What Could Go Wrong? It’s Deja Vu all Over Again

As an investment professional with over 30 years’ experience in public markets, actually managing other people’s money, actually, as they would say in our business “pulling the trigger”, that is not writing theoretical or academic papers and studies on the markets, or publishing a $99/month newsletter service, I seem to rarely get asked “what could go wrong”.  The fact is it almost never happens when equity markets are at or near ATH’s and volatility is low as it has been ending the 1h24.  Outside of Troy Sharpe our founder, I can probably count on my two hands the number of times I’ve been asked that question the last 6 years by an investment prospect, when the markets are up and to the right.

That’s when investors brokerage accounts are at new highs.  That’s when their “net worth” hits new highs.  That’s when many people are marking to market their net worth to new highs almost on a daily basis. That’s when the emotional greed trade is hard to resist.  I’m worth $2500, $25,000, or $250,000 more this month than last month.  That’s a common mentality that I have seen kick in. As if anyone, In the investment world could go 100% to cash at the exact daily or weekly, or monthly top, pulling their entire stack of chips off the investment table and out of the equity markets.

Those rose-colored glasses are hard to take off, and it’s really hard for many individuals to switch financial advisors while the markets are up and to the right.  Why? Because they look at their accounts and think, I’m making money, why change horses?  Even though as one nears retirement or is in retirement, maybe an investor doesn’t need to be riding a racehorse anymore or a thoroughbred.  Maybe it’s the exact right time to look for a slower steady horse that can take on your goals, aspirations, and motivations for that next race? The slower race in retirement when incoming cash flow is less certain.

Investors, I’m here to tell you that if you are a retiree, near retiree, or even a pre-retiree 5 years out, that’s exactly when you should be looking at making a change?  Why? Because an investment account is NOT a financial plan for retirement, The complexities of budgeting for monthly expenditures, generating income, minimizing taxes, maximizing social security benefits, or maximizing net benefits from other government programs such as Medicare becomes a web of complexity versus when you are gainfully employed and saving for retirement.

I’ve learned under Troy’s leadership since coming to OHFG as CIO, those working years are the simple years financially speaking.  Those are the go to work, get paid, contribute to a 401k if you can, pay taxes, pay fixed monthly expenses such as rent, healthcare and insurance, then pay yourself next if you are a saver, or pay monthly variable expenses such as travel, entertainment and discretionary items, and then save whatever if anything is left over if you are like most Americans living on the edge.  Rinse and repeat every month ex unforeseen events. Wake up, go to work, get paid, pay taxes, spend, save, sleep, rinse and repeat.  Day after day, week after week, month after month, year after year. It’s a simple recipe if one can stick to the playbook.

When you are younger and working and generating monthly income, time is on your side.  You don’t and shouldn’t have to contemplate thinking “what could go wrong” that often in the economy or stock markets.  In fact, I will argue that when you are younger, saving and investing, you should actually hope for things in the markets to “go wrong” for extended periods of time so you can dollar cost average systematically at lower prices while you are saving and investing, while you do not immediately need those assets.

All this semi-rant brings me to this week’s topic, “What Could Go Wrong from Here” in the markets.  First and foremost, what I am presenting to you are ideas that I am looking at and things that are concerning to me.  I am not saying these things will happen.  We are not saying that the market will not make new ATH’s in the coming months or into yearend post-election as we previously discussed in our 1h2024 outlook published months ago. However just as I presented the optimistic investment case for stocks and the economy in October 2022 and again in October 2023 while other strategists and CIOs and legendary hedge fund managers” on financial networks were talking recessions, crashes, and other doomer outcomes, I feel compelled to share with you what the data that we follow and key off of is saying.  Suffice it to say, it is not all rosy.   It’s not doomer or dire, but it is cautionary and early warning.

First, since mid-July, when the CPI data was released, the market has quickly and rather violently rotated away from technology, semiconductors, telecom growth stocks, and many growth at high price stocks.  It’s moved quickly away from the mag-7 and into small cap stocks, the Russell 2000, the equal weight SP500 RSP ETF, and more broadly what I call GARP stocks.  “Growth at a reasonable price”.  After many strategists wrongly calling for it for all of 2024, market breadth has finally broadened out.  As JC Parets points out, the equal weighted SP500 finally broke out to a new ATH after marking time for 2 years.  Here’s that chart.  Big base, or some call it a cup and handle.

Here are various index returns YTD into the July 11 CPI number.  The Nasdaq and tech stocks were up over 20% and SP500 up over 17% YTD at that time.  The then lowly Russell 2000 bringing up the rear at up “only” 5ish.  I say only sarcastically because remember investors the LY average return of equities has been somewhere between 8-12% per year depending on your starting point.

Here are those same indexes returns since the CPI data was released.  What was leading YTD, the Nasdaq and large cap tech like the QQQ has gotten crushed or has lagged., while the laggard and unloved YTD Russell 2000 index  has lit it up, up almost +5.5% in 10 trading days.

So, these are the same index returns YTD through 7/26/24.  Investors, while the Nasdaq is still leading, its lead has shrunk considerably.  While the Russell 2000 is lagging the SP500 still, it has made up almost +8% points of relative performance in only 2 weeks. It was lagging the SP500 by -12% into the CPI and now is only about 4% behind the SP500 in 2024.

So Chris everyone says better market breadth is a good thing!  And I have to agree with them, in most cases it is.  Here’s a great table from Willie Delwiche summarizing the recent strength in small caps and how historically things have played out afterwards.

Everyone who knows me knows I love market history because investors are humans and humans are creatures of habit, particularly with their money.  Same people, managing the same money, doing the same things, expect the same outcomes more often than not.  Looking at this table would say you would most likely need to be roaring bullish small caps the next 12 months after a few week lull.

Look at the summary like.  +19.4% subsequent average return with an 85% positive hit rate! Over the next 12 months?  Those are Draftking like house at the casino odds. Sign me up! Or not.  The issue with this data set is if one looks at the years and time frames virtually all of the periods were at the beginning of long economic up cycles. Post Oct 1987 crash.  Post GFC crash. Post covid crash. And unfortunately, this data set happens to include the time period I have alluded to for almost two years now, up until lately in a very positive manner while others were promoting doom and bubbles.   Yep October 1998 -2000?  The Dot.com investment buildout bubble. In fact, as this table shows, one of the worst time periods for small cap stocks came after a rally that started on 6/2/2000 about the same time we just had our big, small cap rally.

Yellow flag #1, what could go wrong? We continue to trade in a very similar pattern at both the index level, sector level, and single stock level as? 2000.Yep late in the economic cycle of the first wave of the Internet buildout.  And while value, Garp and smaller cap names did ok in the 2h2000, we all know what happened to the overall market and the Nasdaq and tech names after August of 2000 into year end and post-election in 2001.

Secondly, what could go wrong? The Federal Reserve has done its job and inflation is coming down back toward 2-2.5%.  However, ex government jobs, the job market is weakening. A weakening jobs market, as represented by initial jobless claims, has been a big warning sign for the economy and stock markets looking out a few quarters.  Here’s a chart from Game of Trades showing that historical correlation.  This is a big yellow flag warning from this data set for 4q 2024 and 2025 for equity stock returns if jobless claims keep heading up.

Third, what could go wrong?  A faster economic slowdown at both the consumer and corporate investment level into the 4^th quarter due to the increased uncertainty of the election and political outcomes in DC.  Investors, 9 times out of 10 I tell investment prospects and clients that worrying over political strife, or investing based on your political biases, is a great way to lose money or keep yourself out of the stock markets.  I ran the stock market return numbers for a video a few weeks ago, the total return of the SP500 from election day 2016 when Donald Trump won the vote through summer 2020 versus election day 2020 when Joe Biden won through the current high in the SP500?  Nearly identical % returns.  I have to dig up the data but under both Presidents, wildly different policies, different deliveries, and different focuses on the markets themselves?  Nearly identical stock market SP500 index returns.

So, Chris why the possible deviation from your normal, pay no attention to the men and women behind the political curtain?  Because looking back in time, economically and politically, the current environment and data keeps reminding me a lot of 2000.  The Fed had aggressively raised interest rates in 99 and 2000 but they were slow to act in the 2h of 2000 as the economy rolled over.

Here’s an excerpt from the June 2000 FOMC meeting, “the incoming data were suggesting that the expansion of aggregate demand might be moderating toward a more sustainable pace: Consumers had increased their outlays for goods modestly during the spring; home purchases and starts appeared to have softened; and readings on the labor market suggested that the pace of hiring might be cooling off. Moreover, much of the effects on demand of previous policy firming’s, had not yet been fully realized. Financial market participants interpreted signs of economic slowing as suggesting that the Federal Reserve probably would be able to hold inflation in check without much additional policy firming. However, whether aggregate demand had moved decisively onto a more moderate expansion track was not yet clear, and labor resource utilization remained unusually elevated.”

Sounds remarkably like the current Feds thinking and comments in 2024 but that was written 24 years ago during the summer of 2000. Yes, it currently appears that the Fed is more aware of the slowing economic environment and worsening labor markets than in 200, it still seems apprehensive to take easing action.  Lest they ruin their reputation again.

The real-time data that the Fed controls have me on edge for the first time in years.  Here’s the 1-year real time, market priced “real interest rate”.  It’s currently trading at over 4% given short term market 1 year inflation breakeven rates.  Both prior times this rate was this high?  Both led to very bad 12-24 month outcomes for the equity markets overall.

Investors, this is the real time bond market saying the Fed’s too tight.

Here is the 5-year real time real interest rate chart back in those prior two periods. It gave a warning signal that the Fed was too tight. Late summer of 2000 and late summer of 2007.

Here is the same 5-year real rate chart today.  It is Toppy looking to me.

At first, lower real interest rates are a “good thing”.  It lifts all equity boats usually. Until it isn’t. At least that is the way it played out Pre-QE and other extraordinary Federal Reserve policies that were put in place in 2009 and extend until now.

Recall investors, in 2000, it was a rollover in economic growth, followed by lower confidence and investment in the 2h20, that was amplified by the hotly contested results from the November 7^th, 2000 Presidential election whose outcome dragged on until mid-December due to the ”hanging chad” controversy in Florida. https://en.wikipedia.org/wiki/2000_United_States_presidential_election#:~:text=The%202000%20United%20States%20presidential,Democratic%20Vice%20President%20Al%20Gore.

So, investors, that’s my take on what could go wrong beyond summer in 2024.  Do I have a strong conviction in this negative outcome, no not currently, but as I have said for 18 months now, I think I’ve seen this show before, and while the first 3 acts of the play are fantastic, I’m not sure what hand the Fed and the markets will deal the next President of the US regardless of who wins.  It didn’t matter in 2000 and it didn’t in 2008, the script was already set by Federal reserve monetary policy that as Milton Freidman first said, “operates with long and variable lags”.

If over the years you have found yourself reacting emotionally in your portfolio to Presidential elections and their uncertainty, now is the time to talk to your advisor to walk through your plan.  Well in advance of other investors concerns of will the 3q24 be a soft-landing pullback that refreshes, or the beginning of a much more painful economic and market downturn.

Our main message for the 2^nd half of June and first half of July has been with the markets making fresh all-time highs, if you are going to make reallocation decisions to shift money out of stocks and equities into less volatile assets, its best to do it when indexes are up and volatility is low. Over the last few weeks, investors have seen a rapid uptick in volatility and quick drop of -5% on the SP500 and upwards of -20% on many NASDAQ tech stocks.  Looking out into the 2h2024, our team is expecting more of this, including some strong rallies, one of which is likely forthcoming.  These rallies will make many investors feel great and exhale while they are in process.  However, that shouldn’t change your actions of contacting your advisor and walking through your financial plan to see how you and your plan might fair just In case “what could go wrong, does”.

If you are uncomfortable with wider range of possible equity outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges and shock absorber “insurance” for a stock portfolio.  Information on this exciting new strategy of ours can be found at OakHarvestFunds.com.

Viewers, for those of you who made it this far, I want to give a shout out to the entire OHFG team as last week, USA TODAY, ranked us as one of the Best Financial Advisory Firms 2024. The award is given to top registered investment advisory (RIA) firms in the United States based on two key criteria:

• Recommendations from individuals from among 25,000 financial advisors, clients, and industry experts
• Growth in Assets under Management (AUM) over 12 months and 5-years, respectively

I personally am looking forward to helping us move up this list over the coming years by taking care of our current and future client base. From the whole team here, thank you and have a great weekend.

Do you need a retirement plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at 877-896-0040 or fill out this form for a free consultation: https://click2retire.com/Connect