Spare
the Axe
Do
you remember the old riddle, “If a tree fell in the woods, and no one was there
to hear it, does it still make a sound?”
Well, today in 2024, we have a version of that question that similarly
begs the question, “if limbs were falling from a branch high above, would you
have the presence of mind to know it, look up, and get out of the way?”
Although
this missive is tabbed as a 3rd quarter expository, it strikes home
more as a 2025 conundrum because contained in the current data is a cause and
effect that we believe is clearly being overlooked. Let’s begin with the fact that the stock
market averages are trading at record highs.
How, then, does one reconcile the enormous psychological and financial gap
that exists between those who report that they are “comfortable” with their
financial situation and those who are desperately falling behind? Why are corporations acquiring new companies
in their portfolios but downsizing nearly 25 percent of the workforce? How are record earnings propelling equity
expectations when high interest rates are decimating the bottom line? To be sure, most of the globe’s economic news
is positive even when measured against highly grossed up expectations. But the
symmetries are way out of balance. Is
anyone looking up at the falling limbs?
Further,
the contentiousness of the 2024 Presidential discourse worries us. Markets count on a cohesiveness and
continuity of economic principles but current deviations from the norm would
account for indecisiveness and fear permeating the electorate. Clearly, in that kind of environment, fiscal
(political) judgement regarding policies and initiatives is stultified. The potential for voters simply to give up is
a possibility and strengthens the vocal minority who say the whole system is
“rigged” or “unfair”. The attitude has
become that no one or nothing makes a difference which exacerbates even further the apathy that
citizens and businesses feel about following the rules or being good citizens. In more ways than one, “downsizing” is
becoming a way of life far too often.
And
yet, the cornerstone of our optimism is that it all works out in the end...usually. While we allow for the pull and push of
political debate a majority of people support isolationism, closing borders,
and law enforcement under the guise of altruism.
It
cannot be ignored, however, that the landscape has dramatically changed. In normal times conciliation is a fact of
life. The risk premiums have expanded
like no other time we can recall. The
unknown outcome of the election in November will exact a higher cost in terms
of volatility and strife than many might predict, possibly resulting in further
erosion of confidence and optimism.
Markets
We
are therefore raising our projected volatility in the financial markets for the
balance of the year and into next. It is
our suspicion that inflation will not budge, perhaps moving higher in certain
core goods, which limits room for bond and equity appreciation. Unless political leaders can accommodate one
another private consumption might sit on the sidelines for several years
hence. Consumer confidence is weak right
now and affecting spending habits that once were robust immediately after the
covid pandemic. On the other hand, low
confidence helps to limit an upsurge in inflation. We clearly observe that we are on the cusp of
major spending changes in the next few years.
The pesky issue of interest rate direction, while not something the
average person obsesses about daily, does affect decisions about future capital
expenditures. Consumers are the engine
of economic capacity and inventory growth.
Budget and spending inertia could impact political and household
goal-setting for years to come.
Much
of this turmoil is politically induced, and not definitionally economic in the
truest sense. The first half of this
year was, in fact, quite successful economically. Businesses have reemerged from a two year
pandemic hiatus, employment and wealth building were both on record pace, and
the markets, as noted earlier, are breaking all time highs. The impact of both the medical and economic
response to the Covid virus has been successful and is raising the bar even higher
for predictions about the economy. All
the while, we watch out for the “limbs” above us…just in case.
The
success of the markets is also its curse.
Higher interest rates continue to be the sticking point in our
projections. Based upon current earnings
forecasts, and the impact of higher borrowing expenses, our valuation models
indicate the possibility of a rough Summer ahead. This “seasonal rotation” should be completed
before the end of year, mostly influenced by the elections in November. We would not be surprised to see a contraction
of ten percent on the Dow and S&P which would bring the numbers closer to
fair valuation. Therefore, we are
advising our clients about near-term caution in the equity markets. We do not see the question as one about “up
or down”, but rather one of timing. Can
the elections lead to a constructive debate about priorities and policies that
allow for sequential cycling of sector allocations? Without strict expectations and direction the
consequences of undisciplined investing become more penal and more meandering. In this observer’s opinion the likelihood of
those issues being resolved in a convivial fashion are not good.
One
must consider that as recently as two years ago the financial markets were in a
tailspin. Valuations were so low that
issuing a “buy” recommendation was easy stuff.
However, the valuation expansion in stocks right now makes the
confluence of fundamental and technical analysis all the more important. It may take several more weeks…or months…of
consolidation and capitulation to bear this out but we see significant
recalibrations that are necessary to find equilibrium and opportunity in a
marketplace that is so extended.
For
example, energy (oil) stocks are highly overvalued based upon events in the
Middle East, Ukraine, and elsewhere, and influenced by surging post-pandemic pent-up
demand for travel. If demand were to
wane so too would valuations of Energy stocks.
We prefer, instead, to value these and other commodity equities based
upon supply and the generational depletion of natural resources, as well as
shifting demographics and expectations about climate and the globe. One might
also include other commodities in that evaluation such as water, food, gold,
and copper.
Further,
our third quarter equity recommended list over-weights Tech stocks and
Utilities, clearly a sign that while investors are interested in capital gains,
they are more concerned about preservation of wealth during tumultuous times.
Hidden
in this message about supply and demand is a not so subtle contrarian view
about retail stocks. As mentioned
earlier, high interest rates and a diminishing appetite by consumers to part
with discretionary funds is going to have a negative impact upon earnings in
this sector for the balance of this year.
Brick and mortar stores, as well as dining establishments, are having a
difficult time bringing in traffic, thus their shares are suffering also. Juxtapose their inertia against the enormous
expansion in infrastructure projects worldwide (roads, bridges, rail, etc.)
which I believe will boost capitalization of industrials during the same
period. Of course, we continue to have
one eye on the future by focusing on socially responsible objectives such as
agriculture (food insecurity), technology, housing, water access, and renewable
energy sources.
We
are also proponents of modest exposure to short term and intermediate
interest-bearing time deposits to maintain balance and defensive allocations
within high net worth portfolios.
Conclusion
Our
work has always been predicated upon the use of quantitative modifiers to
enhance portfolio valuation through the use of information systems that create
greater efficiency in portfolio diversification decisions. But because so much of the current data is
skewed by emotion and fear, rather than data and integers, it becomes more
difficult to engender the shared citizenship required objectively to analyze
the macro and micro data. The rebuke of,
and inability to accept common sense is the most vexing issue of our time, both
financially and politically, and muddies the overlay of any market strategy
worth its salt.
At
no time in the last 3 years have we been more conflicted by the lack of purpose
and direction in macro events which form the basis for our asset allocation
decision making. This equivocation stems
from the harsh rhetoric in our political debate; war poverty and
immigration/migration worldwide; and uncertainty about the future. The most important questions for investors in
the coming quarter revolve around how the current environment of fundamentals
meld with the psychological climate of mistrust which permeate the discussion.
The agenda, such as it is, is disjointed at best and poses severe roadblocks to
our current quarter expectations. We
caution again to look up and listen for the sound of limbs falling….
Suggested
Balanced Account Asset Allocation Q3, 2024
Equities: 48%
Fixed
Income: 40%
Cash: 12%
