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The Brave Report: Market Commentary for Q2 2024

How magnificent…. The markets marched higher this quarter continuing to be powered by the large tech names.  While market performance has been great, the rise of a few large highflyers has given us a false sense of overall market performance.  We continue to wait for more names and sectors to join the rally but so far participation has been muted.

Uncertainties over inflation, rates and the election still create an underlying sense of unrest for the markets but it hasn’t seemed to impact overall market volatility which remains at historically low levels.  The big question moving forward is will these tech names be able to continue to prop up the markets or do we need to see new leaders emerge for this rally to continue?

Market Overview

The markets continued their upward trend in the 2nd quarter.  The S&P 500 gained close to 4% while the NASDAQ jumped another 7.8%. The Dow Industrials were the only laggard during the quarter, dropping 1.7%.  This tech-led rally stalled slightly during the month of April only to surge higher during the later half of the quarter. The S&P 500 is now up close to 15% year to date and more than 32% since last October’s low.

On the fixed income side, we saw rates remain relatively stable throughout the quarter.  The yield on the 10-year treasury rose only slightly, rising from 4.2% to 4.32% to close out the quarter.  There was a small jump in yields in April only to see them drop back to around flat in June.  Inflation and uncertainty around the Fed’s next move continue to be the driving factor on this front.  However, even against this backdrop, rates have been pretty stable for the first half of this year.

While the markets have continued to rally this year, this rally has been a very top-heavy rally with a small number of companies being responsible for an outsized amount of the gains.  So far this year the S&P 500 is up around 15% but only around 25% of companies in the index are outperforming the index.  To put this into perspective, in 2021 when the index was up around 25% we saw 43% of companies outperforming the index meaning participation in the rally was much broader.

If we take this one step further and look only at the seven big tech names that have been driving the rally.  Referred to as the “Magnificent 7,” Alphabet, Amazon, Apple, Nvidia, Microsoft, Tesla and Meta, have been responsible for a majority of the market’s return year to date.  If we carve out these seven names from the S&P 500 they are up 48% year to date.  The remaining 493 stocks in the S&P 500 are only up 7.5%. Additionally, the small-cap Russell 2000 is actually slightly negative for the year. This type of top-heavy performance is typically not a great sign when it comes to the sustainability of a rally.  These names can only carry to the load for so long before other names or sectors need to start contributing.

I don’t want this to be taken as the rally is nearing its end and that some of these names still don’t have more room to run because the long-term story for these names is very intact. My contention is simply that the rally in these names is overshadowing the real performance of the underlying indices.  Most investors have been very happy with the market performance year to date but it is important to understand that the vast majority of the market is not performing as well as the indices would indicate. Furthermore, with the rally these large names have been on we could start to see some valuation concerns unless earnings continue to surprise to the upside.

Another interesting characteristic of the current rally is the lack of volatility in the markets.  It has been more than 385 days since the S&P 500 saw a down day of more than 2.05%.  This is the longest such streak since the financial crisis in 2008.  Apart from a small uptick in April, the VIX or Volatility index has remained historically low for the entire year.  This lack of volatility seems a bit strange considering the continued uncertainty around inflation, rates and the election.

With some names in the market continuing to soar, the upcoming earnings season will be an important one to watch.  We will be watching to see if earnings from these large tech names can justify the rapid rise these stocks have seen. Additionally, we will see if strong earnings from other companies and sectors will help add more participants to the rally and give it fuel for another leg higher.

I will also be looking to see how companies are assessing the current inflation and rate environment.  Inflation has remained stubborn and this has led to expectations of rate cuts to be pushed out even further into the future.  Going into the year, many expected up to four rate cuts, but most are now expecting one or none by year’s end.  While markets have handled this change in expectations well, we can learn from earnings releases how the current environment is actually impacting the economy and not just the stock market.

The other outlying uncertainty that the markets will need to factor in is the upcoming election in November.  I have never believed that the president has much direct impact on the economy in the short term, especially if Congress is split. However, over the next few months, we will start to get a more clear picture as to what if any policies could have a longer-term impact on the economy.  We are still in a wait-and-see mode right now but will get quite a bit more clarity in the next few months.

Strategy Commentary

I continue to remain patient when it comes to my overall equity allocation.  With markets continuing to push through all-time highs it has been difficult to find entry points for new money.  I have begun trimming a few of the high-flying names and sectors, trying to lock in some profits but have not gotten aggressive with any selling.  It has mostly been through adding trailing stops to highly appreciated names to avoid a large drawdown should market sentiment shift.  I am continuing to utilize short-term treasuries as a great place to park excess cash while we wait for new entry points.

Domestically I have not made any major changes, continuing to hold overweights to technology and communication services.  These have been winners for some time now and will look to lock in profits in these sectors if we see any negative shift in the markets.  Small-caps have underperformed throughout the recent rally but I still believe there will be a point where their valuation discount is too much to ignore.

Internationally, I am still quite cautious.  We have seen economic data lag in Europe and geopolitical uncertainty still creates a large overhang in both Europe and Asia.  I still maintain some international exposure but am not looking to add to an exposure at this time.

Short-duration fixed income, specifically treasuries continue to yield over 5% and provide a relatively risk-free place to park excess cash and other fixed income allocations.  I will continue to hold excess cash here while we wait for confirmation of a continued equity rally or we are provided with a more attractive entry point for equities.

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The Brave Report: Market Commentary for Q1 2024

Click here for .pdf version or this report: The Brave Report-2024Q1

I guess markets only go up….  The markets have continued to surge to start the year, adding to the gains we saw to close out 2024.  Equity valuations seem a bit stretched but economic data has also surprised to the upside creating an environment where the Fed is comfortable keeping rates higher for longer.  This higher rate environment would normally be a negative for stocks, but investors continue to focus on the resilience of the economy rather than the elevated rates.

We are probably due for a pause or consolidation period for stocks but it seems that any dips, even small ones, are quickly bought up as investors look to put excess cash to work and chase returns they may have missed out on over the past twelve months.  Without a major change in the economic outlook or some more certainty from the Fed, I do think the upside in the markets could be a bit muted from current levels but if we do see a pullback of any kind a lot of cash will come off the sidelines.

Market Overview

The markets continued their rally to start the new year, maintaining the momentum we saw to close out 2023.  The S&P 500 finished the first quarter right around all-time highs, gaining 10.1% since the start of the year.  The NASDAQ was not far behind, increasing by 8.5% and the DOW industrials added a respectable 5.6%.  After bottoming in late October, markets have been on a straight line up.  This has seen the S&P 500 add 28% over that brief timeframe. While many of the gains can be attributed to a handful of high-flying tech stocks, the rally has been sustained by other participants joining the fun.

On the fixed income side, we saw rates steadily climb throughout the quarter.  The yield on the 10-year treasury rose from 3.86% at the end of 2023, to close the first quarter right around 4.25%. While a sharp drop in rates to close out the year helped to add fuel to the equity markets, during the first quarter, markets were able to shrug off the steady climb in rates.  We have continued to receive clues from the Fed that rate cut expectations were a bit overzealous and this has driven the recent rise in rates.

As has been the case for the past few years, speculation around the Fed’s next steps has been the driving factor around short-term moves in the stock market. However, what we have seen in recent weeks is that as expectations about the number of rate cuts this year have dropped, the resilience and strength of the overall economy has increased.  A year ago, fears of a recession were percolating through the markets, but that fear has dissipated. It seems the economy has handled the higher rate environment much better than many had feared.  I am not saying that we are completely out of the woods yet, but the strength of the economy has given the Fed much more flexibility.

On the economic front, we have seen inflation drop. Albeit it is still above long-term targets, and the speed of the drop has slowed if not stalled.  Jobs numbers continue to impress and have shown little impact from the elevated rate environment.  While this is very positive for the economy, it has reduced the need to cut rates more quickly.  This data point will continue to be important to watch because we don’t want the Fed to wait until it is too late to start cutting rates back to more traditional levels. We have also seen manufacturing data improve, which shows a deeper strength in the economy and that economic growth has some support in a broader range of sectors.

While economic data has been mostly positive, I do not think we are in an environment to go all in on equities.  First and foremost, the market has already run higher rapidly.  We have hardly seen any pause in the upward momentum and there are definitely some areas of the market that seem overbought.  Valuations across many sectors are becoming very stretched and unless we see some blowout earnings over the next few quarters, I think the market upside will be capped into year-end.  I am not saying the market won’t go up anymore, but the pace of the rise will need to slow or the entire market will be highly overvalued.  For the longer-term health of the bull market, some consolidation or even a small pullback would be very healthy as investors let data and risks catch up with current valuations.

Outside of stretched valuations, there are also a number of risks that could weigh on markets moving forward.  We have already discussed the ongoing uncertainty around the path of the Fed.  This will continue to weigh on markets until we have a firmer pathway.

Geopolitical risk has also increased over the past few months.  Wars in Ukraine and the Middle East must be factored in, especially when investing abroad.  So far, the economic impacts of these conflicts have remained pretty isolated, but the escalation of these conflicts could have larger implications in the markets and must be monitored.

Lastly, it cannot be ignored that we are in an election year and domestic issues are moving to the forefront.  Debates over taxes, immigration and government spending will be ever-present.  As we get closer to November and the potential outcomes of the election become clearer, we will need to factor in the economic impacts of the various scenarios.  This is not just limited to the presidential election but also those in Congress.

Strategy Commentary

With these variables all factored in I am very comfortable being patient with any new money.  I am not in a rush to put much new cash to work right now. In the same vein, I am also not reducing any equity exposure either. I think we will see some consolidation or a pullback sometime in the next quarter. At that point I will look to round out any allocations with new cash. However, until that point, I am comfortable earning 5% on my cash using short-term treasuries or money market funds.

On the domestic side, I continue to maintain my overweight to technology and communication services.  However, if both sectors continue to run, I may take the opportunity to trim some of the exposure.  Both sectors are up over 40% in the last 12 months so some profit-taking may be warranted.  Other sectors, such as industrials and materials have begun to catch up a bit over the last three months and will warrant keeping an eye on, especially if we continue to see strong economic data.  Small caps continue to be intriguing as well.  Their valuations are quite low when compared to the large-cap names that have run so much in the past year.  At some point they will have to play some catch up so I will look to add more domestic small caps if the opportunity presents itself.

I am still quite cautious on the international side.  Geopolitical risks still remain, and any escalation of conflicts could ripple through these markets.  Japan has been one bright spot internationally over the past year but like domestic markets, has run quickly to all-time highs so we are not at a great entry point.  Economic growth numbers have also lagged in international markets, so I don’t see much opportunity in the short term.

With rates climbing back up a bit in the past few months, I continue to favor locking in 5+% in short-term treasuries until we see some more confirmation from the Fed that they will cut rates.  With the run equities have been on, I am also comfortable sitting in short-term treasuries with new money while we wait for a better entry point into equity markets.

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The Brave Report: Market Commentary for Q4 2023

Click here for the .pdf version of this report: The Brave Report-2023Q4

Well, that escalated quickly…. Markets surged rapidly to close out the year, posting back-to-back positive months to finish the year near all-time highs.  The S&P logged its best quarter since 2020, helping to erase many of the losses from last year.  Improving inflation data, dropping rates and optimism around the Fed all contributed to a more bullish stance.  Performance was very top-heavy as the larger tech companies contributed disproportionately to the quarterly gains. These bellwethers were able to avoid a slowdown in earnings within an elevated rate environment and were rewarded for it.  We will need to see an expansion in the number of companies leading the markets if this rally is to continue in 2024.

Market Overview

After a brief pause during the 3rd quarter, the markets surged again in the 4th quarter to cap off a stellar year.  Even in the face of geopolitical unrest around the world and uncertainty around inflation and rates, all three major indices surged to close out the year.  The S&P rose 11.2%. The DOW rose 12.4% and the NASDAQ jumped 13.6%. This allowed the S&P 500 to end the year up more than 24%. This represents a nice bounce back after the drawdown we saw in 2022.  There continues to be uncertainty around the Fed’s next moves, but markets have been pricing in a very optimistic scenario and a softish landing.

On the fixed income side, we saw a massive drop in rates across the entire yield curve as inflation data came in better than expected.  After peaking around 5% in mid-October, the yield on the 10-year treasury dropped more than a percent to end the quarter below 4%. This rapid drop in rates helped to add fuel to the equity markets. The bond market is now pricing in an end to rate increases and is predicting a reversal to rate cutting sometime later this year.  These decisions will be data-dependent but the current trend in inflation seems to support at least a pause in rate increases.

With cooling inflation and a relatively optimistic tone from the Fed, equity markets were able to surge to close out the year.  While the Indices had a great quarter (and year), it is important to look a little deeper at the numbers and what led to such great gains.  What we find is that most of the market’s gains can be attributed to just a small handful of stocks.  Some have dubbed these the “Magnificent 7”. They include Apple, Alphabet, Microsoft, Amazon, Meta, Tesla and Nvidia. These 7 large tech names now make up more than 30% of the market cap of the S&P 500 and saw their valuations surge in 2023.  While the S&P 500 notched a strong gain of 24% for the year, these 7 stocks returned an average of 111% over the same time frame.  Additionally, if we compare the equal-weight S&P 500 with the normal market-weighted average, we saw the biggest margin between the two since 1998.

All these companies have been able to continue to put out stellar earnings numbers and have benefited from the surge in AI-related business.  However, the disproportionate performance between these companies and the rest of the market has painted an inaccurate picture of where the overall market stands.  If the markets are going to continue to outperform in 2024, we will not just need to see these 7 companies perform well, but at some point, the rest of the market will need to contribute.

The main theme we have been discussing over the last year is inflation and how the Fed can bring down inflation without destroying the economy.  So far, they have succeeded in doing so.  I do think the markets are a little optimistic about when the Fed will start cutting rates.  Inflation has come down, but the jobs market continues to remain strong.  For the Fed to start cutting rates, Jobs data will need to weaken a bit or show signs of weakening.  Until that point, I think the Fed will be hesitant to start a rate-cutting cycle.  They will eventually cut rates but the timing of it will be more delayed than many think unless we see some real weakness in the economy.

The hardest thing in the markets these days has been handicapping the Feds’ next move.  I will credit them with staying data-driven and understanding that some of the rate hikes they have done have not yet filtered into the economy.  The economy has been more resilient to the rate hikes than I think most originally anticipated but I fear that this optimism has allowed the markets to get a little ahead of themselves.  I would not be surprised to see a period of consolidation as we wait to get some earnings data which will tell us how much the increased rates are weighing on company performance and guidance.

The other major theme driving the markets this year, especially on the technology side, has been the AI revolution that has seemed to move into the mainstream quite rapidly. I think we are still in the early innings of this movement, but we will start to see how companies can take AI from a fun word to discuss on a conference call to a resource that moves the needle from a company earnings standpoint.  The early winners will be those companies that provide the infrastructure that powers AI.  We have already seen that with the performance of NVIDIA.  The next stage will be companies that can leverage the power of AI to drive business results.

The other big variable I will be watching this year is the election. I am not a huge believer that a President has a large impact on the month-to-month performance of the stock market but historically the market has performed well during the election cycle. The S&P 500 has returned an average of 11.28% during election years and has been positive 83% of the time since the S&P 500 was created. Incumbents like to be able to run on a strong economy and members of Congress don’t want to pass anything that could throw uncertainty into the markets. They will focus more on pro-growth stimulus efforts which can help prop up the economy in the short term.  As the election dynamics become more clear, we will start to see the markets handicap the various outcomes.

Strategy Commentary

With inflation data improving in October and November I cautiously added to some of my equity positions.  This is in no way a full overweight to equity, but I selectively increased some of my equity weightings.  I missed out on some of the runup to close the year but with data improving I felt more comfortable adding to some positions.  I continue to be cautiously optimistic going into 2024 but do expect some consolidation and profit-taking in the short term.  I think we need to see some more certainty around the Fed’s next move as well as some widening of the breadth of the rally before I go fully overweight equity.  The “Magnificent 7” have run so far so fast that I think we will need some other names to lead the next leg higher.

Domestically, I have continued to maintain my overweight to technology and communication services stocks, while also adding to my consumer discretionary allocation.  I have been overweight technology for quite some time now and expect the trade to continue to outperform as we move from the phase of AI just being a buzzword to it adding significantly to company performance.  I do think the large tech names will continue to perform well but expect some other names to start to catch up. Additionally, if rates continue to decrease, we will see small-cap stocks perform better.  Their valuations are much more reasonable when compared to large-cap companies, but they have been held back by high financing costs and uncertainty about inflation.  If we get any directionality from the Fed, then I think small caps will do some catching up from a valuation standpoint.

Internationally, I am still focusing on large, developed economies.  Geopolitical uncertainties still plague many of the developing markets.  If I were to look at some small emerging companies, I would focus on India and some Latin American names as their economies are less exposed to the current geopolitical conflicts.

On the fixed income side, even though rates have dropped, I still think there are some opportunities at the short end of the curve, especially if you are worried about the Fed raising rates again or delaying their cuts.  Money funds earning more than 5% have also been an attractive place to park money without having to worry about price fluctuations.

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The Brave Report: Market Commentary for Q3 2023

How high will they go?…. Rates continued their historic climb over the past quarter, and it is now expected that rates will remain high throughout 2024. The larger question that remains is when will these elevated rates start to bite the economy.  So far, the economy has remained resilient in the face of these elevated rates, but I fear there will be a point where the holes in the economy are impossible to ignore. By that time the Fed will have backed itself into a corner with little ability to get the economy going again.

There will still be winners in this scenario, but investors will need to be selective in where they park their money. In the meantime, these elevated rates on treasuries should be taken advantage of while we wait for more economic data to filter through.

Market Overview

After a strong first two quarters of the year, markets took a step back in the third quarter. All three major indices lost ground over the last three months with the S&P 500, NASDAQ and Dow down 3.6%, 4.1% and 2.6% respectively. Rapidly rising rates, recession fears and geopolitical uncertainty all weighed on stocks. Investors took some risk off as we saw large inflows into treasuries. However, even with the rising rates, labor markets have remained resilient and while corporate earnings dropped, they still outperformed expectations.  At some point, we will see the impacts of the higher rate environment on the overall economy, but that impact has been muted so far and has only been visible in some areas of the economy.

The fixed-income side of things has been the driving force behind markets in recent months.  We saw continued rapid jumps in rates across the yield curve. The 10-year treasury closed out the quarter with a yield just below 4.7%, its highest level since 2007.  More than just the current level has been the speed of the rise.  As recently as May, the yield was around 3.2%.  On the shorter end of the curve, we have seen the yield stay above 5% on everything from the 1-month to the 2-year treasury.  Because of this, there has been a rapid increase in short-term treasury exposure as investors continue to be comfortable earning 5% while they wait for the equity markets to show some more conviction in their directionality.

Downward pressure on bond prices picked up steam during the third quarter. These rapidly rising rates put pressure on stocks amid fears that inflation is stickier than most thought and that the Fed will be forced to raise rates again before year’s end. The Fed has slowed its pace of increases, but it is now feared that this environment of elevated rates will be around for longer than many expected.  The most recent Fed “dot-plot” illustrated a higher expected rate throughout 2024.

The big issue we are seeing is that this rise in interest rates has yet to fully bite the economy. Economic data has continued to come out stronger than expected.  The consumer has remained resilient in the face of rising rates, and the labor market has remained strong.  Unemployment still sits below 4% and we continue to see job growth.  The Fed watches these labor numbers closely, as one of their mandates is full employment. While job growth has slowed slightly, we have yet to see elevated interest rates have the desired impact on the labor market.

The difficult thing investors are dealing with is that rate increases tend to have a lagging impact on the economy.  Increased rates don’t have a short-term impact but at some point, the scales are tipped and you see these rates start to have a measurable effect on the consumer and the labor market.  The fear is by the time they start hurting the economy, they will already have been raised too far and the Fed will struggle to right the ship. I do think some of this negative economic impact is already priced in but if we see a measurable pullback in consumer spending, the entire economy will be impacted, and we will see some softness in the markets.

The Fed has also been working to bring down inflation. They have been successful in doing so, to a point, but inflation has remained elevated above long-term norms.  Like the labor market, the question remains as to how much damage the Fed will have to do to the economy before inflation drops back toward its target rate.

The Fed is trying to slow the economy to combat inflation but so far, the economy has been resilient to the elevated rate environment in most areas. Corporate results last quarter were stronger than expected and while earnings did retract slightly, they still outperformed expectations.  What we have seen in the corporate world is that there has been some weakened demand in some areas but larger companies, especially on the tech side, have continued to produce record cash flows.  These companies represent such a large percentage of the overall corporate earnings picture that they have been able to mask some of the holes in the economy. This bifurcated economy has made it difficult to get a full picture of how well companies are doing and I think it would be naïve to think that elevated rates won’t have an impact at some point, especially on companies that need to raise debt or rely on revolving lines of credit.  The winners will continue to be those companies that can produce consistent cash flow.

One of the areas where we are starting to see holes and that I fear could be the first place we see some major issues is in the commercial real estate sector, especially when it comes to office space.  Increased vacancies combined with increased financing costs will make the current model difficult to sustain.  The problem is that issues with these large commercial loans could spill over to the banking sector as they hold and repackage much of this debt.  While I don’t think this will ripple through all sectors of the economy it is something I will be watching closely going out into next year.

Strategy Commentary

Over the past quarter, I have continued to maintain a neutral to cautious positioning across most allocations.  Rising rates along with the other uncertainties that I have discussed have presented a market environment where the risk is to the downside.  I have refrained from adding to my equity positions besides some basic rebalancing.  I am currently comfortable increasing exposure to treasuries, mostly on the short end of the curve until we see some stabilization of rates.  While I have not been buying much equity, some of the recent pullbacks have brought a few names and sectors back into a “buy” range. I will be quick to add to some of these positions should economic and corporate data warrant.  As discussed, there are still some areas of the economy that are holding up, even with higher rates.  These will be the winners if we do see a softer landing for the economy because they provide equity exposure with reduced risk.

Domestically, I am maintaining increased exposure to large technology and communication services stocks.  Growth and technology names tend to be more sensitive to rising interest rates, but we saw during the most recent earnings period that these names have held up better in the current economic environment.  I am still avoiding the more speculative names and focusing primarily on those large tech names that have strong balance sheets and robust cash flow.  These “growth” names are now seen as a safety trade and a good place to park money during times of uncertainty.

Similarly, on the international side, I am also focused on large, developed names.  Geo-political uncertainty, both in Ukraine and the Middle East has led to an environment where any increased international exposure should be done cautiously.  I continue to like the longer-term story in India but am in no rush to add exposure.  Should the geo-political landscape improve, I will again look to increase exposure here.

On the fixed income side, I have continued to add exposure, especially on the shorter end of the curve. Rates have continued to rise rapidly over the past quarter and this has provided the opportunity to park excess cash in these high-yielding treasuries.  I have also started to look at some higher-quality municipal exposure for taxable accounts.  The current after-tax yields are becoming difficult to ignore. When we get to a point where it looks like rates are peaking, I will start to move out on the curve to get a larger benefit from dropping rates. Going into year-end, I will also be looking to tax loss harvest in any of my existing long-dated exposure as the prices have dropped quickly in the rising rate environment and can help provide a tax balance to the equity gains from the first half of the year.

Click here for .pdf version of this report: The Brave Report-2023Q3

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The Brave Report: Market Commentary for Q2 2023

Click here for .pdf version of this report: The Brave Report-2023Q2

What recession?  Markets continue to grind higher as investors price in a soft landing for the economy and only perhaps a mild recession. This performance has been primarily driven by a rush to the large tech names that got beaten up last year. This is partially because these companies have been able to maintain their profitability, but they are also being viewed as a safe place to park assets in case data turns negative. I do think markets have been a bit overly optimistic so I would not be surprised by some profit-taking at some point.  However, if the economy weakens more than expected then we could see a rush into short-dated treasuries.

Market Overview

During the second quarter, the markets added to their first-quarter gains. Although, there continued to be a large performance gap between the major indices. The Dow industrials gained an additional 3.4% and the S&P gained 8.3%. The NASDAQ continued to be the big outperformer on the year, adding 12.8% bringing its year-to-date return to around 31%. The NASDAQ was the big underperformer last year but that has reversed as investors have flocked into some of the big tech names.  Even with the gains we have seen I continue to see the large tech names outperforming as they seem to be the safety trade while other uncertainties exist in the markets.

On the fixed income side, rates continued to rise after being range-bound for much of the quarter. The Fed has hinted that future rate hikes may be needed, and this has put more upward pressure on rates.  After trading around 3.5% for much of the quarter, the rate on the 10-year jumped to end the month of June at a yield just above 3.8%.  Rates across the curve have continued to rise with the short end of the curve breaking above 5%. The spread between the 10-year yield and the 1-year has now reached a level that we haven’t seen since the early 1980s. Historically, this inverted yield curve normally predicts an impending recession, but we will still have to wait and see if the Fed can orchestrate a soft landing for the economy while reigning in inflation.

Inflation pressures, rising rates and the prospect of a recession have still been the driving factors in this market. The question remains of how high the Fed will need to raise rates to get inflation back to their long-term target rate and if they can accomplish it while limiting the damage to the overall economy.

So far economic data has come in mixed.  We have seen some downward pressure on inflation, but we also continue to see strong jobs data coming out which indicates that the economy is still quite strong and can handle more rate increases.  The Fed has hinted as much.  Their expectation is for a few more hikes but at a much slower pace.  We have definitely seen weakening in certain parts of the economy but overall, the economy has remained resilient.

As we enter earnings season, we will start to get a much better picture of how the economy is performing under the surface.  I predict there will be some definite winners and losers.  I also think companies will continue to express a much more cautious outlook in their guidance as economic uncertainties for the next few quarters will make it difficult to project future growth and profitability. I also predict we will start to see the impacts of increased financing costs negatively impacting earnings and adding to the uncertainty, especially for smaller companies.  Larger companies will be able to weather these increases much easier.

From an investment standpoint, we have seen money flood into the large tech names so far this year.  The top seven or so names have been responsible for a majority of the gains in the NASDAQ and the S&P so far this year and I see this trend continuing.  Rather than run to just treasuries or cash for safety, investors are using large technology names as the safety trade while they wait out future economic data.  These companies have continued to grow and be highly profitable.  They were also some of the names that were beaten up the most last year so had a lot of upside potential going into the year.

I still remain cautiously optimistic as we play the waiting game on more economic data. I do think the markets are currently pricing in a very soft landing and might be a little overly optimistic.  The reason I remain cautious is that if we start to see economic data deteriorate or the Fed is forced to raise rates more aggressively then we could see a selloff in risk assets and a rush into safety.  This rush to safety would be in the form of buying short-dated treasuries along with the large tech names.  With the 2-year paying around 5%, it is not a bad place to park some excess cash while we get more clarity on the direction of the economy.

While I think large tech will continue to outperform, if you have made some money in the large tech trade so far this year, it would be appropriate to trim some of this exposure as it probably represents too large of an overweight.

Strategy Commentary

I continue to maintain a relatively neutral stance across the entire allocation.  As I mentioned earlier, I think the markets are currently pricing in a very soft landing for the economy.   If this continues to play out then I am comfortable maintaining my current exposure. However, if the Fed is forced to raise rates again or we see some pronounced slowing of the economy then I will look to raise some cash and wait things out in short-dated treasuries.  I do think we will see some continued volatility as new economic data comes out but we will need to see true directionality from the economy to make any large-scale changes.

Domestically, I am maintaining increased exposure to large technology, communication services and consumer discretionary.  I have also made some slight shifts away from some more defensive value exposure and back to large-cap growth. If the soft landing doesn’t play out as expected I do think some technology names will sell off, but I also think the larger profitable ones will receive inflows as part of a flight to safety.

Internationally, I missed out on some opportunities in the first quarter so have increased exposure slightly over the past few months.  Most of this increase has been in developed large-cap exposure.  The conflict in Ukraine and the potential ripple effects from the war still prevent me from increasing my exposure much more.  I also continue to keep an eye on emerging markets names but my focus has shifted slightly away from China and I am much more closely watching other economies, such as India.

On the fixed income side, I continue to add to the short end of the curve.  The yields on short-dated treasuries continue to rise and I have been rolling maturing treasuries along with excess cash into new ones. If the markets are wrong and we do not see a soft landing then treasuries will be the place to weather the storm.

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The Brave Report: Market Commentary for Q1 2023

Click here for the .pdf version of this report: The Brave Report-2023Q1

Over the past few months, I have paused the publication of the Brave Report in an attempt to fine-tune the proper frequency and format for the report moving forward.  I have spoken with clients and the consensus seems to be that the format works well but publishing on a quarterly basis (rather than monthly) along with one-off pieces when specific events arise is the preferred frequency.  If at any time between publications you have a question about a specific topic and how it impacts the markets, feel free to reach out directly.

Banking crisis, inflation and recession… These are the buzzwords for the past quarter.  Inflation and the fear of recession have been looming over the markets for well over a year now.  Rates have risen drastically to keep inflation in check and many fear that the only way to get it back to “normal” levels is to slow the economy into a recession.  Markets are now trying to handicap how deep and long-lasting any economic damage will be.  Throw on top of this the failure of a few banks and the fears of a repeat of 2008 come streaming back.  However, even with all of this negativity, the markets were able to rally throughout the 1st quarter. They had been sold off pretty heavily last year so they definitely had some room to jump but this resilience in the face of a lot of uncertainty should be looked at as a positive.  For the remainder of the year, I expect this push and pull to continue. Range-bound volatility will be the norm until we can get some more clarity on the strength or weakness of the economy.

Market Overview

Following what was the worst year in the markets since the financial crisis, the markets bounced back in the first quarter of 2023. The bounce, however, was not market-wide as there was a large dispersion between the three indices. During the quarter, the S&P 500 rallied 7% and the NASDAQ rose just shy of 17%. The Dow Industrial Average only advanced slightly, gaining around 0.3%.  This was a reversal of how things ended last year when the tech-heavy NASDAQ was the big underperformer. During the quarter we saw a rush into larger, profitable technology names as cost-cutting within the sector made headlines. These names emerged as the ones that are expected to be able to withstand the elevated rate environment and any subsequent economic downturn. They were also some of the names most beaten up over the previous 12 months.

On the fixed income side of the equation we are still seeing an inverted yield curve, with rates on the short end of the curve remaining elevated above their long-dated counterparts.  We did see rates come down a bit during the month of March as the Fed laid out its projections for future rate hikes and inflation continued to drop. However, if we look back a year, the rate on the 10-year is still 1.25% higher than a year ago.  The Fed, has signaled an end to their rate increases but there are still a lot of moving parts in the equation.  If inflation remains at elevated levels, we could see rates stay high for quite some time. On the opposite side, if economic data starts to signal an imminent recession, we could see rates soften.


The recent failure of Silicone Valley Bank, along with some other smaller institutions has brought memories of 2008 back to the forefront.  Before I dive into it, I want to make clear that what we have seen in the banking sector over the past month is very different than what we experienced in 2008.  The regulatory environment is much different, and our banking system is much better capitalized than it was back then.  With that said, there will be some long-lasting impacts from this recent turmoil.

First, what happened to SVB?  SVB was a unique player in the banking industry, catering primarily to venture capital firms and venture capital-backed companies and founders.  SVB was able to leverage these relationships to be a one-stop shop for the venture community.  These types of deposits were not very “sticky” as companies would routinely need access to their capital as they spent money to operate their companies.  They also had one of the largest non-FDIC insured deposit bases amongst any bank in the country, meaning that the potential for losses, if depositors couldn’t get their money out, would be substantial.

Along with other regional banks, they would offer higher than average rates on their banking deposits to help attract new capital.  In order to offer these higher rates, they had to increase the risk they took while investing these deposits, often investing deposits in longer-duration assets and  a mortgage-backed portfolio.  The problem with investing in these longer-duration assets is that as rates rose the portfolio lost money unless they could hold the positions to maturity.  As redemptions were called in, the bank was forced to sell some of these long-dated assets at a steep loss.  This raised concerns about the financial stability of the firm and when they attempted to raise capital through a stock sale, depositors panicked and started to withdraw assets at record rates.  The government had to step in and freeze redemptions to prevent a further run on the bank and within a few days the bank was no more.

From what we know so far this looks like a product of poor corporate management and not something that is systematically wrong with the banking sector. Thankfully for most depositors, the government was able to step in and insure all depositors, at no cost to taxpayers.  The good news is that this helped to prevent further contagion throughout the banking industry which would have been devastating for the industry moving forward. On the flip side, by the government stepping in they have removed a moral hazard from the banking sector.  If banks and depositors think that the government will just step in during a future crisis, then they are less likely to have proper risk controls in place to protect depositors.

There will be some other long-lasting impacts moving forward. As we saw during the days following the collapse, depositors flooded to the larger money center banks. This will lead to the big banks getting bigger and create a landscape where the smaller regional banks will struggle to attract new capital. Furthermore, the smaller regional banks could become more risk-averse in their investments and thus lose the benefit of offering depositors higher rates.  Profit at these smaller banks will take a hit and the large banks will reap the benefits.

Inflation and Rates

The big market-driving story over the past year has been elevated levels of inflation and the subsequent rise in rates to help combat this inflation.  The big question that investors have been asking is can the Fed thread the needle of taming inflation without causing a widespread recession?  It is a tough task because the impacts of rate increases tend to be lagging so we don’t fully know what impact these rate increases have had on the economy yet.  Pundits, large investors and economists have come out of the woodwork to state their case on what should be done and the dispersion of opinions has been all over the map. Some have said that markets will drop another 20% while others are calling for the start of a new bull market. This has made it very difficult to make investment decisions and even with the jump in some sectors since the start of the year, the markets are still fighting for directionality.

In times like this, when there is a lot of uncertainty, I like to simplify things, and understand what we do know and what we can control:

  • Inflation has been too high for a while but has been trending down over the past 6 months.
  • Prior to the pandemic, inflation was below long-term averages since the financial crisis so some of the jump in inflation could be some reversion to the mean.
  • Rates have been raised to levels we haven’t seen in over a decade, but the Fed has signaled that these rate increases will end soon.
  • The full impacts of elevated rates on inflation and the economy are still not known as there is a lag on this impact.
  • The yield curve is inverted offering investors a way to hide out in shorter-duration assets until the market shows some directionality.
  • The economy and employment market have shown signs of slowing but there are still just under 10 million job openings.
  • Earnings growth is expected to be right around flat if not a little negative but there are still some companies growing rapidly and little impacted by elevated rates.


So, what do we do with this information? I think it is important to first point out that I expect these uncertainties to persist for quite some time. There is too much dispersion of opinion within the investment community for real directionality to happen.  We will see continued volatility in both directions but large bounces in the markets will be sold and large drops will be bought creating a range-bound market, albeit with a relatively wide range.  This volatility will continue until we see some consistent data on the inflation and earnings front. I also expect this earnings season to help us understand who is winning in the current environment and in what sectors the signs of recession are starting to show themselves. Earnings guidance will be muted as is often the case during times of uncertainty, but a lot of this is already priced into many names.

For the long-term investor with few short-term capital needs, now is the time to make sure your allocation hasn’t shifted too far out of balance. There has been a dispersion between sectors, company size and style. This can lead to a portfolio being out of balance.

If you are investing in individual names, I would focus on those with consistent profitability and strong balance sheets.  Timing the market during these times of uncertainty can be difficult but adding to quality names when they are priced at a large discount to where they were a year ago can be a good way to add value to your portfolio.  However, I would recommend dollar-cost averaging into any new positions as I think this uncertainty will be around for quite some time, providing ongoing entry points.

I would also look to take advantage of the high rates on the short end of the yield curve.  The spread between the dividend yield on the S&P 500 and the 10-year treasury is larger than it has been in more than a decade, meaning the premium you are paying for dividend yield is not very attractive compared to bonds. Owning the treasuries or bonds directly is a much better option than owning a bond fund as this helps to eliminate price risk if you can hold the bonds to maturity, which is a lot easier with an inverted curve.

Strategy Commentary

I continue to maintain a neutral stance across portfolios.  I expect to see continued volatility for the rest of the year as the markets grapple with higher rates and the prospect of a recession.  Some of the economic slowdown is already priced into markets.  One of the driving factors for the rest of the year is going to be determining if anything more of the economic slowdown needs to be priced in. As discussed, I expect the market to be volatile within a wide range until we get some more certainty on how much the interest rate hikes will impact economic growth.  I am content maintaining a neutral stance until some of these questions get answered. I will look to add to some equity positions if we see a further pullback or we start to see signs that the recession fears are overblown.

Domestically, I am still advocating for a bar-belled approach with exposure to technology and communication services on one end and defensives on the other.  We saw technology pop in the first quarter and the defensives lag, but if we see the market turn more negative, the opposite will be true.  Within these sectors, especially on the technology side, I am still focusing on high-quality, profitable names rather than chasing the more volatile high beta names.  I do think stock picking will outperform for the rest of the year as some names are able to withstand the economic slowdown better than others. Finding these winners can help to drive outperformance in portfolios.

Internationally, the eurozone has performed well so far this year.  I have been neutral on the region so I definitely missed out on some of its outperformance.  I continue to maintain a neutral stance on most developed markets.  The threat of a spillover from the Ukraine conflict still adds additional tail risk to these markets and I am willing to sacrifice the potential outperformance to miss this risk.  The same can be said for emerging markets.  I have selectively added over the past year but these additions have been short-lived.  Uncertainties around China make it tough to invest with much conviction in the region.

On the fixed income side, I continue to reduce the duration of our positions and have been adding short-dated treasuries to most portfolios, especially in instances where we have excess cash. This is a great place to hide out until we have some more conviction in the equity markets. I have also been shifting some assets from bond ETFs to owning the actual securities. Owning the actual bonds or treasuries and holding to maturity eliminates some of the price risk and since we are buying mostly on the short end of the curve, we are not giving up too much liquidity.

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The Brave Report: Market Commentary for October 2022

Click here for .pdf version of this report: The Brave Report-October 2022

Let’s all take a deep breath…. Over the last few months (and pretty much since the start of the year) it has been very painful to look at our account balances.  Without a strong rally into year-end, we are shaping up to have one of the worst years in the markets that we have seen in quite some time. However, it is important to point out that this is on the heels of three straight great years. The downward pressures on the markets and the economy are real and until we start to see some downward movement in inflation, these pressures will continue. When this dust finally settles, I think there will be some great opportunities since valuations of very profitable companies have been compressed, but we are not there yet.

Market Overview

Over the month of September, all major indices dropped sharply.  The S&P 500 lost 9.3% the Dow dropped by 8.8% and the NASDAQ was down over 10%.  While the quarter had started strong with the markets up in July and August, this September drop led to another losing quarter. The S&P and the Dow ended the third quarter down 5.2% and 6.6% respectively.  The NASDAQ only dropped 4.1% marking a reversal from previous quarters when the NASDAQ underperformed.  This leaves the three major indices in bear market territory heading into the fourth quarter. If S&P were to close the year where it is today it would mark the worst year since the financial crisis and the third worst year since 1974. Albeit this is coming after a run of three great years when the S&P was up 28%, 16% and 26% going back to 2019.

While the equity markets made a large move to the downside, the more pronounced moves have been on the fixed-income side.  Rates continued the climb that started at the beginning of August and jumped sharply across the board. The 10-year treasury peaked just shy of 4%, its highest level since 2010.  It has now risen almost 150 basis points since early August.  On the shorter end of the curve, we saw the 2-year treasury jump above 4% for the first time since 2007.  The markets have priced in continued aggressive action from the Fed but at the same time have made the fixed-income space a lot more attractive from an investment standpoint. With a lot of uncertainty expected in the coming months, getting paid more than 4% for the next 1-3 years seems appetizing and increasing fixed-income allocations may help investors weather the storm. Additionally, if the Fed softens its stance, we could also capture some positive price movement as rates drop.


All major indices are in bear market territory, inflation continues to come in hot and rates seem to rise every day. Equities are dropping along with bond prices, muting traditional diversification benefits. You also can’t just hide in cash because that cash is losing money to inflation. Everywhere you look, there is bad news, and every financial pundit out there is beating the drum of recession. So, the world must be ending soon?

In times like these, perspective is very important. Especially for the long-term investor.  Let me rephrase that last paragraph:  Over the past two and a half years the world has been gripped by a global pandemic that has closed borders, kept people from going to work and killed millions of people. Russia invaded another sovereign country, cutting off supplies of oil and gas to large portions of Europe and driving energy prices through the roof. And, our relationship with our biggest global economic and military competitor, China, has continued to deteriorate. Yet, as of the end of the 3rd quarter, the S&P 500 is still up more than 20% over the last 3 years, and up more than 60% from the pandemic lows.  Over the last 10 years, the S&P 500 has more than tripled. Perspective matters.

Now, I am not saying this to downplay what is going on in the economy today.  The issues are very real.  Inflation is a major problem.  The Fed response has been flawed. There are parts of the economy that are probably already in a recession and that could spill over to the rest of the economy. Because of this, the markets have reacted sharply to the downside.  Whether they have reacted correctly is what is still to be determined. These types of determinations play out over the long run, not the short. The patient investor can capitalize on that.

The stock market is a forward-looking indicator, which means it will normally move in anticipation of data and then correct itself if it was wrong.  This happens in both directions.  We saw it overreact to the upside last year as the consensus was that inflation would be transitory.  As inflation persisted, the Fed and the market realized they had been wrong so needed to correct.  The ripple effects of this have exposed or caused other cracks in the economy, exacerbating the situation. So, where are we today and what needs to happen to stabilize or reverse the markets?

The big elephant in the room that seems to be driving most of this is inflation.  The Fed along with other international central banks let inflation get out of control. While I think their initial assessment that inflation would be transitory was correct, too many external shocks forced inflation higher and made it stickier. China’s continued commitment to its COVID Zero policy forced disruptions to supply chains.  Companies can’t just shift production and distribution on a dime.  With products in short supply, prices can only go up.  On top of this, the Russian invasion of Ukraine then sent energy and other chemical prices through the roof.  These increases trickle through the entire economy and caused a wide rise in prices across many industries.

With inflation now running hot for quite some time, the Fed is left in a precarious position to put the genie back in the bottle. So far, their answer has been to raise interest rates faster than at any time in history and have signaled that this will continue. Their job is not an easy one.  They are raising rates in an attempt to put small cracks in the economy and slow it down, but not enough cracks that it breaks. In other words, they are trying to slow the economy enough to weaken the historically strong job market and bring down inflation without doing enough damage that the economy falls into a deep prolonged recession.

Outside analysts and investors are falling into three groups as they try to predict how this is going to play out and how successful the Fed will be:

The first group continues to beat the drum that the Fed isn’t acting fast enough and needs to continue to aggressively raise rates to bring inflation down, either in one big increase (the rip the band-aid crowd) or continued aggressive increases over the next year. They feel that if the Fed fails to bring inflation under control it will create larger negative economic impacts. With economic and labor data continuing to come out strong there is the thinking that the economy can withstand a more aggressive Fed. The risk to this is that the Fed goes too far too fast and sends the economy into a recession that could have been avoided.

The second group thinks that the Fed is moving too fast and that the impacts of the last few rate hikes haven’t worked their way into the economy yet. An increase in rates doesn’t have an immediate impact on the economy and it takes time to understand its impact.  This group also thinks that natural economic forces will work to bring inflation into check. They think that while this inflation wasn’t transitory, as the Fed had described it last year, it will still fall off due to the alleviation of some of the outside factors that are causing it. This process is taking longer than initially anticipated but it will still happen.

The last group is the smallest group. They think the Fed will be able to thread the needle and bring down inflation without weakening the economy too much. They won’t raise rates too fast and will be able to slow their hikes as the natural economic forces also help to bring down inflation. This is the soft landing.

With this many schools of thought, it is no wonder that we have seen the markets sell-off. Markets hate this kind of uncertainty. I also don’t envy the Fed in this situation.  While quite a bit of blame is being put on the Fed for contributing to this problem, that blame doesn’t help them navigate out of it. Inflation data is backward-looking, and their rate increases take time to trickle into the economy. So, they are using backward-looking data to make decisions that won’t impact the economy for months to come and then have to make another decision before the impact of their first decision has been felt. All while external shocks, that are out of their control, seem to pop up each day. This is no easy task.

With all of these uncertainties, what are we watching to determine when markets are going to stabilize? Outside of just looking at top-line inflation data, I am looking for any signs that these non-Fed-related forces are softening inflation on their own. This would help to inform what path the Fed might take. It would be a signal that they don’t need to bring inflation down on their own.

On the large scale, this would mean some sort of resolution or path to resolution in Ukraine or the reduction of COVID restrictions in China. On a smaller scale, this would mean signs that supply chain issues are abating. We already have seen some small signs that this is happening. There have been some recent reports that the backlog of cargo ships on the west coast has drastically fallen, with some ships starting to come over with empty containers.  This would show a decrease in demand and an alleviation of some of the supply glut. Another example of this is that companies (like Nike last week) are starting to report large backlogs of inventory.  This means that they will need to cut prices to clear this inventory. This would put downward pressure on inflation heading into the holiday season.

The upcoming earnings season will be very informative as it will give us a glimpse into what is going on under the economy’s surface. This will give us a clearer picture of the current demand picture and if companies are still dealing with supply chain issues. We will also be able to see how the current rate increases have impacted earnings so far.  The markets will focus a lot on company guidance, and this could cause a headwind for stocks. With so many uncertainties I expect guidance to be cautious across the board, which is normally not good for stocks.

The paradox we are currently in around earnings is that if company data and guidance show that the economy is slowing, it could signal that the Fed can slow their rate hikes, and this could cause markets to go up. On the flip side, if earnings and guidance come out much better than expected, it could be a sign that the economy can handle a more aggressive Fed and this, albeit counterintuitive to what should happen in a normal market, could send stocks down.

Lastly, for the markets to really reverse we will need to see a change in sentiment across the market. The market is very oversold in some areas and sentiment is very negative.  This is normally a contrarian indicator and a sign we are near a bottom but so far this has only caused a few oversold one or two-day bounces that traders seem to be selling into.  Until one of these bounces can be seen as a buying opportunity then we will be range bound to the upside.

I am still optimistic over the long run and cautiously optimistic over the medium term. If you are a long-term investor with no short-term capital needs, then you just have to take a deep breath and stay the course.  But, on the short term I think this volatility will continue for the next 6-12 months or until we start to see sentiment change in a meaningful way.  If inflation data starts to drop, this perspective will change but for the time being, I am going to be patient and look to add to some fixed-income positions on the short side of the curve and to equity positions only when the right opportunity presents itself. I do not think there is a rush to chase the relief rallies when they happen, yet.

Strategy Commentary

As discussed, I expect volatility to continue for the foreseeable future.  I continue to caution against any large-scale changes to portfolios in this environment.  It is important to continue to monitor your overall allocations to make sure they are in line with your long-term risk tolerance.  As we approach year-end there may be some opportunities to harvest some losses but in doing so it is important to not let your portfolio drift too much. There will be opportunities coming out of this so I will be using this time to identify quality names and sectors that will benefit as inflation subsides and rates steady.

On the domestic side, a lot of damage has already been done, especially in the technology, communication services and consumer discretionary sectors. However, when inflation starts to wane and rates stabilize or drop, these will be the sectors to rally.  I would not try to chase the high-flying names in these sectors but look to the quality names if I am going to add. The defensive sectors have been helping to weather the storm and should continue to do so. Energy continues to be the only sector in positive territory for the year and this should continue as OPEC continues to cut production and the Ukraine conflict persists.  These defensive names are a good place to hide until the storm is over, but these sectors will underperform if the markets turn around. With any clients looking to put new money into equity I am recommending a bar belled approach with some defensives but also some names that could benefit from a recovery.

On the international side, I have been trimming positions and am moving toward being underweight in these areas.  The Ukraine crisis could cause an energy crunch in Europe as we move through the winter and this will create a drag on all Eurozone economies. The strengthening dollar will also cause a headwind for developed and developing countries around the world.  These economies are also dealing with inflation, but the strong dollar is causing even more pressure.  For now, I am reducing exposure.

On the fixed income side, my perspective has completely changed.  I have been underweight fixed income for a few years now and have increased cash allocations as a replacement. With rates rising rapidly I have been becoming more bullish over the last few months and have been adding to positions.  A majority of this exposure has been on the short end of the curve.  I am also recommending clients park some of their excess cash in short-dated treasuries to try to at least keep up with inflation and ride through the volatility. Rates may still rise more but I think we are closer to the top of the range than the bottom which creates an attractive buying opportunity over the next few months.

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The Brave Report: Market Commentary for July 2022

Click here for the .pdf version of this report: The Brave Report-July 2022

Markets only go down… or so it has seemed so far this year.  In a sharp reversal from what we have experienced since the pandemic lows in 2020, the markets have continued to sell off throughout the first half of the year.  All major indexes are down more in the first six months than they have been in decades, or in the case of the NASDAQ, ever.  Rising inflation and fears of an imminent recession have spooked investors to the sidelines and with bond prices dropping as well, there have been few places to hide. A lot of the economic slowdown has already been priced in but is it enough yet and how far will traders overshoot to the downside?

Market Overview

June was not a pretty month across all of the major indices. The Dow Industrials lost 6.71% while the S&P 500 and the NASDAQ lost more than 8% and 9% respectively.  While defensive areas of the market have performed the best to start the year, all of the major sectors were negative for the month.  With the sharp drop in equity prices across the board, there are some areas of the market that are starting to look attractive from a valuation standpoint.  But as has been the case over the last month, sentiment has been more important than valuations in driving stock movements.

On the fixed-income side, we saw rates rise sharply to start the month, especially on the short end of the yield curve.  This rise abated later in the month to see rates settle back close to where they started the month. The 10-year treasury started and ended the month with a yield in the mid 2.8%. However, the yield spikes all the way up to 3.5% halfway through the month.  These kinds of wild rate swings are expected to continue as the markets try to handicap the proper path for the Fed and how many rate hikes they will need to get inflation under control.

The markets just completed the worst first half of the year in decades. The S&P was down more in the first six months than any year since 1970 and the NASDAQ completed its worst start in history. Rapidly rising inflation, uncertainty about the proper path for the Fed, and fears of a looming recession have weighed heavily on the markets. Even with the drop we have already seen, there are many still calling for more carnage ahead, especially if a recession does materialize.  While recession is not the base case for everyone, the probability has been rising and it has spooked investors to the sidelines.

Looking at the losses so far this year, a lot of the economic slowdown is already priced in but that doesn’t mean there can’t still be more trouble ahead.  As is often the case, markets tend to overshoot in both directions.  We saw that to the upside over the last few years with markets storming higher, stretching valuations beyond normal levels.  If we look at the losses so far this year, a portion of them just represents an unwind of the froth from last year. The question is how much of the pullback can be attributed to that unwind and how much represents a pricing in of economic slowdown? Furthermore, how much will markets overshoot to the downside?  The answers to these questions lie in the resolution of the uncertainties in the markets, driven primarily by inflation and the Fed’s reaction to it.

The Fed has put itself in a situation of threading a needle to achieve a soft landing for the economy.  They must raise rates to try to stabilize prices and mute further inflation.  However, they must do this without damaging the economy too much and sending it into recession.  This is no easy task.  Much of the recent selling can be attributed to the market’s lack of confidence that the Fed will be able to achieve this goal.

Inflation is the key driver of all of this at the moment.  In my opinion, the driving factor to whether enough of the economic slowdown is already priced in is how inflation is brought under control. If we see inflation begin to peak and start to drop on its own, then the Fed will be put in a position of not having to raise rates as much as is currently priced in.  This is the best-case scenario and one in which I see the markets bouncing back in the 2nd half of the year, albeit with continued volatility.  However, if inflation data continues to come in hot and the Fed is forced to more aggressively raise rates then some of the more gloomy market predictions could materialize and we would see the markets drop another 10-15%.

While the inflation data will be the key to all of this, we are starting to see some signs we tend to see at or near market bottoms. Consumer confidence and market sentiment are currently at multi-year lows. There are also several areas of the market that are completely oversold and undervalued from a long-term valuation perspective.  These factors do not always predict a market bottom, but these factors are often present when one is close.

So how do you invest during these trying times? If you are a long-term investor with no short-term liquidity needs, you are hopefully already in a well-diversified portfolio. If this is the case, then continue to dollar cost average any savings into your portfolio. Also, make sure your portfolio hasn’t drifted out of balance during this pullback.  If you do have excess cash on the sidelines, you can start patiently putting small bits to work.  We might not be at the bottom yet and while I expect volatility to continue even if the market bounces, slowly buying in over time will give you the best average entry point.

If you are looking for some more opportunistic plays and are comfortable with the risk, now is the time to be making your buy list.  There are a lot of names that have been thrown out with everything else and are down far more than they deserve.  In this vein, I would look for profitable companies with strong balance sheets. I would not chase the unprofitable “story” stocks at this time even though those are the ones that are the most beat up. They are beaten up for a reason.  Furthermore, valuations in the small and midcap space are at some of the lowest levels in more than 25 years so identifying some of the higher-quality smaller companies could present some great long-term value.

Strategy Commentary

Patience continues to remain the key as we see the markets sell-off.  It has been a painful stretch for most investors as there have been few places in the market to hide.  We are also not yet at a point where we can sound the all-clear.  If inflation continues to come in hot and the Fed is forced to stay aggressive then downside pressure will remain.  With that said, I do not see this as the time to start panicking and selling.  I continue to urge clients to stay the course and make sure their allocations are still in line with their long-term risk tolerance.  If you do feel the desire to make moves in your portfolio it should be just to update the quality of the names you own and not feel pressured into making widespread allocation changes.

On the domestic side, the defensive names continue to outperform. Utilities, consumer staples, healthcare and energy are the 4 sectors that are positive over the past year.  These sectors all tend to perform the best during uncertain economic times.  With uncertainty and volatility expected to continue, these sectors should continue to perform well.  However, if the market does start to bounce back it will probably be led by other sectors, such as technology and consumer discretionary as these have been the most beaten up.  As I have been putting together a buy list to start nibbling at over the next few months, I have been looking toward the high-quality names in these sectors.

On the international side, things have not fared much better. Developed international markets also dropped sharply last month. Emerging markets formed the best but still lost 6%.  Moving forward I will continue to look to add to EM as it seems China is committed to getting its economy back on track.  I am avoiding the Eurozone for now.  They are experiencing the same inflation and rate uncertainties as us but they also have additional pressures caused by the conflict in Ukraine.  This pressure could increase as we enter colder months since their reliance on Russian oil is so high.

I continue to hold increased cash positions as a replacement for some of my fixed-income allocations.  With both stock prices and bond prices dropping over the past month, the diversification benefits of fixed income have been muted.  If we start to see rates regulate and we get a more clear roadmap from the fed then I will begin to add back to some of my fixed income positions that I have been underweight for the past year.

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The Brave Report: Market Commentary for May 2022

Click here for .pdf version of this report:The Brave Report-May 2022

Patience, patience, patience… The markets have not been a fun place to be over the past month.  Inflation headwinds and uncertainty about the Fed continue to drag markets lower.  What started as selling in the high multiple stocks a few months ago has rolled over to even include the profitable places of the market and buyers have yet to step in and buy the dip.  In times of this kind of volatility, it is important to remain patient and refrain from making long-term investment decisions based on short-term volatility.  When the dust finally settles there will be opportunities, it is just a matter of dealing with the pain while we wait for those opportunities.

Market Overview

It was a very difficult month for all of the major averages.  The Dow only lost around 5% but the S&P 500 and NASDAQ lost 8.8% and 13% respectively.  This marked one of the worst months we have seen in years. It was the worst month for the S&P 500 since March 2020 and the worst month for the NASDAQ since October 2008. While the selling was more pronounced in the technology, consumer discretionary and communications services sectors, very few areas of the markets were spared.  Consumer staples was the only sector in the green for the month.

The fixed income side also saw some major movement over the past month with rates continuing to spike.  The yield on the 10-year Treasury moved rapidly from around 2.3% to just shy of 3%.  This continued to put downward pressure on bond prices across the board.  The core US Aggregate Bond Index lost almost 4% during the month. We have not seen this type of movement across the fixed income space in years.

The last month has undoubtedly been a difficult time for most investors.  As long-term investors, we understand that volatility is going to happen and that pullbacks are going to occur. These pullbacks are not only healthy for markets but can create the foundation for upward momentum.  The pullback we have seen to start the year and that accelerated over the last month has seemed a bit more painful than most.  This is due to a few factors.

First, with the bull market we have been in for the last decade, these types of pullbacks have been a bit rarer and in recent years the “the markets only go up,” mentality has brought new investors into the fold that aren’t used to corrections.

Second, the day-to-day volatility and the speed of some of the selling has been quite high. Multi-percentage point intraday swings have become the norm.  This makes it very difficult to enter and exit long-term positions, even on the margins.

Lastly, this pullback has left very few places to hide.  We have seen stocks sell off rapidly while bond prices have also plunged, muting many of the benefits of a diversified portfolio.  Additionally, with inflation so high, sitting in cash has also been a losing proposition.  Unless you are an experienced short-term trader, who is comfortable shorting the market, you have just had to take it on the chin and remember that long-term performance is what is important.

I understand that those are not encouraging words, but they are the reality of where the markets currently are, and I expect this kind of choppiness to continue throughout the rest of the year. Inflation is the big elephant in the room and until we get some more clarity around the various forces influencing it, the market is left to decide how high and for how long inflation will continue to rise.

The major factor that investors are trying to handicap is how aggressive the Fed will need to get to keep inflation under control and what damage this will do to the economy.  Will it just slow things a bit or will we experience a recession? Right now, the markets are pricing in around ten quarter-point rate hikes. This would bring rates up to just above where they were in late 2019 and in line with longer-term averages.  The difficult part in handicapping how aggressive the Fed will need to be is that there are several external forces that are impacting inflation and their outcomes are uncertain and often intertwined.

Going through the pandemic there have been numerous supply chain disruptions that put some initial pressure on inflation. The growth of the economy during this time also added to upward pressure on prices.  The thought by many, even those at the Fed, was that this upward pressure would be transitory and as we came out of the pandemic, these supply chain issues would lessen, and inflation would return to historic norms.  However, this did not happen to the extent we expected and then we were hit with two unexpected external shocks.

Just as it looked like we were getting COVID under control in the US and Europe and our economies were opening up, China started to experience widespread surges in cases.  Their “Zero COVID” policy pushed them to lock cities down and put widespread restrictions in place. This sent an additional shock through global supply chains and added additional upward pressure on inflation. They continue to struggle to administer an effective vaccine and until they can get things under control, this pressure will persist.

At around the same time as this, Russia began its invasion of Ukraine.  The fear of war was enough to rattle markets, but it also added upward pressure to inflation.  Energy and food prices surged, especially in Europe. While domestically we do not rely on that part of the world for food or other imports, the global food chain and energy supply is reliant on that region.

With all of this going on, there are also those who think that inflation is just a result of the post-pandemic recovery and the growth associated with it.  Their feeling continues to be that the forces impact inflation will self-correct and that while inflation wasn’t as transitory as initially thought, it will return to historic norms sooner rather than later.

So, what is the Fed to do?  They are trying to walk a tightrope between keeping inflation under control while not causing a recession. All of this, while Russia and China are shaking the tightrope.  That’s what makes the outcome so difficult handicap. When this happens the default setting for investors is to just move to the sidelines and that is what they have done over the past month.

As long-term investors, we are taught to use times of fear and uncertainty to our advantage.  We should use these corrections as opportunities to buy quality while it is on sale.  I think this is again one of those opportunities, but I would be very patient in doing so.  We are not in an all-in, buy the dip moment, but in a time when we should slowly add to positions when the opportunity presents itself.  There will be numerous opportunities to add to positions over the coming months so do not rush.

As we look out over the rest of the year, we will see continued choppiness and volatility as we sort through inflation data.  As I mentioned, ten rate hikes are currently priced into the markets.  I don’t think we will see all ten and if there is any indication that we won’t, then I think we can declare a bottom in this current pullback.  It will be very important to watch the situations in China and Russia.  Any positive developments in those situations will be one indication that the Fed may not have to get as aggressive as the markets currently think.  It will also be important to continue to watch key inflation data.  The markets have and will continue to react swiftly to any data that goes against expectations.  This has driven markets lower so far this year with inflation data coming in hotter than expected but the opposite can happen if we see a surprise in the other direction.

Strategy Commentary

I continue to stress patience when it comes to my portfolio allocation and new investments.  Of course, I wish I had raised more cash in March but with the speed and severity of the pullback over the past month, it is very hard to have great conviction in either direction.  When bonds and stocks become correlated to the downside, you are left to make no-win allocation decisions.  In these environments, it is important to revisit your timeframe and risk tolerance.  If your timeframe is shorter in nature, I would look to raise cash on any strength.  If it is longer, there will be an opportunity to put some cash to work over the next few months, but I am in no rush.

On the domestic side, there have been few sectors to hide in and I think that even within some sectors there are major winners and major losers. For example, I discussed earlier this year that within technology there are two types of stocks, story stocks and profitable stocks.  Even though some of the large tech names have rolled over in the past month, I will still be looking to add to these profitable companies as long-term plays. This upgrade in quality is not limited to technology but can be found across the board.  I still have refrained from chasing energy stocks as they have outperformed and am currently comfortable having a relatively sector-neutral allocation while looking to upgrade quality when the opportunity presents over the next few months.

The international markets have not been spared, especially with Europe’s reliance on Russia for oil and gas. I started adding a little to developed international positions at the beginning of the year but scaled this back when Russia invaded.  The Ukraine situation will be a continued drag on European economies for some time.  The same can be said for emerging markets so I am fine staying neutral

I continue to hold increased cash positions as a replacement for some of my fixed income allocation.  With both stock prices and bond prices dropping over the past month, the diversification benefits of fixed income have been muted.  With continued upward pressure on rates, I do not expect to add any fixed-income positions in the short term.  There will be a point where rates overshoot to the upside and we should be able to start adding back to fixed income at that point.


The Brave Report: The Crisis in Ukraine

Click here for the .pdf version of this report: The Brave Report-Crisis in Ukraine

So far this year, the main driving force behind the market has been uncertainty around how the Fed will keep inflation under control without slowing the economy too much.  That all changed when Putin decided to invade Ukraine. So, in lieu of my normal commentary I wanted to put out some notes on the impact of the Ukrainian crisis and what we can expect as the situation plays out.  It is important to differentiate the human vs. economic impacts this invasion is causing.  We can all agree that the human toll of this invasion is terrible and is only showing signs of getting worse before it gets better.  The major worry is that as Putin becomes more frustrated with the lack of military progress, he will get more and more brutal on innocent civilians. With that said, my job is to understand the economic and investment impacts of this crisis.

So how will this situation play out moving forward and how should you weather the storm? I see 3 potential scenarios playing out over the next few months:

  1. Occupation: This is the most likely scenario we will see. Under this scenario, we see a long-drawn-out occupation of Ukraine by Russian forces.  This could entail complete occupation of the capital and all outlying areas or some sort of partitioning where Russia controls large swaths of Ukraine but doesn’t fully topple the government.  NATO nations are reluctant to get involved beyond providing humanitarian support and small defensive arms.  The Ukrainian resistance consists of traditional military operations as well as insurgency attacks that carry on for a long time.  Under this scenario, no one really wins but the Ukrainian people are the real losers.  Putin’s pride keeps him engaged in the conflict well past any real gain can be had. Economically, we see energy and commodity prices remain high until some alternative source can be secured.  Global growth slows, especially in eastern Europe.  I don’t see the US slowing enough to cause a recession but those countries with high reliance on Russian energy will see a major slow down.
  2. Escalated War: This is the worst-case scenario. Either Putin gets frustrated by a lack of progress and escalates the war to a point where NATO must get involved or he becomes emboldened by success in Ukraine and overreaches into a NATO territory. In this scenario, we see a full military conflict between US/NATO and Russia, the level of which would be the big unknown but brings in several really bad outcomes. Again, the US would be the most protected due to distance but with Russia’s military capability, nuclear arsenal, and desperate leader anything is on the table.  The economic fallout would probably be the least of our worries but if this tail risk scenario looks more plausible, we would see a massive rush toward safety and a huge de-risking of assets.
  3. Ceasefire and Withdrawal: This is the best-case scenario for all involved but also very unlikely due to Putin’s empowerment at this point.  In this scenario, some sort of peace deal is reached, and Russian forces withdraw back to Russia. They may gain a little land in Eastern Ukraine as part of any deal and Ukraine may need to concede to never join NATO but democracy is restored to Ukraine.  For any deal like this to be achieved, China would need to ramp up pressure on Putin and/or there would need to be some discontent within the Russian military and among Russian elites.  With all the sanctions in place, there will be quite a bit of suffering within Russia.  The questions are, will it matter to Putin, and will China be able to exert enough pressure on Putin to force him to withdraw in a way that he can still claim some sort of victory?

Investing Through the Storm

With all the unknowns around this conflict, what is the economic impact and how do we invest through this storm?  First and foremost, volatility is going to be the norm for the coming weeks and months. As the conflict unfolds and the Fed starts raising rates, I expect wide daily swings throughout the equity landscape as news around this crisis continues to drop.  We have already seen a correction in equities that is in line with the average correction, going back to 1929.  Many areas of the market have corrected much more than average and I expect this volatility to continue.

There are some silver linings to this volatility.  Due to earnings results that exceeded expectations in Q4 and the correction we have seen so far this year, valuations have come back closer to long-term averages.  To start the year, the PE ratio on the S&P was pushing up toward 23.  It now sits just under 19 which is in line with the average PE over the last 5 years.  It is still slightly above the longer-term average but is not nearly as stretched as it was to start the year.

Outside of inflation, other economic data has been coming in strong.  Employment and wage data remain strong, the pandemic seems to be waning and the Fed has all but confirmed a 0.25% rate increase this month so some of that uncertainty has been diminished.  This strong economic data gives the US economy a much larger cushion to withstand some of the shocks from the conflict in Ukraine especially because our economy has such little exposure to Russia and Ukraine. This means headline risk will be driving the majority of the market moves and not actual fundamental risk.

I am not saying the conflict won’t have any fundamental impact on our economy and our domestic companies. Obviously, any companies that have revenue exposure to Russia and Ukraine will see a hit to their sales numbers as they stop doing business there or are prevented from doing business there.  Other than that, the major economic impact will be felt from rising input prices, such as transportation and commodities.  Oil prices have doubled since last year and this will have a negative impact on those companies that aren’t able to pass this increase on to consumers.  Other commodity inputs have also risen, and this will keep continued upward pressure on inflation.

The overall slowing of the global economy will also put some pressure on the more economically sensitive sectors.  At some point, rising prices will force consumers to cut back on certain amounts of discretionary spending and this will have an impact on earnings results over the next few quarters. However, with the strength of the labor market and wages, this impact should be muted in the US.

If you are a long-term investor and have no short-term liquidity needs this is a time that you need to just ride out the storm.  There may still be pain ahead but trying to time the market during these types of environments is near impossible unless you are a seasoned day trader.  If you do have short-term liquidity needs, raising cash on any strength, or implementing some hedging strategies would be advised so you are not forced into selling when you don’t want to. If you are worried about the worst-case scenarios then adding some tail risks hedges would be appropriate, albeit this type of protection is very expensive right now.

If you do have cash on the sideline to put to work, I would stress the need for patience.  I do think this volatility has created some great opportunities for the long-term investor and there are a number of great companies trading at huge discounts. However, during times of volatility and geo-political conflict, the importance of valuation is often diminished.  The old saying goes, “Don’t fight the tape.”  If the whole market is de-risking, even undervalued companies will be sold. Use this time to create a buy list of companies that are trading well below their long-term average valuations and who have little exposure to Russia. Slowly add to these positions on weakness. This volatility will persist for a while so there is no need to rush out and buy all at once.