Market Commentary | Q2 2023 Halftime Report


Sam Chaplin:

Hi everybody. Thanks for joining us. Welcome to the Q4 Halftime Report. Today is November 14th. My name is Sam Chaplin, Portfolio Manager at Penobscot Financial Advisors, joined by our fearless leader and CIO Jim Bradley. Afternoon, Jim.

Jim Bradley:

Afternoon, Sam. How are you doing way over there? Two offices down the hall.

Sam Chaplin:

Doing pretty well, doing pretty well. So as usual, we’re going to kick you off here with a speed round through the economy, the markets and our outlook going forward. Keep everybody up to date. First step on the economy, looking at inflation and interest rates here on the first chart. Inflation just had good data out today. That’s why I’m having a good day. Inflation was down to 4.02% on the annual core CPI. That’s some serious progress over the 6.64 we peaked out on last July, shows that what’s going on in the bottom chart here, interest rates have been taking some effect as the Federal Reserve had dropped interest rates back during the pandemic, plowed a bunch of money into the economy, bailed us out of that recession. However, there’s been lingering effects as that inflation has stuck around. So they were a little late to get to the jump of hiking interest rates early in 2022, did some big hikes and some smaller fine-tuning hikes and they actually have stopped hiking since the end of July, was the last hike.

And the market’s widely expecting that they’re at or very close to the peak interest rate level that we’re going to get to going forward with some expectations of rate cuts happening next year which has some benefits for the market. If you look at today’s index is doing pretty well on this data. We’re at this kind of awkward period in the recovery where the Fed is actually trying to slow economic activity by hiking these interest rates so that people aren’t taking out as many mortgages, businesses aren’t taking out as many loans and spending. Really trying to make people poor to get this inflation down. So that’s why you’ll see those counterintuitive headlines going on where we get a bad jobs report and the market rallies or something like that just because people actually on the market side want to see these interest rates come down. And we can’t do that without slowing the economy.

Danger is, if you hike those interest rates too far or hold them high for too long, you’re going to slow the economy too much to the point of recession. So on the next chart here, looking at growth, we can see that really hasn’t been an issue recently. The last quarter was a 4.9% annualized GDP growth, which is well above the average rate of around 2%. And that was really boosted by both consumer spending and government spending. So here, no real danger of a recession. So you might say, “Why doesn’t the Fed keep hiking interest rates?” Until we get that down to the 2% inflation level we’re looking for, that’s really because of some other factors and because these are lagging indicators, this is what happened in the third quarter. The Fed is really trying to skate to where the [inaudible 00:02:50] is going to be, if you will.

So if we’re looking at some other areas here, unemployment is still very low, tipping up a little bit, but historically low at 3.9%. Retail sales after being adjusted for inflation have been pretty flat. Down slightly, but nothing of major concern there. Some areas that we are starting to see trends shift a little, I wouldn’t call these any type of red flags, but maybe we’d say that the peak tightness in the job market is behind us for some of these reasons here. One being US job openings are down pretty far off that 12 million peak they were at down to about 9.55 million. And there’s also some thoughts there about a lot of these job openings may be a little bit fake in that people are leaving job openings posted without actually being likely to hire people. Using the job openings as ways to build databases of resumes and whatnot. So expect to see that number come down further.

US quits also down. A lot of concerns about the great resignation about a year ago where everybody was deciding they didn’t want to work anymore or they were quitting their jobs to go to other places because they found better opportunities elsewhere. We have seen those numbers come down quite a bit. So that suggests that people aren’t as comfortable finding another job or aren’t as comfortable having no income, which is another indicator that the job market is softening a little bit. Unemployment insurance continuing claims have picked up a little bit. Still nothing that’s concerning, but showing that the trend is shifting a little bit. And like I said, the peak job market is behind us at this point, which bodes well for inflation going forward. Jim’s going to talk a little bit about the market and how far we’ve come.

Jim Bradley:

Yeah. From where we sit halfway through the fourth quarter here, a lot of folks are starting to see some hope on the horizon as far as inflation coming down like Sam just said, and yet coming down in a way that doesn’t look tremendously recessionary just yet. And so that kind of seems like the Goldilocks scenario that I think a lot of people were hoping for and they’re looking at statements and saying, “My account’s not back up to where it was before we had this issue.” And kind of thinking about what’s going on here. And it’s interesting to see that we’ve got two charts here, what they call Morgan Stanley Capital All Country World Index, the total return level. That’s stocks, that’s the darker blue line on the top. And the bottom line is the Bloomberg Global-Aggregate dollar hedge to return, which is basically your bond market for you.

And what you can kind of see here is that stocks have staged a bit of a recovery. Today they’re having a good day, as Sam mentioned, November 14th. I hope that that news kind of ages well whenever you’re actually watching this particular bit, but so far so good there. But bonds do have a ways to come back. And that’s probably not going to happen in total until we see some kind of a flattening of that Fed rate policy curve, which Sam already pointed out starting to factor into the market. So the next recovery could very well be a bond market recovery in this type of a situation.

Another frustration that a lot of folks have, not the least of which is us, is the dispersion in the market as far as where returns have come from. We talked a little bit about this last quarter I remember and bears repeating that even though the market has come back up quite a bit, if you measured by some measurements like the S&P 500, if you actually took the S&P 500, which is an index of the 500 biggest companies in the US roughly and divided the performance of all those 500 companies buy 500 to get the average performance, you’re barely up on the year, just up about 1%. Been down a good portion of the year during that period of time.

And yet the S&P 500 is, as of what I’m talking to you today, up about 16.5%. Why is that? That’s because it’s a market weighted index, the S&P 500, meaning that bigger companies have a more out-sized impact on the movement of the index. There’s seven companies that you’ve probably heard tossed about if you listen to the news a lot. They call the Magnificent Seven. They include Google, Amazon, Alphabet, Tesla, Microsoft, Nvidia, and the like.

Those seven stocks have really done quite well, almost 80% on average during the course of this year. And they have an out-sized impact on the movement of the index. So whereas there have been gains on stocks this year and a little bit of a recovery back to where previous price levels, those gains have not been necessarily partaken in by the whole market equally.

And going to the next slide here, what we can see is a little bit of an argument as to why we might not want to look at this as being a good time to get into those growthier kind of stocks. Typically, in periods when growth has outperformed value for a pretty significant degree, that tends to actually be a time when value can return a little bit more than growth can. And we look at spikes upward on this graph, the big spikes upward of periods where in the past growth has outperformed value as far as stocks go.

And you can see that where we just bounced off of from a high, we’ve only been at that point twice in the last 30 to 40 years. And those two times were in 2020 in the early stages of the pandemic recovery when everybody was spending their stimulus checks on buying the Amazon and Peloton stock. And then back in 2000 when we had the dot com bubble that kind of got created where any company out there with dot com in their name was worthy of throwing money at whether they were making money or not. Interesting to see that relative performance after those tended toward value out performance. And just about every spike that we see historically on this one to the upside, it’s almost always followed by a spike to the downside indicating that when growth spikes relative to value, it’s usually a good time to go value instead of growth.

And we’re starting to see maybe a little bit of that trend starting to reveal itself just lately with us coming down off of that more recent growth spike. So in all seasons it tends to be a good idea not to have all of one’s eggs in a growth or a value basket, but to take a little bit of diversification, diversified approach to that.

And going on to the next one is another way that we like to always diversify is geographically and a lot of different forecasters out there, we get forecasts from a lot of different places, but one of the things that we see in common lately is a likelihood that while US stocks are projected to get back toward their positive return characteristics and they’re filling that order today, the real opportunities may actually lie outside of the US. and during periods where US stocks are increasing but going up relatively slowly, typically international stocks outperform and our friends at JP Morgan give us this kind of outlook where they see stocks outside the US having more return potential, mostly because they’re also in recoveries from downturns as a result of rate tightening and yet their valuation, their multiples, the amount of money you pay for each dollar’s worth of earnings is a lot less in overseas markets than what we’re seeing today.

So again, that value trend playing out domestically but also globally is something that we ought to look at. One thing that a lot of people ask when they look at the fact that they can make maybe 5% on a good CD right now, but they can also make 5% on a savings account, is why do they want to lock up their money for a period of time when they might actually be able to get the same amount or even more on a short-term thing like a bank account? And generally the advice that we would give is don’t time the Fed and don’t be tempted into throwing all the money into short-term cash just because of the fact that bonds, longer term intermediate and longer term bonds, have not returned as much over the recent period. And this kind of shows three different types of cycles to be in: a hiking cycle, which arguably we’ve been…Inarguably, we’ve been in for the last about 20 months, a Fed rate plateau, which from Sam’s slide earlier might very well look like where we are now. And then a period of rate cuts, which as Sam also mentioned, we’re starting to price in to the market as a possibility for summer of 2024.

And you can see that in general during hiking cycles, yes, cash has been king, but during where we are right now and possibly a rate plateau and where we might be going toward rate cuts, that’s when taking some of that loose ammunition in cash and actually deploying it out the yield curve, in other words, taking on a little bit more of a time commitment with things like CDs and bonds and that type of thing can make a lot more sense for investors.

So all in all right now we’re looking at a market that’s reflecting a little bit of optimism that rates don’t necessarily stay high for a whole lot longer, that maybe there’s a little bit of light on the horizon when it comes to rate structure and that with a strong economy still we might be able to land this inflation problem and a soft landing. So we’re hopeful.

Sam Chaplin:

Absolutely. Great, thanks Jim. On a looking forward basis, here are the three main topics that we’ve been keeping an eye on. Geopolitics. It’s certainly a big one. Everybody’s aware of the tragic wars going on and it’s hard to talk about the markets in times when people are losing things much more important than money. But we do need to start thinking about how these things can affect the markets. And I’ll say broadly, markets are pretty resilient to geopolitical risks. You can look at charts of going back and pointing out all the wars that have happened and how the market just plows through them for the most part. The wars that are going on at this time are involved in relatively small economies. If we did see them start to spread to more regional wars, that’s when the markets would get a little bit testy, particularly the war spread to Iran.

Now we’re really messing with the energy markets, that could have inflationary implications. So that’s something we’re certainly keeping an eye on and hoping for the best. Next step is monetary policy, which as we’ve been talking about is what the Federal Reserve does, mainly hiking and lowering interest rates as well as printing money and taking money out of the economy. At this point, like we mentioned, they have been raising interest rates, hopefully getting to the peak in that, and they’re also taking some of that money back out of the economy, which will help to lower inflation. Markets have been hyper-focused on monetary policy for the last year to two years. The biggest question was how high are interest rates going to go? How long are they going to stay there? When are they going to be cut? We’re starting to get some clarity about how high they’re going to go. Likely not too much higher. How long are they going to stay there? Really depends on how those economic indicators start to progress, but at least the worst case scenarios of a hyperinflation or stagflation are starting to look much less likely. So that’s been a very positive development for the markets.

I do think from monetary policy, we’re going to start to see some of the focus shift to fiscal policy over the next year. We do have elections coming up next year. That’s not really the primary concern. Primary concern is that US has continued to spend money very fast while not raising taxes at all. That’s caused us to have larger and larger budget deficits. And if the budget deficit is too big for too long, that starts to call into question how credit worthy the debt is that the US is issuing and the treasury side of things.

It’s still the safest debt out there, but maybe not as sure of a thing as it used to be. Start to make international bonds look a little more attractive as well. So that’s something we’re certainly going to keep an eye on. And it also applies to how the US is developing relationships abroad with other economies, which has impacts on globalization as well. So I think I’m hopefully not going out on a limb by saying our Congress is not a well-oiled machine at the moment, and we’re starting to have some concerns about their ability to get things done either by cutting spending or raising taxes. Nothing that is too popular and hard to do politically, but it’s becoming more of an item to keep an eye on. So with that happy note, we’ll end it, but I hope everybody has a great holiday season and we’ll see you next quarter.

Jim Bradley:

We’ll see you guys next quarter. Have a great holiday season and may we all get along.

Sam Chaplin:


Jim Bradley:


The foregoing content reflects the opinions of Penobscot Financial Advisors and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be construed as investment advice or a recommendation regarding the purchase or sale of any security. There’s no guarantee that the statements, opinions, or forecast provided herein will prove to be correct.