2024 has been a great year for the market: The economy has continued to grow faster than predicted; Inflation has slowly but surely gotten better; The elections are behind us, and there was a clear winner and no real protest. We enter the holiday season with a deep sigh of relief, but wondering, what now?
The Fed controls one rate, the overnight Fed Funds rate; all other interest rates are determined by the market, which is under no obligation to follow the Fed’s action. It has chosen not to do so this time because economic data has been strong. That positive economic data also confirms that the Fed didn’t need to lower rates in the first place.
I was reminded of this fable last week as once again the pundits on Wall Street cry, “Recession!” or at least economic slowdown. As we have chronicled already, this incorrect call has been going on at least since the beginning of 2023. They will not admit that they are wrong, but will keep making the same call until it is finally right.
The market is blowing up this morning and the question is, why? The answer is the same as always: Reckless speculators borrowed too much money against the wrong asset. This time it is the yen carry trade. Periods like this are not fun, but for prudent investors they do create opportunities.
It is summertime in the markets, which historically means volume is lower and we get strange, nonsensical movements that most often correct themselves once the professionals return from summer vacation. Four years after the pandemic, we continue to move closer and closer to normal. What does that look like this summer?
Have you heard the one about the dog who caught the car? After chasing numerous automobiles, a dog finally caught up to one and then realized he had no idea what to do next. The market seems to be in that mode.
2024 has been a great year for the market: The economy has continued to grow faster than predicted; Inflation has slowly but surely gotten better; The elections are behind us, and there was a clear winner and no real protest. We enter the holiday season with a deep sigh of relief, but wondering, what now?
The initial market reaction to the election was positive, then investors started to wonder, “What is this Trump administration going to do? Will it be a policy repeat from the first Trump administration?” It could be, but then again, the rhetoric from the campaign trail was not the same. There are new people surrounding Trump who were not there in 2016. A few notable members of this group were on the other side in 2016. What will they do?
Pundits will speculate, but the truth is, we don’t know exactly what the policies of this new administration will be, or for that matter what world events will shape the next four years. So, what is an investor to do? Should we cash in our profits from this year or keep letting those winners run?
The answer can be found in a series of The Quarterly Report newsletters that I wrote in 2013. I began that year with “The Three Rules of Prudent Investing.” Rule one is that all prudent investing is done from the bottom-up. While traders on Wall Street love to speculate on politics, monetary policy, and even who wins the Super Bowl, the truth is that prudent investors focus on each individual investment from the bottom-up. Is this a company I want to own? Apple will sell phones no matter who is in the White House. People will eat at McDonald’s no matter what the Fed does with interest rates. Ultimately, what drives stock returns are the earning of the companies. The primary driver of those earnings is the quality of the company and its product or service.
Rule two is that all prudent investing is absolute return-oriented. I have never had a client whose financial goal was to beat a market index. Real people have real goals, like paying for retirement or their children’s education. There is a rate of return that must be achieved to reach those goals; that is the focus of prudent investors. The opposite of that is what I like to call competitive investing – always comparing to some random index or to what your neighbor claims. This leads to the fear of missing out (FOMO). FOMO leads to some of the dumbest decisions ever made, and not just in investing. Read here
Rule three is that all prudent investing is risk averse. We don’t take risk for risk’s sake; this is different than being risk avoidant. Risk averse means we manage risk, and only take risks that are prudent. Defense really does win championships. Read here
So, what are we going to do now? The same thing we have done since the day I left INVESCO and started Iron Capital in 2003: We are going to do the basic boring day-in and day-out work of prudent investing. We are going to invest from the bottom-up with specific goals in mind for each of our clients, and we will manage risk along the way. Don’t worry, we will pontificate on the world’s events just like everyone else, because it is fun and our clients enjoy it; we just won’t let that tail wag the investing dog.
It is Thanksgiving once more, and we have much for which to be thankful. This has been a year with a lot of change. I lost both of my parents last fall and will miss them at the Thanksgiving table. Iron Capital was acquired by AssuredPartners Investment Advisors (APIA) on June 1. After 21 years of being my own boss I am now part of a much bigger team. My wife has a brand new hip after suffering for too long on the one that no longer worked. My son has a fresh surgically repaired shoulder. This is the give and take of life. There is no return without risk, there is no joy without suffering, and there is no gratitude without loss. The old decays so that the new can grow. It has been a full year with both sadness and joy.
It is Thanksgiving, and I am extremely thankful. In keeping with our tradition here is my list:
~ I am thankful that we base our investment decisions on sound fundamentals, not narratives.
~ I am thankful for the strong foundation that my parents provided for my four siblings and me.
~ I am thankful that college basketball has begun, and that Wake Forest has two more wins than Duke and three more than UNC.
~ I am thankful for all my new APIA colleagues and the bright future we have.
~ I am thankful my wonderful wife and that she can once again keep up with the rest of the family.
~ I am thankful for my son and my daughter, both of whom are growing into wonderful human beings.
~ I am thankful for my family, immediate and extended.
~ I am thankful for my friends.
~ Of course, I’m always thankful for Mama’s pumpkin cheesecake, though she is no longer here to enjoy it. I don’t think she will mind me eating her slice.
~ Finally, I am thankful for you, our clients and friends. Your trust in Iron Capital and now APIA is our greatest asset, and we value it every day of the year.
Happy Thanksgiving!
Chuck Osborne, CFA
Managing Director
~What Now?
My wife and I are blessed with two wonderful children; tragically they have both turned into teenagers. Our son, Charlie, is almost 17 and loves basketball, cars, and terrorizing his sister. Our daughter, Mary Frost, is 14, a good athlete, a great student, and truly gifted at pushing her older brother’s buttons. This daily reality has spawned a new favorite phrase in our household, which usually comes out after a sibling ruckus when the instigator will say incredulously, “All I did was …”. To which my wife or I will respond, “Was that necessary?”
If I were Federal Reserve Chair Jerome Powell, I would be asking myself that very same question. The Fed met September 17-18 with the stock market up significantly year-to-date, the economy growing at 3 percent in the second quarter, and unemployment still low by historical standards, and they decided to lower interest rates by 0.50 percent. On September 16, the day before the Fed meeting, the yield on the 10-year Treasury was 3.63 percent; by the end of that meeting on September 18, the 10-year rate was up to 3.70. The next day, after the meeting adjourned and the 0.50 percent cut was announced, the 10-year rate actually rose slightly to 3.73 percent. The rise has not stopped, and at this writing the current rate is 4.31 percent.
How can that happen? Didn’t the Fed just cut interest rates? The financial media make it sound as if the Fed is some all-powerful controller of financial conditions – as if when they lower interest rates, suddenly all borrowing cost is lowered, the economy soars, stocks climb, and there is peace on earth and good will towards mankind. If only any of that was true.
In reality, the Fed controls one rate, and that is the overnight Fed Funds rate. All other interest rates are determined by the market, which is under no obligation to follow the Fed’s action. It has chosen not to do so this time because economic data has been strong. The initial reading for 3rd quarter GDP is 2.8 percent growth. There is no doubt the economy is growing. In a growing economy, investors are going to demand a higher return on their money.
That positive economic data also confirms that the Fed didn’t need to lower rates in the first place. They seemingly talked themselves into it, largely because they believed the pundits who have been crying recession for almost two years now. Either that, or they have done something that no other Fed committee has ever done to my knowledge: lower rates simply to get back to “normal.” If so, then bravo. The Fed has a long history of reacting to a crisis by taking emergency measures and then never accepting that the crisis is over, until their “emergency measures” have caused the next crisis. If they simply moved to get back to normal before causing a new crisis this would be a huge step, but I have my doubts.
I think they lowered rates believing that a slowdown was on the horizon. It wasn’t, and now the 10-year rate, which is most important to investors and homebuyers, is actually up and the stock market has leveled off. The Fed will meet again next week, and they have put themselves in a tough situation. If they hold tight, they basically admit that their earlier cut was too early or too big. If they lower again, they risk reigniting inflation. I’m sure they are looking back at the last meeting and asking the same thing we keep asking our kids, “Was that necessary?”
This is just one more reminder why prudent investing is done from the bottom-up, analyzing each individual investment on its merits, and not from the top down, trying to guess what the Fed will do (or, for that matter, who the next president will be). Our way may seem simple and perhaps even boring. Making investments based on Fed actions seems exciting, but it has to be stressful. Fortunately, it isn’t necessary.
Warm regards,
Chuck Osborne, CFA
~Was That Necessary?
You have heard this one before: A village picks a boy to watch over the sheep. The boy is supposed to yell “Wolf!” if a wolf comes around and the townspeople will come running to save the sheep. The boy watches regularly and nothing happens to the sheep, and finally out of boredom, he decides to cry, “Wolf!” The people come, but there is no wolf. The boy thinks it is funny even though he gets in trouble, so he does it again and again. One day when a wolf finally arrives, the boy yells and yells but no one comes; the townspeople were not going to be fooled by the boy again. The wolf eats all the sheep.
I was reminded of this fable last week as once again the Wall Street pundits cry, “Recession!” or at least economic slowdown. As we have chronicled already, this incorrect call has been going on at least since the beginning of 2023. They will not admit that they are wrong, but will keep making the same call until it is finally right. It may be 2030 by that time, but then they will crow about how right they were. “See, I told you in late 2022 a recession was coming, and now in the year 2030 it is happening! I was right all long.”
The danger now is not that people are still listening to the doomsayers, but that they are becoming like those townspeople: They have come running so many times for the false warnings that they may ignore them when the wolf finally comes.
This time, unlike most of this period, there are some signs that slowing could be occurring. A bad jobs report for July took unemployment to 4.3 percent, which is not high historically, but higher than it has been for some time. Then, throughout the first week of September we heard that everything hung on the August jobs report, which came in okay – not great, but not bad. The unemployment rate went down to 4.2 percent. The world is not ending after all, but things may be slowing down.
GDP for the second quarter came in at 3 percent, and as of September 9, the Atlanta Fed’s GDPNow says our current run rate is 2.5 percent. That is slower. We are moving from the recovery phase of the economic cycle to mid-cycle. In other words, we are getting back to normal with a growth rate around 2 to 2.5 percent. That isn’t a recession and it isn’t even a “soft landing,” it is the normal everyday not-booming-or-crashing run rate.
What does this mean for markets? As painful as it may be in the immediate term, this two steps forward, and one step back in markets is healthy. We are seeing signs that the long-awaited rotation away from big tech toward the rest of the world seems to be slowly happening. While the entire market has gyrated up and down, large value stocks, as represented by the Russell 1000 Value index, has made higher highs and thus far higher lows, while large growth stocks failed to rebound above the highs from earlier this summer before their fall last week.
The dollar has weakened, which provides a tailwind to U.S. investors who are investing overseas. This also helps the diversified portfolio. There is plenty to be constructive about.
The constant calls for a recession are getting very tiresome. However, prudent investors cannot become like the townspeople who simply stopped listening; we must pay attention to the data and continue to refute the pundits until the data changes and we finally say this time they are right. The wolf will come for our sheep, but he isn’t here yet, no matter what that silly boy keeps crying.
Warm regards,
Chuck Osborne, CFA
Managing Director
~The Boy Who Cried Wolf
The market is blowing up this morning and the question is, why? The answer is the same as always: Reckless speculators borrowed too much money against the wrong asset. Will they ever learn?
This time it is the yen carry trade. In plain English that means some speculators have borrowed money against the yen because Japan has some of the lowest interest rates in the world. They then use the money to speculate in stocks, which increases their returns dramatically, right up until the moment when it blows up and they lose everything.
Long-term readers will recall we wrote about this in 2008. At that moment it was mortgage-backed securities. It was the same in that massive borrowing led to the eventual collapse. That was more important because the asset people were borrowing against, mortgages, were more central to our economy and the speculators were big banks.
This appears to be more similar to the late 1990s when a hedge fund ironically named Long-Term Capital Management got over its skis with rubles (Russian currency). I lived through that one as well, but it was before we started Iron Capital. Long-Term Capital famously was staffed with a bunch of PhDs, who were living proof that there is zero correlation between intelligence and wisdom.
In that crisis we went through a short period of extreme volatility and then the market came roaring back. There are no guarantees in life, but I suspect the same thing will happen here. This has nothing to do with the real economy, which is still fine at this moment. Nothing in the real world has changed since we sent out last week’s Insight.
Periods like this are not fun, but for prudent investors they do create opportunities. We need to give this some time, but as the old saying goes, we want to be greedy when others are fearful, and fearful when others are greedy. In the meantime, we will do what we can to mitigate short-term damage. The most important thing is to remember that panic is never a wise strategy.
Warm regards,
Chuck Osborne, CFA
Managing Director
~Will They Ever Learn?
I have heard a lot of complaints this summer about the heat and humidity here in Atlanta. Every time I do and just laugh and wonder if they forgot what summer in Atlanta feels like? It is understandable as we have had multiple mild summers in a row, but this summer we are back to normal, which for Atlanta means 90 degrees, 90 percent humidity, and a thunderstorm every evening. This isn’t the best time of year to be in the ATL.
We seem to be getting back to normal in the markets as well. The old saying used to be that traders should “sell in May and go away.” That isn’t because summers are always negative, it is because summer is much nicer in the Hamptons than it is in Manhattan, not to mention Atlanta. The serious traders historically would take their profits in May and spend them on the beaches of Long Island, then return in time to get the kids back in school after Labor Day. As a result, volumes would go down during the summer and only the amateurs, and/or people who had no choice, would buy or sell any stocks. When that happens, we get strange nonsensical movements that most often correct themselves once the professionals return from summer vacation.
This summer that has meant the market has flip-flopped from the so-called Magnificent Seven stocks being the only thing working, to everything but the Magnificent Seven working. This bipolar action has been attributed to everything from Fed Policy to the presidential election. With Fed policy, the idea is that when the Fed lowers interest rates, if they actually do, then the economy will be stimulated and stocks other than the artificial intelligence (AI)-driven Magnificent Seven will rebound, especially small company stocks that are thought to be more sensitive to overall economic activity.
On the other hand, if it appears that the Fed may wait longer to lower rates, then the Magnificent Seven zoom ahead as they will grow with the AI movement and regardless of the overall economy. Similarly, there is a thought that another Trump administration would be good for economic growth while being bad for international trade, so smaller companies will do well while the big technology multinationals will be hurt by trade restrictions.
When President Biden dropped out of the race, the same people said, “Hold on.” Kamala would be good for the status quo, which would mean slower growth and more regulation. That means the big multinationals will be winners and the small companies will be losers.
Both sets of “experts” are fooled by randomness. As author Nassim Taleb pointed out in “Fooled by Randomness,” markets move randomly and then the professional pundit class searches for an explanation. Frankly, I don’t buy either of those explanations. I think it is as simple as we are finally having a normal summer.
In the meantime, prudent investors don’t try to trade anyway. We can enjoy our summertime, knowing what we own and why we own it. We are owners of companies not traders of stock, and the real world in which companies actually operate is doing pretty well. The initial reading for GDP for the second quarter came in at 2.8 percent. According to data from FactSet, with 41 percent of S&P 500 companies having reported their second quarter results, 78 percent have beaten estimates for earnings. The blended rate of growth of earnings, which includes actual earnings for those who have reported and estimates for those who have not, is 9.8 percent as of July 26. That is pretty solid growth.
Having said that, it is summertime and markets have been very strong year to date, but some short-term volatility should be expected and we might even get a short correction. There will be plenty of things for pundits to blame it on – elections, Fed policy, and global tensions all provide plenty of fodder for the pundit class. In the meantime, we should remember that prudent investing is done from the bottom-up. It is much easier to analyze the future of a specific company than it is to estimate the economic consequences of lower interest rates or one administration versus another.
Regardless of all of that noise, people will adopt AI. Smartphones will be purchased and used, as will groceries and clothes. People will still go on vacation, especially over the summer. Four years after the pandemic we continue to move closer and closer to normal. There are crowds at the Olympics, it is hot and humid in Atlanta, the Braves are already starting to choke down the stretch, and the market is being silly. Welcome back to normal.
