4th Quarter Market Risks

It’s 106-110 degrees in Houston as I write this week’s episode which will be posted at the beginning of the long Labor Day weekend.  Clearly, summer in the Southwest is far from over, in fact it usually doesn’t cool off for good here in Houston until after Halloween, so why would I ever think of writing about what the risks are for winter in the markets this year and first half of 2024?  Because that’s what a good portfolio manager does, they worry about what could happen in the future, size up the probabilities if it is happening, and take action or more often than not, inaction.

The title of this week’s episode, “looming 4^th quarter risks”.  Before we press onward, please take a moment to click on both the subscribe and notification bells so you will be alerted when our investment team uploads our latest content.  Or better yet, give our OHFG team a call at 877-896-0040 to speak to our team and set up an initial consultation with an OHFG advisor to discuss your personal financial situation.

Post the strong first half move, we have entered what has become our anticipated sloppy, choppy sideways behavior.  Call it a trading range, call it a general consolidation, call it a lull.  A good swing trader will call it heaven or goldilocks as we have now seen no net price appreciation in the S&P 500 since mid-June.  More precisely, we’ve seen little to no net appreciation since the Thursday June 15th option expiration cash closing high of 4425 in the S&P 500.  I have to remind investors this was only 3 days after hedge fund billionaire, and market guru to many CNBC viewers, Ray Dalio, having missed almost +20% off the October 2022 lows said it was time to buy stocks. Here’s the daily chart of the S&P500 for the last 18 months.

We got oversold late Friday August 19^th just as many bears emerged once again from their caves preaching “crash forthcoming” calls for the umpteenth time the last few years, or decades if you’re Jeremy Grantham. And of course, just as sentiment had gotten dour, the markets started to bounce, just as they have historically more often than not in 3^rd year Presidential cycle in late August through mid-Septmeber.

With the markets bouncing around, our investment team has been processing 2^nd quarter earnings reports, some of the important economic data, of which there is much less than TV economists, politicians, and newsletter writers want you to believe, and are trying to already position our portfolios for the 4^th quarter of 2023 and first half of 2024.  Remember nothing is certain in the markets, nothing except investor behavior does tend to repeat time and time again.

Biggest risks to the markets and the economy in the 4^th quarter of 2023?  I my eyes that’s easy. Federal Jerome Powell remains inflexible and thinks inflation is running too high, and like Clubber Lang in Rocky 3, he feels the need to “bring the pain” and keep raising interest rates in the 4^th quarter and beyond.  Investors, as the investment team projected back in mid-summer 2022, inflation as measured by almost every metric in the CPI has plummeted, symmetrically since it peaked over 9%. Since the investment team at OHFG likes to look at real time data, not always adjusted and seldom right government data, here’s a few market based data series and charts for you.

1-year breakeven inflation rates, which peaked at almost 6.25% in March 2022 are back below 1.5%.  The same level they were pre-Covid, pre-covid relief money printing, and pre-government fiscal spending boom the last 12 months.

1 year “real interest rates”.  Which are the premium over inflation investors earn by buying treasury bonds has gone from -4% during the Fed balance sheet explosion in 2021-22 to almost 4% currently.  Here’s that chart. Let it sink in.

The market is saying you will earn a 4% real return vs. inflation over the next year by buying 1 year treasury bills.  Of course, you will have reinvestment risk beyond one year, but as one can see that is historically high except for the 4q98 period where Powell stayed too tight into XMAS and year end.

Ok one year is too short of a window to look at?  Let’s look at the real time market data for 10-year Treasury bonds, inflation and real interest rates. 10-year breakeven inflation rates in real time, in tradeable markets, say inflation peaked at over 3.1% and is now down to 2.3%.  About the same level pre-Covid, the same level as the peaks in inflation during the Trump Presidency, and pretty much the same peak level every years since the Dot.com bubble ended in March 2000.

The 10 year real return of an investor buying a 10 year Treasury is now around 2%.  Here’s that chart.

Ok, so I know what you’re thinking. Chris, pretty charts, thanks for the update on inflation and interest rates, but what does it mean to investors.

To me it means that the Federal Reserve is already plenty tight in monetary policy.  And they should not only not interest raise rates further. They should tone down the academic economic mumbo jumbo speak around “R-star” and get back to looking at the real world and the real time evidence.  You don’t get a 4% real return on 1-year Treasuries if the Fed is not tight.  You don’t get massive amounts of crime at lower and mid-tier retailers when the economy is rocking higher.  You don’t get T-Mobile laying off 5000 employees in good times.  You don’t get Macy’s surprised by the exponential increase in credit card delinquencies and losses in goldilocks moments. You don’t get commodity prices trading at 2-year lows when the global economy is on fire.  You don’t get regional bank stocks trading at multi-year lows if credit is easy to come by.

The biggest risk to the economy and the markets in the 4^th quarter is that Jerome Powell, and the rest of the crew at the Fed is too tight into the 4^th quarter.  that job layoffs increase, the US consumer doesn’t show up for the holidays, and the Fed creates a repeat mess in the stock markets and banking system just as they did in the 4^th qtr of 1998 when liquidity evaporated into year end and J. Powell had to reverse course.

Will the same things happen in the 4^th quarter 2023 that happened into Xmas 1998 because the Fed wants to prove a point?  They want to prove they have it, inflation, under control even though it already mostly is? For now, our investment team thinks no, and we expect the 3^rd and 4^th quarters of 2023 and 1^st quarter 2024 to play out much the same way most 3^rd year Presidential cycle years do.  A pause and consolidation in the 3^rdand early 4^th quarter that refreshes, a year end rally and a strong initial 2024. But we, like others, are busy monitoring our data and client portfolios busy watching how the remainder of 2023 plays out.

At Oak Harvest, we currently manage broadly diversified equity portfolios that balance risk and reward for our clients.  We don’t concentrate our clients’ funds in only one or two sectors, seeking to hit a grand slam.  We try to hit singles, doubles and occasionally a homer if someone makes a mistake and we find a stock at the right price at the right time. For those investors who are less optimistic and risk taking, those seeking higher dividend income that grows, those investors willing to forgo some potential price appreciation in favor of lower volatility, we have a dividend growth equity model.

Those investors who are more in the optimistic camp, seeking higher long-term price appreciation which does carry higher expected volatility without the focus on dividend income, we have a Blue-Chip growth equity model. The overall tools our advisors and financial planners use are usually a combination of markets based and insurance based tools to meet your retirement goals. Our investment team is busy working on some new, and highly unique equity models, and few advisor teams have the experience our investment team has.  We plan on introducing one of these new equity products for our advisors to use as tools for our clients in the not-so-distant future. One of these tools may even  allow our investment team to express negative views on single stocks, sectors, or the markets in general if we so desire.  Stay tuned.  The future and stock markets are always uncertain and that is why our retirement planning teams plan for your retirement needs first, and your greed’s second.

Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at 877-896-0040 or click here to schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.