As we head into the last month of the year, here is where we are in markets.
1
Since January 2022, money market funds and cash have outperformed the S&P 500 and the Nasdaq.
The financial press lives off daily headlines.
This makes it challenging to track market performance and to compare relative performance.
Our conservative stance in the face of unconventional risks has paid off.
2
Short-term bonds pay the best coupon in over fifteen years.
Old paradigms are hard to kill.
We have lived through fifteen years of easy money.
In this environment, low rates encouraged excessive risk-taking and punished conservative investing.
We are in a new paradigm where conservative investors are well compensated.
This is good news for prudent investors.
3
The equity risk premium (ERP) is the excess return for assuming risks in equities vs. fixed income.
In 2023, the ERP has either been negative or only positive in a marginal sense. Why?
Short-term bonds pay high-interest rates compared to equity earnings per share.
4
The S&P 500 is more tech-heavy than the tech boom-bust era.
The so-called Magnificent 7 stocks currently compose 29% of the S&P 500.
This is the highest market concentration in S&P 500 history.
Every bust has a group of expensive stocks that investors thought were impenetrable.
In every case, high valuations resulted in significant losses.
In 1968, IBM, part of the Nifty Fifty, traded at $11.91 per share when the correction began.
IBM would not see its prior high until the fall of 1983.
5
Interest rate policies have a lag effect on the economy.
We have seen the most aggressive interest rate policy by the Federal Reserve in over forty years.
The cost of consumer debt has skyrocketed from credit cards to mortgages.
It takes time for these lag effects to work through the economy.
Our premise is that a recession at this point is hard to avoid.
6
High-interest rates are not only affecting consumers.
Small businesses face higher interest rates than consumers.
Today interest rates for small businesses are at levels not reached since 2007.
The next year, those higher interest rates played a role in the Global Financial Crisis.
7
COVID changed the economy forever.
This is most evident in commercial real estate, especially office buildings.
The headlines of major office building foreclosures are only getting started.
Banking loan portfolios face deterioration.
This will slow down the offering of bank credit to consumers and businesses.
8
Labor is the last shoe to drop before a recession.
We see a softening in temporary and part-time labor.
Continuing claims are continuing to trend up.
This means that the unemployed are finding it challenging to find a job.
9
Inflation continues to affect businesses and consumers
In other words, the 8% inflation we experienced in 2022 hasn’t disappeared.
The 2023 inflation rate is on top of the 2022 rate for everything you buy.
Historical instances show that recessions slow inflation in a significant way.
10
Recessions don’t last forever.
History shows that recessions are entry points to healthy long-term returns.
Heading into 2024, short-term rates compensate investors very well for having patience.
