- Stocks rallied for their best week thus far this year. The catalysts included intense short-covering, lesser than expected bond sales from the U.S. Treasury, soothing words from Fed Chair Jerome Powell and a weaker than expected October Payroll Report on Friday (including downward revisions for September and August). Bonds were also the beneficiary as the yield on the 10-year U.S. Treasury Note which breached the 5% mark during mid-October closed at 4.57%.
- Despite the sharp move to the upside, we are presently sticking to our belief that “stock prices will be supported by better than expected earnings along with positive seasonality, but held back by valuation along with fears that the war between Israel and Hamas will spread. We are most likely in a trading range with the bias to the upside. Despite the gains thus far this year, we counsel patience. There is no need to be a hero.”
- Within their policy statement released immediately following their regularly scheduled meeting, the Open Market Committee of the Federal Reserve (FOMC), the body that dictates monetary policy changed some key phrases, notably:
Recent indicators suggest that economic activity expanded at a strong pace in the 3rd quarter. Job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low. Inflation remains elevated.The Fed, seldom at a loss at providing ambiguity within their policy statements was quite clear when they replaced expanding with expanded in describing economic activity. The result was a unanimous decision by voting members to maintain the target range for the federal funds rate at 5¼ to 5½ percent.
- Other key statements by Chair Powell at the post FOMC meeting press conference include:
- “I still believe, and my colleagues for the most part still believe, that it is likely to be true…that we will need to see some slower growth and some softening in the labor market to fully restore price stability.”
- “The idea that it would be difficult to raise again after stopping for a meeting or two is just not right. The committee will always do what it thinks is appropriate at the time.”
- “A few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal. The process of getting inflation sustainably down to 2% has a long way to go.”
- In order to finance the U.S. Debt load in an efficient manner, The U.S. Department of Treasury decided to increase the auction sizes of the shorter duration obligations in comparison to the intermediate to longer-term thereby putting less pressure on the latter.
- Third quarter earnings remain strong. According to Bespoke Investment Group, “the cohort of 1,126 companies that have reported earnings so far this quarter have beat EPS (Estimates Per Share) at a 71.2% rate. That’s in the 82nd percentile of all earnings seasons since 2001 for this cohort of names and the highest since the reporting period of Q1 2002. That’s a big contrast with revenue beat rates which are running around 60.3%. Two quarters ago they were in the same as EPS beat rates, but they’re now the lowest since the earnings season covering the Q4 2016 reporting period
- Apple Q3 revenue and earnings results come in above estimates. However, outlook remains tepid. Stock treads water. Gross margins remains strong as does growth in services. Future worries include the strength of the global consumer and China.
- Year-End (Q4) Capital Gain Distributions. In a non-qualified account, keep in mind that whether you reinvest dividends and/or capital gain distributions, they are taxable to the registered shareholder. Moreover, given the volatility in the equity markets over the past two years, in many cases, we expect those distributions to be substantial. As we enter the final two months of 2023, Fagan Associates will keep a close eye on these and then attempt to mitigate the damage. It is also important to note, especially given losses in bond portfolios as a result in the rise in interest rates, that mutual funds cannot distribute losses to shareholders. Rather, they must save them to offset potential gains in future years.
- “It’s all about the bonds, ‘bout the bonds, ‘bout the bonds.” As we scan the internet, are fed information, and listen to or watch the radio or television, we feel inundated by the amount of attention the bond market is getting. On one hand, we seldom follow the herd mentality as they are often late to the party. However, on the other and as we have noted weekly within our Snapshot for much more than a quarter, bonds merit a look. We also have noted that to ladder those maturities to include intermediate term issuances is often prudent.
- The normal. Prior to the pandemic, the tenor of the economy was one in which there was growth in GDP of approximately two percent in a sub-two percent inflationary environment. Many economists labeled this period the “new normal” as GDP growth prior to this period, which began after the Great Recession ended in Q1-2009, was typically 4% GDP and 2-plus percent inflation. Post-pandemic, GDP and inflation appears to be regressing back to pre-Great Recession numbers.
- 4.0% is now 4.7%, according to the revision of a study originally in 1994 done by Bill Bengen in 2020. This study is an attempt to determine what percent can you withdraw from your investment portfolio and feel confident that it will last you for your lifetime. We agree with this figure and given the current level of interest rates, might push this to 5% as individuals tend to spend less as they enter the passive stage of retirement, beginning around age 78.
- Should growth investors consider intermediate- to long-term bonds? Despite the rally, “we are getting there.” As it is very unlikely to pick the exact bottom in stocks, don’t think you can pick the exact top in interest rates (the equivalent of the exact bottom in bond prices). For example, an investor is only giving up $430 per year in income with the yield on the 10-year U.S. Treasury currently at 4.57% as opposed to its more recent 5.00%. Hogs and sheep both get slaughtered.
- Every environment has a temptation. Right now that “siren song” calling is cash. We say, use cash for short-term liquidity. Sure, it is nice that you are getting a return on that cash. However, cash is not a long-term investment option. Don’t get sucked in by investing solely in short-term fixed income securities such as money markets, short-term bonds or Certificates of Deposit (CDs) despite their yields being higher than longer dated securities as a result of the inverted yield curve. With the interest on the 10-year U.S. Treasury climbing to within an earshot of 5%, we recommend laddering bonds in order to add predictability to your stream of future income.
- The market is continually weighing the promise of AI versus the economics. This past week economics trumped the promise as several tech stocks slumped. However, over the longer haul we believe that the promise of AI will fulfill expectations leading to higher relative valuation. We also believe that the recent weakness in the NASDAQ Composite is more directly correlated (on an inverse basis) with the movement in interest rates (bond market) as opposed to correlated with the earnings of the underlying companies.
- Over the last two years (October 31, 2021), this has been more of a time rather than a price correction for equities but both for fixed income as interest rates have risen back to pre-great recession levels.
- Your money is not a competition but rather a means to allow you the freedom to do the things you want to do. It is security and with this in mind, perhaps it is time to lengthen the duration of your fixed income portfolio.
- Time will tell if investors/consumers will be inclined to slow down purchases as interest rates have moved higher just as they may have been inclined to increase purchases in the previous low interest rate environment. For example, stocks did well during the late 1990s even though the 10-year U.S. Treasury Note was well above 5% perhaps because interest rates prior to this period were much higher so they deemed this rate “low.” Today’s environment is quite the opposite as interest rates over the past decade were much lower. Perhaps investors deem this interest rate “high.”
- Autumn is a time to harvest and in regard to the non-qualified accounts managed by Fagan Associates, we will continue looking for ways to offset realized capital gains by realizing some losses in portfolios, if available. With that in mind, feel free to contact us should you have any questions regarding this process which occurs throughout the year, but quite often at an accelerated pace during the final quarter.
- Don’t get sucked in by investing solely in short-term fixed income securities such as money markets, short-term bonds or Certificates of Deposit (CDs) despite their yields being higher than longer dated securities as a result of the inverted yield curve. With the interest on the 10-year U.S. Treasury climbing well over 4%, we recommend laddering bonds in order to add predictability to your stream of future income.
- Corporate news – FTX founder Sam Bankman-Fried found guilty on seven counts of criminal fraud; Solar stocks (Solaredge, Enphase, et.al.) get crushed on weaker than expected revenue, earnings and a forecast for slower growth; Starbucks (SBUX) Q3 beat on both revenue and earnings estimates pushing the stock 10% higher.
- Upcoming Economic Reports scheduled to be released this week include the following, on Tuesday, September U.S. Trade Balance and September Consumer Credit; on Wednesday, September Wholesale Inventories; on Thursday, the Weekly Report of Initial Claims for Unemployment Insurance; and on Friday, the preliminary November Survey on Consumer Sentiment from the University of Michigan.
- Earnings season is in full swing. Some notable companies reporting Q3 earnings this week include the following – Vertex Pharma (VRTX), Occidental Petroleum (OXY), Gilead Sciences (GILD), Uber Tech (UBER), Disney (DIS), Honda (HMC), and Becton Dickinson (BDX).
“This presentation is not an offer or solicitation to buy or sell securities. The information contained in this presentation has been compiled from third party sources and is believed to be reliable, but its accuracy is not guaranteed and should not be relied upon in any way, whatsoever. Fagan portfolio characteristics and holdings are subject to change at any time and are based on a representative portfolio. Holdings and portfolio characteristics of individual client portfolios may differ, sometimes significantly, from those shown. This information does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities listed.
Additional information including management fees and expenses is provided on our Form ADV Part 2. The actual return and value of an account fluctuate and, at any time, the account may be worth more or less than the amount invested. Bond Investments are affected by interest rate changes and the credit-worthiness of the issues held in the portfolio. A rise in interest rates will cause a decrease in the value of fixed income positions. Past performance results are not indicative of future results.”