Nicholas Bohnsack
Chief Executive Officer

Trying to Make the Bull Case

06/22/2023

Early last August, with the S&P 500 index in the midst of an alluring +19% rally off its then Jun’22 low, uncertainty over Strategas’ generally bearish outlook for the market and the economy had become a consistent feature of our daily morning research meetings.  Ultimately, the framework on which we had relied – and continue to rely – to gauge the durability of any signs of nascent economic reacceleration and the concomitant market advance carried the day: 1) had inflation, and the volatility of inflation expectations, been arrested back to a level acceptable to both the investors and policymakers; 2) had valuations reset to levels historically commensurate – or in the ballpark – with both the higher prevailing level of interest rates and intense pressure on margins; and, 3) had organic drivers of growth emerged durable enough (time) and capable of generating the required returns (breadth) to call capital from both corporate operators and investors? Last August the list largely went O-fer.  What proved to be a powerful counter-trend rally broke down a few weeks later and the S&P 500 corrected back to the increasingly lauded Oct’22 low. With the S&P 500 now solidly +20% above the October mark, intellectual honesty (and most of the sales team) begs us to revisit our framework again…

First, is the framework itself still relevant?  If individual investors are any measure – we think they are – qualitatively, the answer would seem to be yes.  The feedback loop may be self-reinforcing but inflation, valuation, rates, liquidity, and “AI” (the leading organic growth candidate of the moment), regardless of the view expressed, dominate discussion on client calls and in meetings – along with the LIV Tour’s acquisition of, ahem... merger with the PGA and the omnipresent presidential election handicapping. 

Second, in contrast to last summer, notable “progress” has been made on several tenets of our framework.  Is it enough to support a new bull phase or has the equity market momentarily and near-convincingly, decoupled from underlying fundamentals? 

Headline price measures are well below their 2022 peak and investors appear reconciled to a structural, higher lower bound for inflation – i.e., 3.0-3.5% vs. 2%.  But policymakers are unconvinced; some of the stickier core elements of inflation, particularly wages & rents, remain too high for their liking.  The global policy vernacular has retreated from “pivot” to “pause” to “skip.”  Global monetary policy is likely tighter before it's easier.

Source: Strategas Securities, Bloomberg as of 5/31/2023

Valuations are in-line, even slightly higher than levels in evidence last fall; the numerator is higher and aggregate S&P 500 EPS has been flat at ~$220-$225 since 3Q’22.  Consensus estimates show S&P EPS bottoming in 2Q’23 (~$215) before finishing the year roughly flat (~$220). Analysts have looked through 4-5 quarters of negative real revenue growth and margin compression and are estimating earnings to increase +12% Y/Y in CY’24.  An earnings “soft patch” is sufficiently rare.  We see the world differently believing sluggish top-line, a higher cost profile and the lagged-effects of tighter monetary policy will conspire to knock earnings down, in-line with the median -22% median drawdown evidenced in recession-related profit cycles.

Source: Federal Reserve, US Treasury, Bloomberg LLC and Strategas Securities, as of 6/12/2023

One aspect of the bull case that has troubled us was how dependent higher share prices were on easier monetary policy.  Expectations have downshifted from the “pivot,” to – and until recently – the “pause,” and now – as the Fed chair intimated most recently and has already been executed by Canada and Australia – the “skip.”  Taking up the slack – and then some – has been easier fiscal policy, in the form of the Treasury’s drawdown of its General Account (“TGA”) during the debt ceiling showdown.  Risk assets responded favorably to this super dose of Marshallian K, i.e., liquidity growth in excess of nominal GDP.  But can you have it both ways?  The knock-on effects of the impending refill of the TGA when coupled with signs of weakness in the Labor market and softer Capex, doesn’t portend well for the economy or risk assets.

Source: Strategas Securities, Bloomberg as of 5/31/2023

What can we say about AI that it can’t say for itself in 2,500 words at the click of a button?  While the commercial applications and emerging use case are still early days, the vocal championing of, productivity-enhancing investments in and, commercial roll-out of applications for, artificial intelligence (or “AI”) appears to have all the makings of a durable, long-term trend.  Is AI enough to pull this economy out of its malaise?  We are watching closely but remain suspicious as to the power this new pocket has in the near-to-intermediate-term to offset the cost of global economic disequilibrium and the growing list of deterioration we see developing domestically.  The leading indicators of economic activity keep us worried. 

That said – thematically – this AI as an emerging technology and the related capex follow-through likely has legs.  The realities of both managing a business and running money, suggest few will want to be caught absent from seemingly durable new area of investment – ourselves included.  “Artificial Intelligence” has become an important alpha-seeking theme[1] in our Strategas Macro Thematic Opportunities ETF (NYSE:SAMT) alongside the more defensive themes: Cash Flow Aristocrats; De-Globalization; Recession Protection; and, Energy Security. 

Broadly, we remain cautious on the prospects for the economy and the capital markets in the intermediate-term and, as we have written in these pages in the past, “comfortably wrong” on our base case vs. the generally narrow – though expanding – performance profile of the equity markets.  We fully acknowledge the potential power of the incipient AI revolution, though we will tread carefully.  NB

 

[1] Alpha measures the amount that the investment has returned in comparison to the market index or other broad benchmark that it is compared against -Fidelity Learning Center 2023

 

 

 

 

 

 

 

 

 

 

This communication was prepared by Strategas Asset Management, LLC ("we" or "us" or “our”).  This communication represents our views as of 6/15/2023, which are subject to change. The information contained herein has been obtained from sources we believe to be reliable, but no guarantee of accuracy can be made. This communication is provided for informational purposes only and should not be construed as an offer, recommendation, nor solicitation to buy or sell any specific security, strategy, or investment product.  This communication does not constitute, nor should it be regarded as, investment research or a research report or securities recommendation and it does not provide information reasonably sufficient upon which to base an investment decision. This is not a complete analysis of every material fact regarding any company, industry, or security. Additional analysis would be required to make an investment decision. This communication is not based on the investment objectives, strategies, goals, financial circumstances, needs or risk tolerance of any particular client and is not presented as suitable to any other particular client. Past performance does not guarantee future results. All investments carry some level of risk, including loss of principal.

Strategas Asset Management, LLC is an SEC Registered Investment Adviser affiliated with Strategas Securities, LLC, a broker-dealer and FINRA member firm, and an SEC Registered Investment Adviser. Both Strategas Asset Management, LLC and Strategas Securities, LLC are affiliated with Robert W. Baird & Co. Incorporated ("Baird"), a broker-dealer and FINRA member firm, and an SEC Registered Investment Adviser, although the firms conduct separate and distinct businesses.

Holdings are subject to change. Current and future holdings are subject to risk. Index information does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged, and one cannot invest directly in an index.

Nicholas Bohnsack
Chief Executive Officer

Unmoved by the Countertrend Rally

08/23/2022

Stick to the plan…

The equity market has provided a welcomed reprieve from 2Q weakness as investors are increasingly drawn in by the “peak inflation” narrative and the view the Fed will soon soften the intensity of – or even reverse – its policy rate normalization scheme.  As we noted last month, we remain suspicious.  A month on, however, and a notable number of clients are calling b/s.  Hard to lay blame.  The tape is strong.  The labor market, while a pinch off its 1H flex, remains robust.  Growth, while still tepid relative to a self-sustaining recovery, is projected to be positive (the Atlanta Federal Reserve’s “GDPNow” tracker for third quarter 2022  is 1.6%).  The pull is real.  Most importantly, investors appear conditioned to anticipate all recoveries to be “v-shaped.”  History suggests the opposite.  While posting peak year over year rates of change in the various price indexes is mathematically probable, as Strategas’s Chief Economist, Don Rissmiller reminds us, the Fed appears mindful of the effect its “stop-and-go” approach to fighting inflation had in the 1970s, i.e. a decade long stagflationary malaise they are keen to not repeat.  While late to the game, the Fed can catch-up quickly.  Chair Powell and other FOMC members have been consistent in their stated desire to see both the level of inflation move lower and the volatility of inflation expectations to become “anchored” before making material changes to their prescribed policy course.  By our lights this suggests additional rate increases through 3Q under the cover of the aforementioned strength in the labor market and slightly-stronger-than-1H’22 economic growth, even if at a less aggressive pace (i.e. 50bps) than they’ve implemented at recent meetings (i.e. 75bps).  We struggle to reconcile a policy rate below 3.5 or 4% with an inflation rate hovering at, or above 6, 7 or 8%, even if directionally “correct.” What’s more, the knock on – and lagged – effect of an increasingly restrictive policy rate coupled with just underway balance sheet reductions (i.e. quantitative tightening) is likely – in our view – to result in weaker growth in CY’23.  This would not appear to be the environment to back the truck up, particularly if looking to add the long duration, pre-profit darlings that have caught a summer bid on low volume and the hope the Fed will pivot on policy.

 

Source: FactSet Financial Data and Analytics (As of 8/17/2022)

 

As we look through Labor Day, in addition to the current battery of issues, the U.S. mid-term elections loom large.  Historically, the mid-term has served as a referendum on the incumbent president and his Administration.  It’s never as easy as it seems from the steps of the Capitol on Inauguration Day.  As our policy ace, Dan Clifton, reminds us that this explains the tight correlation between a president’s approval rating and the number of House seats their party generally loses in the mid-term.  (On average a sitting president’s party loses 29 House seats in their first term midterm election.)  Only two presidents have seen their party gain seats in last hundred years: FDR during the Great Depression and George W. Bush following 9/11. In both instances the president’s had strong approval ratings preventing an anti-incumbent wave from forming.  Irrespective of one’s politics, President Biden does not hold this advantage; his approval rating is as low as any president at this point in their presidency and is consistent with a 50 seat House loss.  Democrats appear, however, to be narrowing the gap.  Wherever credit is due, despite a double bout with Covid the President has enjoyed a few good weeks.  In addition to the broad market’s advance, gasoline prices have fallen from their highs (as reflected in July inflation data) and the Supreme Court ruling overturning Roe has energized voters (and donors) on the left.  While the House still appears poised to fall back into Republican control, even if less of a stranglehold than a wave 50 seat majority, the probability of the Senate remaining in Democratic hands has increased.  If you’re not sick of the political discourse now, gird yourself for the next few months.  The impact of the market may be particularly acute given the general environment. 

The yield curve remains inverted near historical lows (U.S. 2s/10s -30bps) as of 8/19/22.  With demand appearing to slow, corporate operating margins under pressure and consumer sentiment uninspired – though painful – we remain unconvinced by the recent rebound in equities.  We see little incentive to shift broad allocations among the major asset classes: in our Tactical Asset Allocation model, we remain neutral Equities (60% in our 60/40 benchmark allocation portfolio), a position we established earlier this year.  The decision point to reduce our Equities exposure below benchmark has, admittedly, been held hostage by the market’s insistence that the Fed will reverse course next spring.  We are, with this writing, increasing to Overweight portfolio exposure to Consumer Staples and reducing to Neutral exposure to Materials, deepening our move toward a more defensive U.S. equity sector allocation.  We continue to make tactical shifts with our fixed income sleeve of our Tactical Asset Allocation model: trimming exposure to Dollar-denominated EM debt and increasing exposure to short duration investment grade credit. 

Thematically, in our view, intermediate-term momentum, remains in four areas: Inflation for Longer; Quantitative Tightening; Less Cyclical, More Defensive; and, De-Globalization.

-NB 

 

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