Trademark Financial Market Update – June 1, 2022
1) Overall: Last week was a great one for risk assets. Both stocks and bonds had been oversold from a technical perspective since perhaps the middle of March, but the previous rally attempts consistently collapsed in short order. The rally that began on May 20th, has been supported (as the previous rallies weren’t) by falling treasury bond yields – in this case underpinned by the expectation that interest rate hikes after July’s will be only 25 basis points. The 10 year is now around 2.75%, and as long as it doesn’t move back to the 3% range again, the stock market rally can continue. Of course, the stronger risk assets perform, the better the prospects for increased consumer spending and higher inflation, so falling bond yields cannot support the rally for long. Stock market bulls are hoping for signs of either moderating wage costs and/or improving productivity. This Friday we will get another employment report. I suspect bad news (fewer jobs added or a higher unemployment rate) will be good news (within reason).
2) Bonds: I believe that there is room for a more lasting risk-on rally in the bond market. Municipal bonds and high yield bonds are much more “retail” driven than treasuries and high grade corporates. Individuals panicked out of munis and to a lesser extent high yield corporates this Spring as total returns turned negative to an extent not seen in at least 40 years (probably ever). Interest in these bonds at “bargain” levels has ramped up sharply in recent days, so if one cannot move sooner rather than later, best to let it go. Floating rate has outperformed corporate high yield fairly substantially year to date, but this is a time for the latter to partially catch up. I am more bullish on municipal bonds gaining back lost ground right now than I am on corporate bonds.
3) Stocks: I believe stocks have a chance to rally back near the support levels they broke in March over the next several weeks. Inflation peaked in the late March-mid April period, so economic reports should be friendly from now to at least August in terms of showing inflation falling from 8% down towards 4.5%-5.0%. The problem comes later in the year when progress on inflation seems to stall as the economy responds negatively to restrictive monetary policy. In other words, it will be much harder to get from 5% inflation to 3%, and the very effort itself through tighter monetary policy risks recession. Stagflation is a tough environment for equity prices. I think of the U.S. market as being in a trading range now where the downside is S&P 3600-3700 and the upside is 4800. Breaking below the range indicates something is very wrong and therefore a more defensive strategy is appropriate, while moving above the range suggests the inflation situation has been resolved and a “get long and hold” approach is again the most optimal. I think we will spend the next six months between 3850 and 4450.
4) Investment Approach: I began my investment career in 1986. Inflation was falling sharply due to a plunge in oil prices. Successful money managers had portfolios completely different from what they would have looked like five years earlier. Interest rates were volatile and business cycles were short, so one could and did enhance returns by trading along the business cycle. The skill set and mindset one developed during that era was of absolutely no help to you from 1995 through 2000 and from 2011 through 2020. Whatever short term interest rate volatility one might see during those periods, the big picture was that interest rates were headed lower long term and credit was plentiful, so one should get fully invested in growth assets and keep one’s foot on the gas pedal! I believe that this decade will be more of a hybrid between the 1980s and the 2001-2007 period where U.S. stocks will be at best a “middle-of-the-pack” asset and investors will need to be more active with regard to adding risk when credit conditions improve and scaling back risk when they deteriorate. Moderate growth with next to no inflation, such as we experienced last decade, will not be possible going forward without a significant breakthrough in productivity (technology of some sort), because there is no new “China” that we can import deflation from. In fact, “re-shoring”, which is the trend these days, is in-flationary.
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