In the short-run, the market is a voting machine.
In the long-run, the market is a weighing machine.
– Warren Buffett
The Market and Economy Today
(The chart above shows the rate of change for the Leading Economic Indicators Index. Source : https://www.conference-board.org/topics/us-leading-indicators)
There aren’t too many instances I can think of where fund flows and market activity are so divorced from the economic data. The most recent update from the Conference Board showed the Leading Economic Indicators Index declining for the 19th month in a row.1 Existing home sales have dropped to the lowest in 13 years.2 Earnings guidance from companies continues to trend lower.3 And yet, the market in the near-term has been trading higher.
(The chart above shows the S&P 500 index for the last 2 years.)
Now to put things into some perspective, the S&P has literally gone nowhere in the last 2 years. It’s true that it’s up 20% year-to-date, but that’s after falling 25% the year before. This is still bear-market math, in Wall Street speak. To me and to Macbeth as well, it still sounds like “sound and fury, signifying nothing.” The recent huge upward moves in several unprofitable companies doesn’t inspire a vote of confidence either. Long-term, the puck is going to go where it is going to go and I want us to be ready for it when it comes.
(The Schiller PE or CAPE Ratio shown above is the The Cyclically Adjusted Price/Earnings Ratio Adjusted For Inflation)
Let’s revisit the CAPE ratio that we discussed a year ago to see where it is at. We are still at incredibly elevated levels. Remember, the higher the price we pay now, the lower our future returns are likely to be. We can’t escape basic math, no matter how the talking heads may be spinning it on Wall Street.
(The return for the top 7 stocks in the S&P versus the remaining 493)
The other factor that we have to consider is how narrow the breadth has been. There are basically 7 stocks that account for 92% of the return of the S&P. The other 493 stocks are flat. It’s true that historically a small percentage of stocks account for the majority of the S&P’s return, but 7 stocks out of 500 is extremely narrow, even by historical measures.
All this ultimately boils down to a fundamental question I keep asking myself:
What is the risk versus return of equities at current valuations?
With the 6-month T-Bill yielding near 6%, what is the probability of the market yielding a greater-than-risk-free return? The numbers aren’t flattering as you can see below.
(The chart above represents the equity risk premium, which is the return that investors expect stocks to yield above the 10-Year Treasury. Currently, that number is less than 100 basis points, or less than 1%.)
Let’s talk about Oil for a Minute
(Chart of Brent Crude Oil)
My personal opinion is that there are never any winners in war and, for any nay-sayers, I’d suggest folks read up on the over two thousand years of human history to see if they can find any war that has led to lasting peace. I say again, that there are NO winners in war and the current conflict between Israel and Hamas is likely to be no different. I can’t say so callously like I heard one money manager say in a recent interview, “It’s amazing what a few bombs in Israel can do.”
A fully-functioning human being would have no choice but to respond with incredible compassion towards the Israeli and Palestinian civilians – we’re talking innocent men, women, and children – who have lost their lives and those who will inevitably lose their lives in the near future over the course of this conflict. It is perhaps idealistic, but I hope for a future possibility on Earth where there is no war. It is probably very unlikely to happen in our lifetime, and it may take a few hundred years for us to get there, but I certainly don’t see anything wrong in envisioning such a future, however farfetched the possibility.
That is why, at ConCap®, we have a Conscious Investing Policy and do our best to avoid investing our clients’ funds in sectors like weapons manufacturers, including military-grade weaponry. I’m proud of the role we are playing, however small, in helping humanity towards a future without war. Our returns may suffer as a result of our rigid ethical stance, but I have always felt there to be an enormous economic value to investing with a conscience. The fact that we are an exception and not the rule is a sign of the incredibly dysfunctional and borderline sociopathic nature of the financial industry. You and I will hopefully sleep better at night knowing that we aren’t investing in companies that manufacture weapons, which will ultimately end up killing people in a war.
That said, from a market and economic perspective, this conflict does have an affect on oil prices. And something very peculiar is happening with oil.
Normally, during a conflict or turmoil in the Middle East, we see spikes in the price of crude oil. It rose dramatically during the Arab Oil Embargo of 1973, the Iranian Revolution of 1979, and it spiked during Saddam Hussein’s invasion of Kuwait in the 1990s. And yet, oil has gone down by 20% since the start of this conflict.
That tells me two things:
One, that there is a less likely probability of this conflict burgeoning into a regional one. Iran has indicated no military involvement up to this point and, more to the point, Hezbollah, which is a terror group on Israel’s southern border of Lebanon, hasn’t entered into the fray. This is definitely a positive, which may be keeping oil lower.
(This is a screenshot from a CNBC article on Maersk, a shipping giant that is projecting series earnings difficulties for 2024)
The other is that there is likely a lower overall global demand for oil. Shipping, trucking, and transport companies are bracing for a dramatic slowdown in demand and that is telling for the health of the near-term economy. In economic speak, this is definitely a negative and infers demand destruction, which would mean less consumption and less growth in the near future.
Until the data tells me otherwise, this just means that a recession is still coming. It has, no doubt, taken a very long time, but it has been delayed and not derailed. As a result, we are holding firm to our current asset-preservation strategy with a view to deploy in the next year. It may be the conservative route, but remember my mantra:
Rule #1: Don’t lose money
Rule #2: Don’t forget Rule #1
Inflation and ‘T-Bill and Chill’
I want to make a final point on inflation. Historically, inflation is very difficult to get rid of once it has started. I don’t envy Fed Chairman Jay Powell’s position in the slightest. He has, arguably, a very difficult job. Some say, well isn’t he responsible for the inflation that came in the first place and wasn’t he late to see it and act properly? The answer is ‘Yes’ to both questions, but it was a totally unprecedented time. The policy actions were in response to a global health crisis, the likes we hadn’t seen in a hundred years. There are others who say, well isn’t President Biden is responsible for inflation, which tells me how totally ignorant and shallow-minded some folks can be about how the economy works. One person is never responsible for fiscally-induced or monetarily-induced inflation; it’s always a confluence of factors.
(S&P 500 Chart from 1968 to 1982. Source: https://www.macrotrends.net/2324/sp-500-historical-chart-data)
However the inflation was caused, we need to now get rid of it or it’s likely to stick around. And inflation is bad for stock returns. Let me remind you that the inflation from the 1960s-1980s led to a total stock market return of 0% – yes you read that right, 0%. It went up and down several times, but from 1968 to 1982, we had 4 recessions and the total S&P 500 return was 0%, excluding dividends. Navigating this environment is going to be very challenging for stocks, so long as inflation is around. It is, therefore, apt that the Fed Chair remains hawkish on interest rates to stamp out inflation.
(Same chart as above, only this time adjusted for inflation. Source: https://www.macrotrends.net/2324/sp-500-historical-chart-data)
As a result, barring some sort of credit event that makes rate cuts necessary, we are taking Jay Powell at his word and we should be prepared for “higher for longer” – higher interest rates for an extended period of time. Of course, this is not going to be good news for stocks in the near-term, hence our continued cautious stance.
Hanging out in Treasury Bills and collecting close to 6% may not be an exciting investment strategy, but, at the moment, it’s a pretty good risk-adjusted play considering all the other factors. Like everything in the market, however, things can change quickly, and I am still hopeful that our patience will yield better results down the line.
Sources:
1https://www.conference-board.org/topics/us-leading-indicators
3https://www.factset.com/earningsinsight
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