals Fed on hold” – it’s premature.

Irrespective – if the Fed were to hold rates here – I expect them to stay high for many months ahead (e.g., well into 2024).

And with inflation slowly falling – that means real rates are going up.

That will hinder both growth and earnings.

Regards
Adrian Tout

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Trade the Tape – Buffet is buying Bonds

Stephen Strowger — Mon, 07 Aug 2023 10:39:40 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

August 6, 2023 – Adrian Tout

Buffett is Buying Bonds

Why fixed income is very well placed here
Buffet is buying tens of billions in bonds
Quick update on my 2 favoured bond ETF’s

Warren Buffett is pouring tens of billions of Berkshire money into short and longer-term bonds.

And I’m not surprised…

For example, July 9th I offered this post “Think About Adding Bonds”

Shorter term bills were offering investors ~5.50% and the longer-date 10-year bond above 4.0%

That’s extremely attractive.

Here’s another way to frame it…

With the S&P 500 trading close to 4600 (at the time) – the Index would need to trade ~4850 over the next 12 months to offset what you can receive risk fee.

Now with earnings expect to come in around $220 this year – and perhaps $235 next year (which assumes we avoid a recession) – that’s 2024 PE of ~21x

From mine, that’s a high bar (and not without risk)

For example, if we are to suffer a recession in 2024 (my base case) – then earnings of “$235 per share” will not materialize.

Do you think we can rule-out either a recession or slow-down?

I don’t.

So why not secure between 4.00% and 5.50% with some of your portfolio?

That’s exactly what Buffett’s Berkshire Hathaway decided to do…

Smart.

US 10-Year Above 4.00%

Warren Buffett told CNBC he is actively adding exposure to both treasury bills (shorter duration); and longer term bonds.

In an interview with CNBC’s Becky Quick last week – Buffett said:

“We bought $10 billion in U.S. Treasurys last Monday. We bought $10 billion in Treasurys this Monday. And the only question for next Monday is whether we will buy $10 billion in 3-month or 6-month” T-bills.

For those less familiar – T-bills are shorter-term. Bonds are longer duration.

Personally, I think Buffett’s timing is quite good.

And whilst I think there is every chance yields could trader higher (i.e. bond prices fall) – Buffett is securing very attractive risk-free long-term returns.

If nothing else, it also acts as a great hedge in the event things turn negative.

And if we do happen to enter a recession next year – the capital appreciation on those bonds will increase meaningfully.

But let’s take a look at the all-important US 10-year yield:

Aug 6 2023

Last week, these yields traded as high as 4.22% – as high as we’ve seen since October last year.

Towards the end of the week – they pulled back closer to 4.0% (which resulted in stocks catching a small bid)

Again, my feeling here is they could easily go higher.

For example, one scenario is these yields surge above 5.0% (also ~61.8% outside the distribution I’ve flagged) – which would likely see stocks trade meaningfully lower.

I would be surprised if that were the case – but you never know.

However, this is a bet billionaire investor Bill Ackman is willing to make…

Bill Ackman sees Long-Term Yields Surging

Ackman thinks bond yields still have a long way to go…

He believes inflation will be far more persistent than what the market is pricing – betting the US 30-year yield will trade at 5.50%

Today the US 30-year treasury trades at 4.20%

Put another way, Ackman sees bond prices crashing…

From CNBC:

“We implement these hedges by purchasing options rather than shorting bonds outright,” Ackman said late Wednesday. “There are many times in history where the bond market reprices the long end of the curve in a matter of weeks, and this seems like one of those times.”

Ackman argued that if U.S. inflation is 3% in the long term instead of 2%, 30-year Treasury yields could hit 5.5% “and it can happen soon.”

“I have been surprised how low US long-term rates have remained in light of structural changes that are likely to lead to higher levels of long-term inflation, including de-globalization, higher defense costs, the energy transition, growing entitlements, and the greater bargaining power of workers,” he said.

Ackman pointed to several factors including the desire of China and other countries to decouple financially from the U.S., growing concerns about U.S. governance, fiscal responsibility and political divisiveness — the latter three issues prompted the latest Fitch downgrade.

“I have also been puzzled as to why the (U.S. Treasury Department) hasn’t been financing our government in the longer part of the curve in light of materially lower long-term rates,” Ackman said. “This does not look like prudent term management in my opinion.”

Now Ackman could be right… however it will be disastrous for equities if he is.

Further to what I outlined last week – the market is bracing for a deluge of new (longer-term) treasury bonds being issued from the US government.

Deutsche Bank strategist Steven Zeng said in a recent research note he expected net bill issuance of $400 billion in June, followed by $500 billion between July and September.

In total, Zeng estimated $1.3 trillion in net bill issuance by the end of the year.

Investment firm Glenmede added that this influx of funds into Treasury securities in the coming weeks may have the adverse effect of reducing overall liquidity (e.g., as investors like Buffett take money out of the market to take advantage of these yields)

Again, if true, that could be a negative for equities.

Two Bond ETFs to Watch

Last week I was adding to my bond exposure as yields rose.

In other words, I was taking the opposite side of the trade to Bill Ackman.

I chose to do this via two bond ETFs

AGG – iShares Core U.S. Aggregate Bond ETF (note: similar ETF is LQD)
EDV – Vanguard Extended Duration Treasury ETF (note: similar ETF is TLT)

Again, I talked about the composition of these (low cost) bond ETFs here.

With the sharply higher move in yields – both ETFs were marked down to what I think are attractive (long-term) levels.

1. EDV – Extended Duration Treasury ETF

Let’s start with the long-term chart for Vanguard’s EDV:

Aug 06 2023

When I issued the post ‘Think About Adding Bonds’ – I suggested there was no need to rush into this trade.

My expectation was the Fed would not only raise rates – but also use more hawkish language – sending yields higher.

However, US yields also got a surprise boost from the Bank of Japan, allowing their interest rates to go higher.

The ETF subsequently dropped from $82 (when I wrote the post last month) down to around $78.91 at the time of writing.

The long-term low for EDV is around $73 (which we could re-test if yields keep rising).

However, I think adding some exposure around the current level is a good long-term risk/reward bet.

Not only do you secure an attractive yield – there is the opportunity for capital appreciation should yields fall (opposite the increased risk of recession and/or economic slowdown).

And if we see a price closer to $73 – I would add more.

2. AGG – iShares Core U.S. Aggregate Bond ETF

The other ETF I added exposure to last week was AGG.

This is quite different to EDV as it gives me exposure to high quality corporate debt.

Aug 06 2023

AGG also moved sharply lower on the back of higher yields.

Similar to EDV – I think this also represents a good long-term risk/reward bet at current levels.

Again, it’s an attractive yield with the likelihood of meaningful capital appreciation next year.

Putting it All Together

Most investors will yawn at the prospect of buying a bond ETF.

And I get it…

There is nothing exciting about owning fixed income.

But the game of investing isn’t supposed to be exciting.

It’s meant to be lower risk and boring.

Now given the staggering ~30% rally in equities over ~9 months – the pathway higher feels narrower.

What’s more, it’s now laced with risks.

For example, if economic growth and the labor market continues to be strong – it justifies the Fed to continue with rate hikes.

On the other hand, if the economy shows signs of weakening (as we saw with the most recent labor report) – investors will once again start worrying about recession.

Recessions typically mean lower bond yields / higher bond prices.

My view is economic growth slows into next year – where the ‘long and variable’ lags of the Fed’s higher rates start to bite.

What’s more, I think banks continue to restrict lending.

If I’m right (and I may not be) – then bonds are a good hedge.

For example, longer-term treasury debt (EDV); and high-quality investment grade debt (AGG) offer investors strong yields and a hedge against a weaker economic outlook.

Now if the S&P 500 was trading around ~3800 and interest rates were closer to 3.0% – I would be betting on stocks.

But that’s not the equation…

We now have the S&P 500 trading at 4478 with an effective Fed funds rate of 5.50%

With earnings per share expected to come in ~$235 next year – the asking forward PE isn’t attractive.

For me, fixed income looks well-placed at this juncture.

Regards
Adrian Tout

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Trade the Tape – Will a US Debt Downgrade be a ‘Bearish’ Catalyst..?

Stephen Strowger — Thu, 03 Aug 2023 07:30:13 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

August 2, 2023 – Adrian Tout

Will a US Debt Downgrade be a ‘Bearish’ Catalyst?

Fitch downgrade US Debt
Interest payments relative to GDP sky-rocket
Could the market stumble if bond yields continue to rise..?

Earlier this week, Fitch Ratings downgraded the U.S.’ credit rating.

Stocks slipped a little on the news and bond yields ticked higher.

The US 10-year treasury yield is now north of 4.10%

Fitch cited “expected fiscal deterioration over the next three years” and an erosion of governance.

Hard to argue…

Fiscal restraint is not one of the government’s strengths.

But this isn’t entirely new news…

For example, the credit agency placed the nation’s rating on watch in May following a near-default after members of Congress butted heads over raising the debt ceiling.

However, this put the wheels in motion.

The debt ceiling was raised (surprise surprise) which meant the spending was set to continue.

As a result, yesterday Fitch marked the country’s rating down to AA+ from AAA.

Here’s what they said:

“In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025”

I will show what a “deterioration in standards” looks like in a moment.

But first, there were some people who were ‘less than thrilled’ by the announcement.

“Ridiculous” says JP Morgan CEO

Never one to mince words, Jamie Dimon called the credit downgrade “ridiculous”

Here’s what the CEO of the US’ largest bank (by assets) told CNBC:

“It doesn’t really matter that much because it’s the market, not rating agencies, that determines borrowing costs.

Still, it’s “ridiculous” that other countries have higher credit ratings than the U.S. when they depend on the stability created by the U.S. and its military.

To have them be triple-A and not America is kind of ridiculous. It’s still the most prosperous nation on the planet, it’s the most secure nation on the planet.

We should get rid of the debt ceiling. It’s used by both parties in ways that sow uncertainty for markets.

Dimon makes a good point… the U.S (specifically its debt) remains the ‘center’ of the financial universe.

I often say the US 10-year treasury is the most important financial asset on the planet.

Every financial instrument is tied to it.

Your mortgage, car loan, student debt, credit card debt – all tied to the US 10-year yield.

And if that goes… so too does the entire financial system.

However, just because you are the “prettiest girl at the dance” (which is what Jamie Dimon is trying to tell us) – it doesn’t mean you don’t make poor decisions.

The U.S. is the world’s reserve currency and that comes with enormous responsibility.

What’s more, it doesn’t mean you can abuse it.

And when I look at the data (vs people’s opinions) – there are reasons to raise some ‘yellow flags’.

Total Public Debt to GDP

The first chart worth noting is the level of total public debt to GDP:

Aug 2 2023

This chart is slightly older than me (I was born in ’71) – going back to 1966.

For context, just after World War II, the total public debt to GDP managed to exceed 105%.

However, in the absence of any additional ‘world wars’ – the debt contracted as the economy grew faster than the debt needed.

And that’s what should happen…

As an aside, the debt is never really paid down. We just assume the economy continues to grow faster.

Now there are two key points to highlight on this chart:

During the 1980’s we had a period of massive fiscal deficits. This saw the debt balloon to a level which many thought was simply not sustainable. Ross Perot’s Presidential campaign was based on the US not being fiscally responsible. Wiki states “Perot focused the campaign on his plans to balance the federal budget, further economic nationalism, strengthen the war on drugs” (he wasn’t successful)
The second point of significance is the period of the Global Financial Crisis. The US economy crashed – we had the Troubled Asset Relief Program – massive public debt was issued (‘bail outs’) – and we had the S&P downgrade US debt.

Which brings us today… where we touched a level of 135% opposite the ‘COVID debt binge’ and fiscal stimulus.

However, given recent economic growth (and need to stimulate less) – the debt ratio has come back to around 119%.

Still very high – but better in relative terms.

This led Treasury Secretary Janet Yellen to say “Fitch’s timing is a little odd”:

“Fitch’s decision is puzzling in light of the economic strength we see in the United States. I strongly disagree with Fitch’s decision, and I believe it is entirely unwarranted“

“Its flawed assessment is based on outdated data and fails to reflect improvements across a range of indicators, including those related to governance, that we’ve seen over the past two and a half years.”

Yellen is clearly talking to the move down from 135% to around 119%

But there is more work to be done…

However there is another chart which may help explain why Fitch issued the downgrade.

Federal Interest as a Percentage of GDP

Whilst a public debt ratio to GDP of more than 100% could be cause for concern – the growing interest bill on that debt deserves attention.

This brings me to this chart:

Aug 02 2023

This shows the interest expense of the total public debt relative to the size of the economy.

Through the 1980s – when Fed Chair Volcker was raising rates to ~18% to squash inflation – the interest expense got very high.

Not only was it above 3.0% of GDP – it was also a whopping ~10% of the total federal budget.

This chart above is only current to the end of 2022 (you can find it here)

However, as it stands at the time of writing, the current ratio of interest expense is now pushing 2.50% and many fear on track to challenge 3.0%

This is what should be ratcheting up the ‘heat’ on the current Administration to curb spending.

But this is real money flowing out (which could be spent elsewhere)

Remember:

The denominator is the size of the economy.

Therefore, if the economy continues to grow north of 2.5%, this helps.

But what doesn’t help is if the primary source of that growth is government spending (which it has been)

The growth needs to come from the productive (revenue generating) private sector.

And when (not if) we suffer a recession, this will only push the interest expense ratio higher.

As regular readers know, I think we are going to suffer a recession at some point towards the end of the first half of next year.

If the fiscal situation has not improved by then (and I don’t see why it would given the policies) – this could be a problem.

And I think this is where Fitch is coming from.

Could be wrong.

Stocks Could Stumble on Downgrade

The market lost a small bit of ground today on news of the downgrade.

However, it could be more to do with the strong upward move in bond yields we have seen the past week or so.

For example, the US 10-year is back above 4.0%

What’s more, that move isn’t done.

I say that because the US Treasury is set to issue over $1 Trillion in new bonds in the next month or so… and they will need to offer higher yields to attract investors.

This is going to put pressure on bond prices (given the torrent of new supply) — which is an opportunity for long-term holders.

But in the short-term – bond prices will likely fall.

From my perspective, I would like to see the 10-year closer to 5.0% (vs 4.0%) – but that’s not what the stock market has in mind.

Anything north of 4.0% on the 10-year will act as a headwind (particularly for growth based stocks)

What’s more, that hurts economic growth – placing more pressure on the interest expense ratio to GDP (i.e. where you need economic growth to outpace debt).

Let’s take a quick look at the S&P 500 using the weekly chart…

Aug 2 2023

Using this timeframe, we can see how stocks have barely reacted to the news of the credit downgrade.

Over the weekend, I said to readers to act with some caution – as we were overbought using the weekly RSI.

I also said the RSI is not a signal I use in isolation to “sell” or “go short”.

It simply means we could be about to see a pullback.

For what it’s worth, I don’t think stocks have pulled back yet.

When the Index moves higher or lower by “2-3%” – it’s par for the course.

I don’t pay zero attention to those moves (in either direction)

However, I will pay closer attention once we test the 10-week EMA (around ~4400)

At that point, we will be trading around 5% off the highs.

But I won’t be buying…

5% is not a lot given how far we have come.

But it may be enough for tactical buyers to come back in after some profit taking?

Could we see a bigger move lower?

Yes…

For example, if bond yields continue to push higher (especially on the back of $1T in new Treasury issuance), this could act as a tipping point for the bulls.

And if we see 4200 on the S&P 500 (which acted as a strong level of resistance for ~12 months) – this would be an area to add to quality positions.

To be clear, if earnings are to come in around $220 this year (which I think is still optimistic) – you’re paying ~19x forward.

That’s not a bargain… so be very selective.

Putting it All Together

Downgrades to US credit are not new.

Is this one deserved?

Well that all depends on your lens.

I can understand why the likes of Jamie Dimon and Janet Yellen were not impressed. They see the US as the best looking girl at the dance.

But do other countries see it the same way?

I’m sure they have a very different frame of reference.

Irrespective of your lens, there is no debating the US is going to be paying a lot more in terms of its interest expense.

What’s more, that money could be used for things like (not limited to) education, health or defense.

Instead it’s being ‘wasted’ on interest (due to excessive spending)

Now whilst bond yields traded near zero – no-one was paying too much attention to the interest payments.

“We can afford it” was the mantra…

Not now…

The level of debt (relative to the size of the economy) deserves scrutiny when interest costs grow 35%+ for two years straight.

The CBO project by 2030 – the US’ interest expense will exceed 3.3% of GDP (which would exceed previous levels).

Here’s another way to frame it:

Within 10 years, net interest costs will exceed federal spending on crucial programs like Medicaid and defense.

Is that a good thing?

A healthy debate is needed on the levels of borrowing and spending by government.

No government has ever spent their way to prosperity.

And if a credit downgrade (or two) is needed to have that discussion… that’s a good thing.

In the near-term – continue to keep an eye on the US 10-year yield.

It’s not finished going higher and that could pressure equities……

Regards
Adrian Tout

The post Trade the Tape – Will a US Debt Downgrade be a ‘Bearish’ Catalyst..? first appeared on Ethical Offshore Investments.

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Trade the Tape – Half Way Through Earnings: 81% Beat on EPS

Stephen Strowger — Sat, 29 Jul 2023 09:43:35 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

July 28, 2023 – Adrian Tout

Half Way Through Earnings: 81% Beat on EPS

Earnings & Revenue are beating expectations
Why lower inflation could be headwind to earnings growth
Is paying 21x forward earnings a good risk / reward bet..?

This week was the busiest week of earnings on the calendar.

Half of all S&P 500 companies have now reported for Q2.

And so far… so good!

81% of companies have beaten earnings per share (EPS) expectations – by an average of about 6.4%

By way of comparison – prior to COVID – the average EPS beat was in the realm of ~3%

What’s more, about 64% of all companies have also beaten top line expectations.

Here is a list of what sectors are performing best (relative to expectations)

Consumer Discretionary – up 36.3%
Communication Services – up 16.1% (dominated by Google and Meta)
Industrials – up 11.5%
Technology – up 0.3%

What’s interesting (to me) is tech is basically flat.

However, with prices rallying, what we have seen is simply multiple expansion. I will talk more to why this is a risk shortly…

And in terms of the worst sector performers:

Energy – down 48.5% (which is now a good sector to start looking)
Materials – down 29.3%; and
Health Care – down 29%

In summary, the market is celebrating the stronger-than-expected numbers.

And this has some asking – is the bottom in for earnings (after what will be three consecutive quarters of contraction)?

Is the Earnings Trough In?

Given the above, it’s little wonder stocks continue to rally.

But another reason we’re seeing new highs are improved expectations looking forward.

That is, they think the bottom is in.

And whilst that assumption could be true – it also assumes there is not a recession next year.

Earnings will always contract during a recession. No exceptions.

For example, below is what the market is pricing in with respect to EPS growth YoY:

Q2 2023 – Down 6.4% (vs initial expectations of around 7%)
Q3 2023 – Up 1.1%
Q4 2023 – Up 9.3%
Q1 2024 – Up 8.4%
Q2 2024 – Up 14.5%

From Q4 onwards, the market has set high expectations.

And that’s the essence of the bullish thesis; i.e.,

Very strong earnings; and
Strong economic momentum

Now the S&P 500 commands a forward multiple of close to 21x – on the basis we will grow into these valuations.

So what could go wrong?

Reasons to Challenge the Bullish Thesis

Look, there’s a lot to like with what we have seen with earnings so far.

There is very little ‘blood on the streets’… basically none.

What’s more, we’ve seen exceptionally strong fund flows – with over $70B going into mutual funds.

That’s a good sign of bullish momentum.

But does that translate into everything will “come up roses” the next 12 months?

That’s hard to say but let’s try and think of a few questions we should ask.

Let’s start with what the market is asking you to pay.

Remember:

It’s not just about what you buy – it’s equally how much you pay.

For example, no-one debates that “Apple or Microsoft” are great stocks. But that doesn’t mean you can’t get badly hurt paying 31x forward earnings.

To start, with EPS for 2023 forecast around $220 per share – with the S&P 500 at 4582 – that’s 20.8x forward.

If we take the inverse of this PE ratio (1 / 20.8) – we get an earnings yield of 4.8%

That’s far less than the risk-free money market yield of around 5.25%

As a benchmark – the last time we saw this happen was in 1999.

Not surprisingly, it was also when tech stocks traded at 31x forward.

We all know what happened next…

But think of it this way…

With a risk-free rate of ~5.25% (or thereabouts) – the S&P 500 would need to rally to 4834 to match what you can get risk-free today.

From mine, that’s a tall order, where the forward PE would be closer to 22x.

Therefore, you need to ask yourself two things:

Is the risk to the upside? or is it
More towards the downside?

If you ask me, it’s the latter.

However, if you believe that earnings are about to explode higher (and economic conditions are going to become more favorable) – then maybe you think the risks are to the upside.

But that’s not me…

What are the Potential Triggers?

From mine, the most important thing to consider is what we are being asked to pay for earnings.

Again, if everything goes to plan, earnings will see:

Q3 2023 – Up 1.1%
Q4 2023 – Up 9.3%

But is that unrealistic?

Let’s consider the following…

One of the primary beneficiaries of inflation are earnings.

That is why it’s always good to buy stocks in a high inflationary environment.

Consider Walmart as a basic example.

Last quarter they reported sales growth of 6% YoY.

But guess what inflation averaged over that time? You got it – it was ~6%.

Put another way – in real terms their sales were flat.

Company revenue is always reported in nominal terms. Therefore, they benefit from inflation.

Now consider the alternative…

When inflation is cooling (as it is) – then earnings do not stand to enjoy the same “free” ride.

That will be headwind in terms of year-on-year comps… making those double-digit growth assumptions very aggressive.

The other factor is what is happening in the broader economy.

I talked to some of the questions we should be asking here… below is a recap:

Consumer excess savings falling from $2.3T (2022) to less than $1.0T;
Credit card debt exceeding $1.0T – carrying an average interest rate of 24% (where banks have doubled their loss provisions);
Retail sales are slowing;
Fiscal spending is starting to be curtailed (after record deficits the past two plus years);
The Fed likely to continue to hold rates where they are – meaning real rates are rising (as inflation falls);
Central bank also continue to reduce their balance sheet (a form of monetary tightening); and finally
The 18-24 month lag effect of the 525 basis points of rate increase (which is only just starting to bite)

All of these are potential triggers for a generally slowing economy.

With that let’s take a look at how the market finished the week.

S&P 500: Euphoric

The price action so far this year has been nothing short of euphoric.

Rarely do we see the S&P 500 up ~20% in the space of just 7 months.

But here we are…

And whilst the market has the potential to keep going (as it has a lot of momentum) – one needs to be mindful of the downside risks.

The one technical thing to call out is what we see with the weekly RSI (lower window)

It’s now in overbought territory (above 70)

For clarity, this is not a trading signal where you sell or go short.

The market can remain in an overbought zone for weeks or months.

For example, look at what happened through April to September 2021.

The market was overbought during this entire time (based on the weekly RSI). However, it rallied from 4220 to 4535 before correcting to the tune of around 6%

We could easily see something similar…

But I would not be surprised to see the S&P 500 trading closer to the 10-week EMA (4377) at some point over the next 4 weeks (e.g. ~4.5% lower)

Finally, in terms of how I’m trading this – I continue to maintain 65% long exposure.

I do not have any short positions and/or puts (nor have I through this entire rally).

Year-to-date my returns are 13.2% – underperforming the market due to maintaining lower exposure.

I had a solid week – with banks doing well (where I added exposure to the likes of BAC, JPM and WFC during the so-called banking crisis).

It’s too early to call that trade a win (ask me in 3 years) – but so far they are doing okay.

I also accept I will continue to underperform the S&P 500 should the market continue to rally from here.

However, I’m happy maintaining around 35% cash to buy at more attractive levels (which could happen very quickly)

I’m not willing to put new capital to risk at these valuations.

Putting it All Together

If you are wondering what to do – you should answer these two questions :

Is it a good long-term risk / reward bet to pay 21x forward earnings for stocks with interest rates at 5.25%; and
Is it a good strategy to buy on the assumption of double digit earnings growth – in the face of a potential recession (next year)?

For example, with respect to #1, history shows that buying the market at this multiple has not been a successful strategy.

Sure, it may rally another 5% or so, however the risks are to the downside.

With respect to the #2 – if we are to experience a recession next year (and I still think we do) – then earnings will contract (they will not expand double digits)

But your view will be different to mine…

In summary, both the forward PE is far too high (at 21x) and earnings expectations feel naive.

That said, I continue to maintain a healthy level of long exposure.

Regards
Adrian Tout

The post Trade the Tape – Half Way Through Earnings: 81% Beat on EPS first appeared on Ethical Offshore Investments.

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Trade the Tape – What Banking Crisis..??

Stephen Strowger — Tue, 18 Jul 2023 08:23:27 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

July 17, 2023 – Adrian Tout

What Banking Crisis..??

S&P 500 now up ~ 30% from the October 2022 low
Financial conditions continue to ease; and
Will the Fed remove their ‘liquidity put‘ with the banking crisis over..?

Are things actually looking up?

If your measure is the equity market… you would say absolutely.

Stocks continue to charge higher on the back of lower inflation and optimism the Fed is closer to the end of its hiking cycle.

What’s not to like?

However, there’s something else giving markets a boost.

Easy money!

Financial conditions are as easy as they’ve been all year.

For example, it was only 4 months ago and we had a mini banking crisis… where funding was a lot tighter.

That’s now a distant memory.

Take a look at the Chicago Fed’s Financial Conditions Index:

Jul 17 2023

The spike higher in financial conditions happened in March (when SVB went belly up) – coupled with a distinct loss of risk appetite.

That’s mostly now rear-view mirror…

However, what it led to deserves comment.

Banking ‘Crisis’ Led to a Narrow Market

Last Friday marked the unofficial start to the Q2 earnings season.

We heard from the US’ largest bank by assets (and stock I own) – JP Morgan Chase (JPM).

Revenue rose 34% as JPM took advantage of higher rates and solid loan growth.

It was an incredibly strong quarter.

Wells Fargo and Citi also beat expectations… commenting that consumers remain in good shape.

We will hear from Bank of America tomorrow (which I also own) and other key regionals.

Now March 10 this year – Silicon Valley Bank (SVB) collapsed.

The sentiment was very different… it was ‘risk off’.

I had some readers (who unsubscribed at the time) telling me I was totally wrong – and this was a repeat of 2008.

I wished them well with the short bets on banks (and the market).

As it turns out, it was not the end of the US banking sector (as they predicted) – and it was the start of a very narrow rally:

July 17 2023

From mine, this tells an interesting story.

What we saw was money finding its way to whatever offered the best return opposite the lowest risk.

Stocks like Apple, Amazon, Google, Meta, Microsoft, NVIDIA, Tesla, Netflix all ticked that box.

Strong predictable cash flows with great balance sheets.

But this behaviour isn’t new…

In fact this is a pattern we have seen many decades ago.

For example, almost 30 years ago a hedge fund known as Long-Term Capital Management collapsed – which saw the Fed rush in to ensure there was liquidity.

The Fed – under Alan Greenspan – also announced an intra-meeting cut in the fed funds rate and the effect was immediate.

Here’s Bloomberg:

Rinse and repeat in 2023.

Now the events which caused the collapse of LTCM were nothing like what we saw with SVB and First Republic.

But the (central bank) remedy and subsequent market impact were similar.

For example, whilst effective Fed funds rates continued to rise, the extra liquidity offered from the Fed acted like a “put” in the market.

I talked about effect on May 20 – with a post titled “The One Thing Driving the Market”

But here’s the thing:

It’s unlikely the Fed has any motivation in creating a new asset bubble.

But that’s what we might have (in tech at least) – where forward PEs (in many cases) are now above 30x for popular stocks.

From Matt Maley of Miller Tabak framed it this way (bold emphasis my own):

A big part of the reason for the very positive action in the stock market (and other asset classes) since March has been the return of the “Fed put”; there is little question in our minds that this has been the case.

The very large injection of liquidity that they engaged in during the regional bank crisis in March (which can be seen by the BIG jump in their balance sheet at that time) shows that the Fed took a page from their emergency playbook from the pandemic-induced crisis in 2020.

The question now… is whether the banking crisis has calmed down enough to allow the Fed to remove their “Fed put” once again (or to at least push it to a level that is more “out of the money” than it has been in recent months)… or if the situation is still more precarious than anybody is letting on.

Listening to most of the “Fedspeak” recently, it sure looks like they want to be much less accommodative with their “Fed put” than they have been over the past few months.

And therein lies the rub…

S&P 500 Optimism

Below is the ‘straight up‘ price action we have seen the past few months.

July 17 2023

If we look back to October – we are up a staggering 30%

But for me, what makes this rally even more curious is its been without any increase in earnings.

In fact, according to Factset, we are about to see the third consecutive contraction in earnings.

In other words, what we have is meaningful multiple expansion.

Most of that has been less than 10 tech stocks – however more recently – we have seen other sectors catch a bid

For example, banks, energy and industrials are now participating.

Irrespective, the market clearly thinks that conditions are only going to get better.

What’s more, they believe the Fed is not about to take away the punchbowl.

For me, stocks are too expensive given 2-year bond yields are trading close to 5%

That’s the equivalent of a forward PE of 20x (where 1/5 = 20) – where it’s risk free.

Now by comparison…

With the S&P 500 trading 4522 and earnings expected to be ~$220 (which feels optimistic) – that’s a forward PE of 20.6x

That’s an earnings yield of 4.9%

From mine, that is not a compelling risk / reward opposite the risk-free rate.

Putting it All Together

I do think that Matt Maley is asking the right question:

Whether the banking crisis has calmed down enough to allow the Fed to remove their “Fed put” once again (or to at least push it to a level that is more “out of the money” than it has been in recent months)… or if the situation is still more precarious than anybody is letting on.

With respect to the latter – banks are in the process of telling how precarious things remain.

So far so good… but most of the uncertainly sits with smaller regionals.

The big banks will be fine (as I wrote at the time).

But in terms of the former – should the Fed remove their liquidity “put” – it will be interesting to see whether this continues to buoy markets.

More on that July 28/29 when the Fed gives their most recent update on monetary policy.

Until then, the focus will be earnings and whether current prices justify the frothy valuations.

Regards
Adrian Tout

The post Trade the Tape – What Banking Crisis..?? first appeared on Ethical Offshore Investments.

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Trade the Tape – Fed can Keep Raising

Stephen Strowger — Fri, 14 Jul 2023 08:48:01 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

July 12, 2023 – Adrian Tout

Fed Can Keep Raising w/Core CPI 4.8% YoY

Market celebrates headline CPI at 3.0%
However, Core CPI remains well above the Fed’s objective
Bond yields quick to fall on anticipated cuts – but I think they overshot

From the market’s perspective – today was “beer o’clock”

The inflation job is done! Tools down!!

The market cheered the news of the latest monthly CPI and Core CPI print.

Here’s a quick summary:

Headline CPI rose 0.2% in June and was up 3% from a year ago, the lowest level since March 2021.
Excluding food and energy, Core CPI increased 0.2% MoM and 4.8% YoY
Soft gains in food prices and declines in used vehicle and airline prices helped keep inflation down, while shelter prices continued to rise.
Worker wages adjusted for inflation increased 1.2% from a year ago.

In fairness, there is good news.

Headline CPI down to 3% from a year ago is a welcomed relief.

That said, it was mostly inline with expectations given the baseline effect (i.e. it’s coming off a very high inflation number last year)

But…

Core CPI at 4.8% for the past 12 months (4.6% over the past quarter) should temper some of the enthusiasm.

July 12 2023

From mine, it’s still meaningfully above the Fed’s 2% objective (green line).

Question is – how much of that was considered?

Bond Prices Rally / Yields Fall

Last Sunday I talked about how it was time to consider adding bonds to your portfolio.

I offered readers a couple of helpful ETFs for exposure.

For example, with the US 10-year, you were paid paid ~4.0% with the chance of considerable price appreciation on the basis:

(a) inflation continues to cool over the next 12+ months; and
(b) Fed could start reducing rates late next year (pending Core PCE inflation)

In other words, if rates start to fall with a lower inflation risk, it means bond prices could materially appreciate.

But for now, you are being paid 4.0% risk free at the longer-end (and near 5.0% at the front end)

That’s attractive.

Since I wrote that blog – bond yields have dropped (which means bond prices have gone slightly higher)

Following today’s CPI print – yields saw another move lower.

But here’s the thing:

I think both equities and bonds are getting a little too ‘trigger happy’.

To be fair, the market is slowly getting on board with the fact the Fed is closer to its terminal rate (e.g. perhaps another 50 basis points from here).

But the pattern I have observed is investors will often get “bulled up” on the back of one positive print.

Identifying patterns and investor psychology is critically important (more on why in my conclusion).

From there, the market is making the (bold) assumption the Fed is pretty much done.

Presumptuous?

I think so.

Core inflation is likely to only come down slowly over time. For example, it could something be closer to this:

For example, it would not surprise me to see Core CPI still above 3% 12 months from now.

And if that’s true (and it may not be) – then the Fed could comfortably hold rates where they are.

Powell has said (and I’m paraphrasing here “we will get to the policy rate where we want it” (likely to be at least 25 bps higher) – and they will keep it there for a long time.

He has said this could easily be one year or two.

And for me, that’s the disconnect in the market.

Here’s what I mean:

After today, the market now believes we will see 125 basis points of rate cuts in 2024.

Last week that was 80 basis points

Question:

Do you think the Fed is thinking of cutting rates by 125 basis points next year (or more like 150 bps after they raise 25 the next meeting)?

My best guess is not if Core inflation is anything above 3%.

When Powell talks at the next Fed meeting – he is going to remind investors that Core inflation is still far too high and their work isn’t done.

And when we get Core PCE on July 28 (their preferred inflation metric) – that will probably reinforce the case.

Yield Curve to Remain Deeply Inverted

The other reason to hold on “breaking out the bubbly” is what we see with the yield curve.

The longer this stays inverted (i.e., below 0%) – the more pain this is inflicting on business.

And at some point later this year – it’s likely to have a meaningful impact on the real economy (if not already).

For example, take the popular 2-year / 10-year curve:

July 12 2023

Another way of reading this chart is it’s the (bond) market saying the Fed is far too tight.

In other words, they need to lower rates at the short-end (so they are below that of the longer end).

However, as I discussed last week, the US 2-year yield was close to ~5% and the 10-year ~4% – resulting in a 100 bps inversion.

But if the Fed continues to hold rates higher (with core inflation well above its objective) – the yield curve will remain inverted.

And from mine, only when the Fed starts to cut rates will we see this curve back above 0%.

To be clear, the curve may steepen a little if the market thinks the Fed is closer to being done (like it did this week).

That’s simply the short-end getting “in front” of the Fed.

But in terms of the shorter-end trading at a lower yield than the long-end (implying it moves above 0%) – that could be at least 12+ months away.

And that hurts.

Keep Watching Bonds

As I was saying last week – keep your eye on treasuries as a great risk / reward play into next year.

With yields dropping this week – bond prices have rallied (along with stocks)

However, they may have overshot on just one data point.

That’s the typical pattern.

I think once we see the Fed raise rates again July 26th – reminding investors their work is far from done – yields will resume their upward move.

That’s the point where you can add bond ETFs like:

AGG – iShares Core U.S. Aggregate Bond ETF (note: similar ETF is LQD)
EDV – Vanguard Extended Duration Treasury ETF (note: similar ETF is TLT)

… as you position your portfolio to be more “recession ready” for 2024.

Putting it All Together

On an unrelated note – I encourage readers to subscribe to Howard Marks’ free newsletter.

His latest memo is titled “Taking the Temperature”

He provides a great review of the various times (in his 50+ year career) when the market was showing either irrational exuberance or extreme pessimism.

However, the ability to identify these patterns is difficult.

For Marks… it took him three decades to really understand. I quote:

You may have noticed that the first of the five calls described above was made in 2000, when I had already been working in the investment industry for more than 30 years. Does this mean there were no highs and lows to remark on in those earlier years? No, I think it means it took me that long to gain the insight and experience needed to detect the market’s excesses.

That gives you some perspective on how much time it takes to really understand markets. It’s both time and continued study.

To that end, he adds:

Hopefully we learn from our experiences as we go through life. But to really learn from them, we have to step back on occasion, look at an entire string of events, and figure out the following: (a) what happened, (b) is there a pattern that has repeated, and (c) what are the lessons to be learned from the pattern?

Could not agree more.

I think what we’re seeing with bond yields and the shape of the yield curve is a pattern that has consistently repeated.

And given the pessimism in bonds (with yields high) – and the risk of recession next year – that could represent opportunity.

But please read Marks’ latest memo – it’s packed with timeless insights and perspective.

You will be smarter for it.

Regards
Adrian Tout

The post Trade the Tape – Fed can Keep Raising first appeared on Ethical Offshore Investments.

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Trade the Tape – Think About Adding Bonds

Stephen Strowger — Tue, 11 Jul 2023 09:55:00 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

July 9, 2023 – Adrian Tout

Think About Adding Bonds

Two bond ETF’s: AGG and EDV
Some insurance here could pay longer-term dividends
US 2-Year Yield at its highest level in 16 years

For me, 2023 has been a year of repositioning and managing risk.

I lowered my exposure to large-cap tech (down to ~20% portfolio weight) and increased exposure to banks, energy and some industrials (which all trade at reasonable valuations).

In hindsight my move was a little early – as large cap tech added to their recent gains.

However, I don’t trade with the mindset of ‘weeks or months’.

These things are always very difficult to time.

Due to my (mostly) defensive position – my YTD returns are 11.47% (~3% lower than the Index)

July 9 2023

Keeping a large cash position (~35% at the time of writing) can pay dividends in the event of a market downturn (like last year).

However, when the Index surges (as it has done this year) – it will result in underperformance.

As part of my repositioning – I’m adding to fixed income.

For example, with the US 2-year yield now above 5.0% (first time in 16 years); and the 10-year yield above 4.0% – this is attractive.

July 9 2023

Let’s explore why some quality bond exposure deserves a place in your portfolio and vehicles to consider.

But first, some helpful context.

10-Year Yield Back above 4.0%

The US 10-year yield closed at 4.06% on Friday – the highest level since early March.

The last time a rate-hike cycle saw the 10-year yield this high was 2008.

July 9 2023

Obviously with rates artificially low for some 15 years – risks assets boomed (i.e. houses and stocks).

That’s now changed.

The risk/reward for stocks (and houses) now comes at a premium.

What’s more, the market now (finally) appreciates that the Fed is likely to keep rates high.

Inflation is not falling at the velocity many expected (especially stickier forms)

As an aside, we will get an important read on CPI and Core CPI later this week.

Should Core continue to trade with a 5-handle – it will only reinforce the thesis that the Fed is likely to keep rates in restrictive territory.

Beyond rates, the Fed can also tighten another way.

For example, they have no intent of participating in the bond market (QE) whilst inflation stays above their 2% target.

With the banking system now stabilized – the Fed has resumed reducing their balance sheet (QT)

With respect to QT – the Fed has reduced their balance sheet by ~$60 billion a month post the SVB collapse.

My view here is they will continue to reduce their balance sheet by as much as $1 Trillion over the next two years (in turn pressuring stocks)

Why Add Bond Exposure?

Over the next 6-9 months – it’s most likely that bond prices continue to drift lower (i.e., yields rise)

And whilst lower bond prices is not a great outcome for bond investors… investors are being compensated with attractive yields

For example, if you are of the view that:

Inflation will gradually come down over the next 12 months; and
A recession is likely later this year (or early next)…

… it’s plausible yields fall and bond prices rise.

In this scenario – bond investors will receive both price appreciation and the yield they secure today (vs a lower yield if buying at the time of recession)

Two Bond ETFs to Consider

There are many bond ETFs available for investors (here’s a list)

However all bond ETF funds are not created equal.

Not only do each vary in terms of bond duration and composition of assets held (e.g. short and long term; government vs corporate debt) – they also vary in terms of management fees.

Two bond ETFs you should be aware of:

AGG – iShares Core U.S. Aggregate Bond ETF (note: similar ETF is LQD)
EDV – Vanguard Extended Duration Treasury ETF (note: similar ETF is TLT)

Let’s take a look.

#1. AGG – iShares Core U.S. Aggregate Bond ETF

AGG boasts an Assets Under Management (AUM) of over $91B.

Similar to many other funds in Blackrock’s iShares stable – they feature very low management fees (only 0.03%).

The ETF is described as an intermediate bond fund, which means it holds a mix of bonds with different maturities with an average effective duration of ~6 years.

There are more than 10,000 investment-grade bonds in the ETF – 72% of which are AAA rated (the highest quality).

That said, it also contains exposure to BBB (14.1%) and A-Rated (11%) bonds which are higher risk.

But overall – this is considered a higher quality corporate bond fund.

At the time of writing, the average yield to maturity for AGG is 4.98%

Let’s look at the weekly chart from 2008:

July 9 2023 – AGG 15-Year Chart

The fund is well off its $120 high it hit in August 2020.

At that time, bond yields were close to zero (e.g., the US 5-year was just 0.2%)

Bond prices trade inversely to their yields.

At the time of writing, AGG is trading $96.53 – close to as low as we have seen since 2008.

Again, this is due to the Fed raising rates some 500 bps in 12 months.

Now should interest rates continue to rise (which I expect in the near-term) – then it’s likely we see AGG drift lower.

However, I think the longer-term upside reward meaningfully outweighs the downside risks.

Two things:

If buying AGG around $96 – you’re securing a yield of ~5.0%
On the basis rates fall next year (as inflation cools) – this ETF could appreciate 10-15%.

The other consideration is should the economy fall into recession (which I expect) – this will result in fund rotation to fixed income.

As an aside, the ETF AGG is similar to the LQD ETF (comparison below)

#2. EDV -Vanguard Extended Duration Treasury ETF

Unlike AGG – EDV is long-dated US treasury bonds only.

It has AUM of around $2.18B with a management fee of just 0.06% (lower than TLT)

From Vanguard:

Tracks the performance of the Bloomberg U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index.
Provides current income with high credit quality.

This ETF is very similar to Blackrock’s TLT – however offers a lower management fee.

Similar to AGG – the fund is designed for investors looking to lock in relatively high bond yields in anticipation of a fall in inflation (and decline in rates).

The fund offers a yield of 4.07% – which is higher than long-term inflation expectations (and expectations for GDP growth).

However, what is most attractive is the hedge EDV (and TLT) offers during times of recession.

And it’s not hard to explain – high quality bonds act as a source of (valuable) portfolio protection during times of economic contraction.

Let’s look at the long-term chart (from 2008)

July 9 2023

Note how EDV is a lot more volatile than AGG – however the direction of the charts are similar.

Similar to AGG – I see the potential for at least 10-15% upside on the basis we see a decline in rates the next 12+ months.

Again, it’s likely this ETF continues to drift lower should the Fed continue to hike.

However, I think the downside move is limited – where you are also compensated by the ~4% yield.

Should we see a recession next year (my base case) – this ETF is likely to move higher.

Below is comparison between EDV and TLT ETFs:

Putting it All Together

Two important questions you need to ask.

What is your outlook for:

Inflation; and
Economic growth?

With respect to the former – I see both Core PCE and Core PCI staying higher for longer.

Headline inflation will continue to fall (we will get a read on CPI this week) – however the Fed are more focused on Core PCE.

To that end, with Core PCE trading with a 4-handle – they are likely to raise at least twice more this year.

The bond market has now come to this realization.

What’s more, rates will likely stay high for a sustained period (until Core PCE is closer to their 2% objective)

Given this (and what we see with the depth and duration of the inverted yield curve) – the Fed are likely to cause a recession (later this year or early next).

In the unlikely event we avoid recession – GDP growth will be subdued (as consumers and corporates struggle under the weight of higher rates)

On that basis, the yields offered by both AGG (~5.0%) and EDV (~4.0%) are attractive.

What’s more, these ETFs offer a strong risk-reward in the event of recession.

In closing, you don’t have to rush into these trades.

Higher rates will keep these bond ETFs anchored near their all-time lows.

However, don’t try to get “too cute”.

We never try to pick bottoms (or tops). And if we do – it’s more luck than skill.

Our primary interest lies in whether the long-term upside meaningfully outweighs the downside risks.

I think the probabilities are in our favour here.

Regards
Adrian Tout

The post Trade the Tape – Think About Adding Bonds first appeared on Ethical Offshore Investments.

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Trade the Tape – Fed Minutes Suggest More Hikes

Stephen Strowger — Thu, 06 Jul 2023 11:09:18 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

July 5, 2023 – Adrian Tout

Fed Minutes Suggest More Hikes

The bull vs bear debate
Fed minutes suggest more hikes to come
Three consecutive quarters of earnings decline?

Today the market poured over the latest Fed minutes…

No real surprises – expect rates to be higher for longer.

Almost all Federal Reserve officials at their June meeting indicated further tightening is likely.

And whilst the pace of hikes is expected to be slower – they are not done.

Citing the lagged impact of policy and other concerns, Fed officials saw room to skip the June meeting after enacting 10 straight rate increases.

Officials felt that “leaving the target range unchanged at this meeting would allow them more time to assess the economy’s progress toward the Committee’s goals of maximum employment and price stability”

They add:

“The economy was facing headwinds from tighter credit conditions, including higher interest rates, for households and businesses, which would likely weigh on economic activity, hiring, and inflation, although the extent of these effect remained uncertain,” the minutes said.

Here’s the thing:

There is a 12-24 month lag in terms of the full impact of rate hikes (in combination with QE)

We are about 15 months in.

And whilst they are starting to have some impact (e.g., mostly for anyone with a variable loan and/or buying a new asset) – we are early in terms of the impact.

This was mostly offset by the massive amounts of government stimulus (well over $2 Trillion) still sloshing around in the economy.

We remain awash with liquidity.

But over the next few quarters (as the Fed reduces its balance sheet) – those lag effects will likely become more pronounced.

Or will they?

The Bull Bear Debate

Perhaps the question of whether you are a bull or a bear is not whether the economy is about to endure a recession early next year…

But rather…. what is the expected state of liquidity and monetary conditions?

After all, excess liquidity was the primary reason stocks had a blockbuster first half of 2023.

Put another way – it was not growth in earnings.

Earnings contracted for the second consecutive quarter… and are now expected to contract again (more on this in my conclusion).

But there remains strong debate on the outlook for monetary conditions.

For example, it’s my view rates will remain higher for longer.

And let’s say the Fed simply holds rates where they are for the balance of the year (as inflation slowly falls) – this means real rates will rise.

But that’s the bearish view…

However, if you’re bullish heading into the second half, you expect rates will ease and monetary conditions will loosen.

If that’s true, it’s likely stocks will continue to rally.

However, the level of rates is only one part of the equation.

With respect to inflation, many are of the view that higher prices are less a monetary phenomenon – but more supply chain related.

And now that the bottlenecks are clear – inflation will fall rapidly.

I agree with that logic for goods related inflation (which has already come down to pre-pandemic levels in many cases).

However, I believe inflation is largely a monetary phenomenon.

Consider the definition of inflation:

“Excess money chasing too few goods”.

Put another way, without excess money in people’s pockets, it’s very difficult for prices to rise (irrespective of whether the goods are available)

On that point, I think the Fed will continue to reduce its balance sheet.

And if I were to guess… their intent is by as much as $1 Trillion over the next 24 months.

However, that is not what the bulls are betting on.

In summary, we all know the economy can’t get out of first gear.

Some of us think it will likely go into reverse towards the end of this year (or perhaps early next).

That is mostly due to the expected lag effects of restrictive monetary policy.

However, the bulls believe central banks will reignite the liquidity spigots before long.

I’m not buying it… certainly not with Core PCE still well above 4.0%

Putting it All Together

Beyond all things monetary policy – earnings season is almost here again.

What’s interesting (to me) is expectations are slowly but surely being ratcheted down.

It’s curious because stocks have been going higher.

That’s multiple expansion.

Investors are being asked to pay a high multiple for certain stocks today – mostly in tech.

However, there are sectors which offer reasonable (long-term) value (e.g. banks, energy and industrials)

But in terms of the outlook for earnings – they continue to fall opposite a softening economy.

Here’s a chart I came across via Bloomberg this week:

Mmm… expectations are falling.

As I said earlier, don’t be too surprised to see earnings contract for three straight quarters.

A positive for stocks?

We will see.

Regards
Adrian Tout

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Global Exposure for a Fraction of the Cost

Stephen Strowger — Mon, 03 Jul 2023 15:29:10 +0000

Global Exposure for a Fraction of the Cost

Investment Charges – How much is it really costing you & your future.

Our solution keeps more of the investment growth in your pockets.

At Ethical Offshore Investments, we have been strong advocates of helping clients reduce their ongoing costs. And we believe that our Global Index Investing option will not only provide clients access to investing in the world’s greatest companies, but doing so at a fraction of the costs.

Before we show you how low the total charges are if you become a client of Ethical Offshore, below is an illustration of why reducing your costs is so important.

Don’t let high costs eat away your returns

There is the common saying that you have to spend money to make money…. But the money you spend to invest has a big effect on what you have left in your own pocket.

Points to know

All investments have costs

Money you pay for costs compounds (rises exponentially) over time

Because some investments with higher costs have to overcome these expenses, their performance tends to suffer vs. lower-cost investments.

Understand what you are paying

At Ethical Offshore Investments, we have always strongly suggested that you ask your adviser or investment consultant, for a breakdown of all of the costs associated with holding an investment portfolio (don’t stop there….. ask your financial consultant what service or benefit is being provided for that specific fee / charge).

Every investment has a cost, even if you don’t realise that you are paying it

There are many different kinds of costs, but they all have one thing in common: if the money is going somewhere else, it is not going to you.

Why do costs matter

Investment costs might not seem like a big deal, but they add up, compounding along with your investment returns. In other words, you don’t just lose the tiny amounts of fees you pay – you also lose the growth that money might have had for years into the future.

For example: you invest $ 100,000 and the underlying investments generated a gross 6% each year for the next 25 years and had NO costs or fees, you would end up with an investment value of $ 429,190.

If on the other hand you had paid a combined 2% a year in investment costs & charges, after 25 years, you would have an investment value of only $ 266,580

That’s correct: the 2% of total charges you paid every year would reduce your investment value by nearly 38%……. that 2% doesn’t sound so small anymore, does it..??

Costs can eat away at your investments

The above example & image is provided by Vanguard Ltd

What can you do to control your costs..??

Because all investments have some form of costs, it might seem like a waste of time to worry about them. Or maybe you assume that a high cost means that you are getting higher quality investments & better total returns.

Unfortunately, nothing could be further from the truth. Research on mutual / managed funds has shown that in most cases that the higher-cost funds generally underperform lower-cost funds. That is because the fund managers charging these higher costs may struggle to add enough value to overcome the additional expense (in addition to this, they may have to take a slightly higher risk, more volatile approach to achieve the higher returns).

A Diversified Global Exposure for less than 1%pa

Actually, our global equity allocation total costs is 0.80%pa – that includes the fund manager charges, the offshore holding platform charges and the costs for having your dedicated, Private Manager at Ethical Offshore Investments who will continue to provide guidance and is your direct contact if you have any queries or concerns.

For clients that would like to invest in a dedicated US equity or a UK equity portfolio, the total cost is even lower at 0.75%pa

This is done through a selection of high quality Exchange Traded Funds (ETF’s) from the likes of Legal & General (L&G), iShares (Blackrock) and Vanguard. Our Global Allocation will result in exposure to over 1,600 of the worlds biggest and most successful companies, which includes Apple, Microsoft, Amazon, Nvidia, Alphabet (Google) and Tesla. This can be invested in a range of different currencies.

Clients can also choose to have dedicated Ethical and Socially Responsible Investment index ETF which will only include the highest quality, screened ESG companies….. and all still for less than a total all up cost of 1%pa.

Finally, we can also offer a risk adjusted, diversified approach (using the expertise of Vanguard Ltd) where you can select a diversified asset portfolio of Bonds and Equities in-line with your preferred risk tolerance and investment objectives.

Vanguard LifeStrategy 100% Equity
Vanguard LifeStrategy 80% Equity (20% Fixed Interest / bonds)
Vanguard LifeStrategy 60% Equity (40% Fixed Interest / bonds)
Vanguard LifeStrategy 40% Equity (60% Fixed Interest / bonds)
Vanguard LifeStrategy 20% Equity (80% Fixed Interest / bonds)

The above funds are invested across a range of 10 different Vanguard index funds or ETF’s, which will result in portfolios having allocations across the different geographical locations, economies (both developed and emerging) and business sectors.

The total maximum cost with utilising the Vanguard LifeStrategy range of funds, along with the platform and client servicing costs would be 0.92%pa

What is the benefit to you…… the investor.

Well let’s go back to the previously mentioned $ 100,000 being invested, but instead of 2%pa ongoing charges, it is the 0.80%pa of total charges being deducted (& don’t forget, you still will have your own dedicated Ethical Offshore consultant to assist you with queries & guidance).

That cost saving would result in a portfolio value after 25 years of $ 355,140…….. that is $ 88,560 more in YOUR POCKET…!!!

For clients that have a personal offshore pension (QROPS or a UK SIPP), the investment cost savings are even more important. In addition to the platform, fund management and client management costs, Pension portfolios are also subject to Trustee fees as well as their own administration costs. While we will always try and use the more cost effective pension schemes and trustees, there will unfortunately continue to be trustee costs associated with offshore pensions….. so the more you can save on the portfolio costs, this will help negate the additional trustee charges.

At Ethical Offshore Investments, we are determined to show how clients can invest in a global portfolio of quality companies, but ethically through low cost, flexible investment structures.

If you would like to learn more on how you can invest in a quality global portfolio with minimal costs, please click on the More Information button below and our senior consultant will contact you personally.

Ethical Offshore Investments also provides guidance on portfolios that have an ESG (Environmental & Social Governance) bias and an SRI (Socially Responsible Investing) focus. By avoiding high charging, commission paying funds, this results in lower portfolio costs, so more of the growth staying in the pockets of our clients.

The post Global Exposure for a Fraction of the Cost first appeared on Ethical Offshore Investments.

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Trade the Tape – S&P 500 Meets Resistance

admin — Wed, 28 Jun 2023 10:46:33 +0000

Please find below the latest update from Adrian Tout from his regular newsletter, “Trade the Tape”.

Please note that this is for general information only and should not be considered personal financial advice.

June 21, 2023 – Adrian Tout

S&P 500 Meets Resistance

Weekly initial jobless claims the key to a ‘soft landing’
Market trading through a key area of resistance
Bulls need the Fed liquidity spigots to remain wide open

You can only laugh…

Apparently markets extended their ‘sell-off’ after Powell stuck to the (rate hike) script:

Here’s my question: what constitutes a sell-off?

Turns out that if stocks inch lower by less than 2%… well… that’s now a sell-off.

Reality of course is stocks have barely moved:

June 21 2023

As the weekly chart shows – the S&P 500 is still up ~20% from the October low; and 13.7% year-to-date.

Sell-off?

You tell me.

I might be off the mark – but I consider a sell-off as something we saw in the first part of the year – where the S&P 500 fell from around 4200 down to 3800.

Similarly, mid-last year when the Index dropped from ~4300 down to ~3600, that’s a sell-off in my book.

And there are other examples.

But less than 2%?

It’s just more mainstream noise… a headline written to get you to ‘click’.

That said, I think there is the potential for the market to give back a little more ground.

My math indicates that could be in the realm of 7-10%

But rather than call that a sell-off… my headline would be “healthy market development”

Resistance

Over the weekend I said be ready for a 7-10% correction.

I don’t know if that will play out (it probably won’t now that I’ve called for it) – but that’s what I see.

Specifically I was looking at the distance above the 35-week EMA (blue line).

Below is a closer look:

June 21 2023

Now before you ask…

I don’t have some “hard rule” that when the price extends a given amount – that it’s about to reverse.

No.

And markets can extend a lot more than 8% higher than the 35-week EMA.

What’s more, they can remain extended for several weeks.

However, when I see this order of extension (as I did in Q4 2021) – things deserve our full attention.

This is also reinforced with the weekly Relative Strength Index (RSI) (middle window)

Last week it was challenging 70 – an overbought environment.

Again, this is not a sell signal as it can go far higher and stay above 70 for weeks on end.

But it is an area to be watchful.

Now a few weeks back – I flagged the zone of 4400 to 4500 as the next target for the S&P 500.

Last week we traded as high as 4447.

This is 61.8% to 76.4% outside the distribution (“A-B”) I’ve been watching for over 12 months.

So far that call has been accurate but it’s too early to call a coupe yet.

My feeling however is the market gives back a little ground (e.g. up to 8%).

The challenge of course is we will need to hold that level once we pull back.

If we do – it’s a big win for the bulls.

However, if we don’t, then the rally of the past few weeks was nothing more than a head-fake.

It can go either way.

But I think the bulls need a few things to continue to go their way.

Liquidity

This is the market’s oxygen.

Take it away and the market will suffocate.

The good news for the bulls is they have plenty (and not just from QE)

I talked about this a few weeks ago here.

On various occasions, I’ve highlighted the striking correlation between the Fed’s purchasing of bonds (QE) and the performance of the S&P 500

We saw something very similar post the global financial crisis of 2008.

Billionaire Hedge Fund manager – David Tepper – famously called it at the time – when the Fed first announced QE.

It’s since been dubbed the “Tepper Rally”

But what’s perhaps confusing some bears is despite the obvious slowdown in the economy – when the Fed turned on their liquidity spigots – stocks rally.

The market and the economy are not the same thing.

Now if you jump up and say “hang on Adrian… aren’t the Fed reversing QE”?

Yes they are…

But as I explained in here and here – the Fed can inject liquidity outside of just bond purchases.

For example, the liquidity provided by making it easier for banks to borrow has made its way into risk assets.

And from mine, this was the single most important 2023 pivot point for the market.

Bears were saying “this is a repeat of 2008…. banks are going bust…. time to sell and/or short the market”

Trust me, I had readers telling me it was the GFC all over again.

However, the bulls were saying “here come the liquidity spigots and up we go”

As for me, I was stepping up and buying banks at around 1x book value.

I will let you know if 2-3 years if the trade works out.

The “crisis of confidence” (which now seems to be idiosyncratic and not systemic) provided more impetus for the Fed to keep the spigots open.

For example, in fear of more banks potentially failing, they went to extraordinary lengths to make sure institutions had enough access to cash.

They didn’t want any accidents.

And whilst we can argue whether this has worked counter to bringing down inflation – the effect on risk assets is clear.

Putting that all together – if the liquidity is there – that bodes well for the bulls.

And right now – it is.

However, should we see signs of liquidity drying up… then we cue the exits.

A ‘Soft Landing’

The other premise the bulls are leaning into is the prospect of a so-called soft-landing.

Every second day you will hear some talking head saying “we expect a soft landing”.

It’s now consensus from Wall St.

For clarity, this language implies immaculate disinflation down to ~2% without unemployment exceeding 4.5%

Now whilst I buy the liquidity argument…. a soft-landing is a harder theory to swallow.

And here I come back to the indicators I talked to here.

For example, the inverted yield curve suggests a soft-landing is most unlikely.

Possible? Yes. Probable? No.

Let me explain:

When interest rates over short periods are higher than over longer periods, it implies the market expects rate cuts soon.

In other words, the curve itself implies a recession will force the central bank’s hand.

But what did Powell tell us today?

From the Financial Times:

Jay Powell reiterated his defence of the Federal Reserve’s recent decision to forgo an interest rate rise at a high-stakes congressional hearing on Wednesday, but signalled further tightening as he said the battle against inflation was not over.Powell, chair of the US central bank, told members of the House financial services committee that skipping a rate rise last week was “prudent” given “how far and how fast” the Fed had lifted its benchmark rate since March 2022.

We are now approaching 11 months of inversion.

By way of comparison – it was inverted for 18 months going into 2008

Sure, the curve steepened slightly after the idiosyncratic bank failures. At the time, the market was certain rates were about to be cut.

Wrong.

Now we know that is not going to be a systemic problem (as the bears were betting on) – we are back down to almost 100 basis points inverted.

June 21 2023

As I explained here – it can take between 12 and 24 months after the initial point of inversion for the recession to take hold.

The bulls are saying history is unlikely to repeat.

But from mine, that is a lower probability outcome.

Putting it All Together

In closing, there are a few arguments not to be overly bearish.

For example:

Q1 earnings were better than feared;
Bank deposits have stabilized;
Inflation is slowly (but surely) working its way down (there’s more work to do);
The Fed is closer to its terminal rate (vs where they began); and
We’re yet to see any major deterioration in credit

The last point is critical.

Neither businesses (or consumers) are collapsing under the weight of the Fed’s tightening.

For now, things appear to be relatively robust.

The most direct way for tighter monetary policy to slow the economy is through stemming the flow of bank loans.

And whilst we have seen some of this – so far credit conditions are good.

To be clear, credit growth has stalled (which is not a bad thing) – however we are not seeing any credit squeeze.

Not yet at least.

Before I close, tomorrow we get initial weekly unemployment claims.

The last two weekly initial claims came in around 260,000.

If we see this start to inch above 300,000 (and hold around that level)… it’s a sign the job market is weakening.

That’s the risk to any so-called ‘soft landing’ script.

Regards
Adrian Tout

The post Trade the Tape – S&P 500 Meets Resistance first appeared on Ethical Offshore Investments.

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Lindsell Train Global Equity Fund – Manager’s Report

admin — Thu, 12 Mar 2020 05:50:19 +0000

Lindsell Train has published the Lindsell Train Global Equity Fund – Manager’s Report:

The report includes basic facts on the fund, some portfolio characteristics, recent and historic performance as well as some commentary from the portfolio manager.

To read the report, Click here

The post Lindsell Train Global Equity Fund – Manager’s Report first appeared on Ethical Offshore Investments.

The post Lindsell Train Global Equity Fund – Manager’s Report appeared first on Ethical Offshore Investments.

Managers Reports - Ethical Offshore Investments

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