Aptus Quarterly Market Update – Q4 2023

 

Transcript for Above Market Update:

Derek:

Welcome. We have wrapped up the fourth quarter and on our way to the first quarter of 2024. Thanks for listening to us. Thanks for being clients and prospective clients. I have a couple of guys here that love talking about stocks and bonds and allocation and everything in between. So I’ve got Dave Wagner, who is a CFA and our equity specialist, and John Luke Tyner, CFA, and our fixed income specialist. I will read a disclaimer before we get rolling. The opinions expressed during this call are those of the Aptus Capital Advisors Investment Committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. More information about Aptus’ investment advisory services can be found in its Form ADV Part 2, which is available upon request.

All right. Well, pretty wild year. I think relative to expectations, I don’t know that anyone expected that pretty much every portfolio would be up double digits through the course of a year regardless of risk allocation. Even bonds came back at the end of the year. And obviously, we talked about the Mag Seven all year long, and thankfully at the end of the year, the rest of the market caught up a little bit. So I’ll let the guys roll with what they feel are some of the most important things coming out of 2023 and going into 2024. I don’t know if, Dave, you want to kick it off a little bit with an overall summary?

Dave:

Yeah, I can do that, Derek, but first I’ll start saying, on behalf of the entire investment committee team here at Aptus, we want to thank everyone for the support of our firm. I mean, we wouldn’t be able to do what we love doing without the support and basically everyone listening to this call. And I think that a lot of our partners have really seen a pretty substantial increase to our market and sales material relative to probably just a few years ago. And that’s very purposeful because first and foremost, with a lot of our calls, our videos, we hope that we have been and continue to be thought-provoking. So we want to attempt to show you and provide data, especially through our Friday charts on a weekly basis to really help encourage all of our partners to really think about the world and maybe go about your work just a little bit differently than what you would have just a few years ago. So I really hope that we accomplished that.

But moving forward, there’s certainly a lot to talk about, much like what Derek just mentioned on the onset of this call. I think this year for the 60/40 portfolio is probably a top 20-year going back to the 1930s, and that was definitely against consensus really heading into this year. But as many of you all know and heard me talk, I’m not huge on outlooks based off of a calendar year by any means. But the purpose of our outlooks is not to prove or to show conviction like, “Hey, if we’re going to look through our crystal ball, this is going to happen.” But more importantly, have the recognition and the necessity to show that we need to remain flexible in this type of market to be open to change, to be open to a world very much looking very differently than what it has probably over the last 40 years. And that’s what we try to make our outlook to look like because we want to focus on the long-term and not really be handcuffed to short-term expectations of a single year calendar outlook.

But if you simply just go back to the beginning of last year, basically every single analyst was calling for some type of recession and you fast-forward 12 months later, all these analysts are calling for some type of soft landing and you’re probably thinking yourself, that’s some type of big turnaround. Well, actually not really, because a lot of those recession calls that happened just 12 months ago involved just a large dose of narrative because all those forecasts that you had just 12 months ago just were stating that we’re going to have the stellar recession really in history. And then you fast-forward to today, [inaudible 00:04:27] forecast for next year that… Well, they’re not widely different than what we had going into 2023, but now they’re all calling for something different.

So that’s one why we don’t really fully believe in outlooks because it’s basically just analysts reheating old forecast and sticking new labels on what they’re predicting and they’re calling it fresh. But at its core, it’s really showing the buoyancy of risk assets and how they’re such a large portion of the explanation to these forecasts based [inaudible 00:04:56] saying that pricing move narratives. And as the market performs better, well, you know what? The narrative is probably going to be a little bit more optimistic and that’s why I think it’s a good starting point here, good trampoline to really go into an annual recap for this year because I want to focus on why did the recession that was called just for 12 months ago really does not occur. And I think you could boil it down to maybe five, six, seven, eight things.

But the two things that I would focus on here on what happened was that consumers and corporations just did a substantially better job on funding their leverage than Uncle Sam. To a certain extent, the economy just wasn’t as interest rate sensitive as many would have thought. And if we did some type of poll on this outlook right now and I pose a question of, “Is your life better off with higher interest rates or not right now or is it worse off?” I think a lot of you all would actually say, “You know what? It’s actually a little bit better off because we’re starting to finally clip some type of nominal yield and while we probably just not moving from house to house.” But this past year for me, I’ve always said you have to follow the tape of what the market is saying. And I think that big point this year was when Silicon Valley Bank collapsed and the Fed really stepped in with some type of liquidity program that really nullified any substantial contagion or damage into the market.

And if you go back to that date, that fateful early March date, the market was flat heading into that weekend before this progress came out. And basically, all the return here to date for the S&P 500 came after that date. So the Fed’s actions are really what buoyed the market higher just nine months ago. And I think what that tells me is that that was the date that the market became substantially more enamored or dependent on the movement of interest rates. And obviously, John Luke will talk a little bit more about interest rates, but this year was all about rates. As rates came down, valuations increased and vice versa from what we saw back in 2022.

But I think the second big factor for me on why we didn’t see some type of recession this year was doubling from the resiliency of the consumer itself. They are the ones that drove earnings expectations higher in 2024 and actually made them pretty stabilized in 2023. I think a lot of analysts heading into this year were calling for a 20% pullback and earnings expectations for the S&P 500 when in fact they came in about 1% higher. So I think that was a very big surprise to the market and I think buoyed obviously by the propensity of the consumer to spend of what’s really kept us out of a recession.

But moving forward into this year, I think the burden of proof right now on the market still resides on the bears themselves because the momentum, what we’re seeing underneath the hood, whether you’re looking at small caps, large caps, or even a little bit of internationally, it’s pretty strong momentum that can tend to [inaudible 00:07:55] higher returns into the future. But at its core, as investors, as allocators, I think it’s really important to remain nimble here and most importantly, remain balanced. Don’t be too bullish, don’t be too bearish, don’t let your political narratives get in the way of investing in this probably hotly debated topic heading into November of this year.

So as everyone on this call knows, we’re very thematic in everything we do here at Aptus. And our theme this year for our outlook was off of the 1957 novel Atlas Shrugged by Ayn Rand, and our one last year ultimately ended up being incorrect. It was a marketing constant sorrow. And as we know, this [inaudible 00:08:36] was pretty strong. But if you go back two years ago, we were right because we based our thesis off of Larry David’s HBO show, Curb your Enthusiasm, stating that investors may have to curb their enthusiasm heading into 2022. So we’re basically calling 50% right now and be right on our outlooks, but that’s why we’re pretty much more bland in our outlook heading into 2024 because I think the market’s very simplistic in everything that it does. And many people believe that a complicated problem requires a complicated solution when in fact it’s much more simplistic in my mind.

And the one thing I’m focusing on, and I think that the market’s performance is going to hinge on moving forward next year is just the consumer’s propensity to spend. And so that comes down to the themes, “Will the consumer shrug?” Because much like Atlas, the mythological Greek creature who has to hold up the headings or the earth in that depiction of that statue. So if the consumer shrugs, I think that we could see earnings come down substantially and that’d probably be off the back of a much weaker labor market and that could cause some stress in the market or vice versa. If the consumer remains strong and their propensity to spend is strong, well, they could continue to insulate the market much like what we saw just this past year in 2023. So with that, I’ll pass it off to John Luke to give us a little bit more of a recap on the fixed income market.

Derek:

One thing that kind of, I guess, covers a little bit of yours, a little bit of what John Luke might talk about in the bond market though is the Fed does have a dual mandate and they’re trying to maintain full employment and also keep inflation down. And so I guess, I mean Fed raise rates a lot and we haven’t seen squat in terms of unemployment rate going up. So maybe there’s a lag effect. JL, it’s probably something you’re more in tune with, but I think a lot of people are surprised. That’s probably where one of the bigger surprises was is that all these hikes and it really didn’t do anything to employment.

John Luke:

No, I think a couple of things that we’ve learned on the year has really been impacted by the market has been less sensitive to rising rates and maybe it is a lagged impact. And I think that’s probably true for a lot of the corporate bellwether companies of having to potentially refinance debt into these higher rates. And I think one of Dave’s first comments was most companies are in such a good shape from a financial and balance sheet perspective that the higher rates just led to them making more income on their cash. And so in order to see an impact of higher rates on companies, you probably have to see a very prolonged period of higher rates where companies actually have to refinance debt into the backdrop. And we haven’t seen that. And I think that you could argue that a lot of consumers are probably better off because they’ve got a lot of cash in money markets that are getting five 6%.

And the other part of the coin that I think everyone underestimated was just the fiscal spending side. And so you think about the Fed, they’ve got the ability to impact monetary policy, and then really the government and the treasury have the impact on fiscal policy. And what we’ve seen is a tightening of monetary but very loose fiscal policy, and that’s helped sort of aid some of this recession impact or fear of recession that I think a lot of people are scared of.

It’s funny. You take a step back and you look at yields at the very end of 22 and you look at yields at the very end of 23 and the 10-year treasury was within a basis point of where it was, and so that annualized volatility on an annual level was pretty low, although the pathway to get there was a yo-yo throughout the year where you just saw fixed income really struggle in the latter part of Q2, really all of Q3 in the first part of Q4, and then you had just this catapult lower in bond yields that was in response to a little bit softer inflation data, a little bit more reasonable economic data, and then some repositioning of how the treasury was issuing debt and aiding a little bit of the concern of term premiums rising and things to that extent.

But all in all, you look back on the year, and for fixed income investor, it was pretty decent, right? Unless that you held long-term bonds, then your returns still were pretty crummy. But if you held the ag, you got your four or 5% from income and a percent or two from price appreciation, which I don’t think that we would necessarily continue to bank on that price appreciation aspect. But all in all, it was volatile and you continue to see stocks and bonds be positively correlated, which obviously is concerning for building asset allocation portfolios and thinking about how bonds can fit in a portfolio. And one of the questions that we’ve gotten and I think is important is after this move in rates, does it still make sense to add bonds to the portfolio? And I think that a lot of that move got sucked out.

One of the key themes, I think, of 2024 is obviously rate cuts. That’s top of mind of every investor that’s in tune, where what’s the market pricing in versus what’s the Fed telling us. And then you kind of have to think about some avenues of how you can actually get those rate cuts. So right now, the Fed is telling you via their dot plot that came out in mid-December, three rate cuts for 24, the market’s pricing in between six and seven sort of depending on the day. And in all honesty, that’s probably pretty reasonable because if you think about really the three outcomes that could happen, if you look back at history, the Fed doesn’t usually cut rates in a smooth linear line on the downside when they’re cutting. It’s typically in response to a recession.

And so I’m guessing what markets are pricing in with that six or seven rate cut outlook is that, hey, if things get really bad, maybe the Fed cuts more, maybe they cut back to 3% and that equals roughly 10 cuts. Or maybe if things aren’t as bad and inflation sort of firms and growth stays resilient that there’s going to be less cuts. And so I think we’re probably going to continue to see this volatility of rates and just the outlook based on a lot of economic data. We’ve got inflation data that will continue to come in and it has had trouble with the last mile of getting back down to 2%. Obviously, you’ve seen really strong sort of immaculate disinflation the last couple of years or the last year. And really I think that looking at that moving forward, it’s going to be harder to see that level of deceleration moving forward.

And so where inflation sort of bottoms out, how comfortable the Fed is with inflation running above target, and if they can continue to sort of prolong things, and then if you continue to see this economic resilience that we have, it’s not going to lead to quick Fed rate cuts in my opinion. It probably continues to be a very prolonged drawn out process. And so I think that’s probably one of the biggest risks to markets is that this rate cut agenda that’s been sort of prognosticated, it doesn’t play out like markets hope.

Derek:

I’m taking an interesting takeaway from what you said as you were going through it is that basically the market’s anticipating six cuts, it’s probably going to be three or nine. That’s not where it’s going to be. The worry is… I mean, the Fed’s been pretty resilient that they’re going to fight this thing and the market’s now saying, “All right. They’re going to hit it perfectly.” But you’re saying if they do start to cut and if they start getting into five, six rate cuts, it’s probably because they need a lot more. So for now, the market’s just buying the whole soft landing hit the middle spot scenario.

John Luke:

Yeah. And we’ve had a lot of discussions internally about what the market’s pricing. And it’s not really pricing that big deep recession type of environment happening. It’s really pricing in the Fed sort of nailing the soft landing and effectively just taking rates down as inflation falls and having real rates at a slightly restrictive level instead of a really restrictive level. And so pulling rates lower is ultimately good for stocks and for bonds as long as there’s no carnage to the economy and to the consumer.

Dave:

This comment may surprise both you and probably a lot of listeners because I tend to be more of the optimist and bull out of probably our crew, but obviously the narrative right now is soft landing. But every single time that we’ve had a hard landing, there’s been an aspect or point in time proceeding that hard landing where it looked like it was going to be a soft landing.

John Luke:

Yeah. It always is a soft landing until it’s not. And so you’ve got the really deep curve inversion. We’re going on one of the longest curve inversions that we’ve seen historically. I think the longest one historically it was like 460 something days and we’re at like 420 days or so roughly. And so obviously, an inverted curve continues to create problems for the economy, which is another telltale sign of a recession, but it hasn’t been right at this point.

Derek:

One other page that I pulled out of your yearly recap and look ahead, it’s an election year. For better or worse, there’s going to be a lot of noise. I guess it’s generally positive for markets unless something really unexpected happens. But I don’t know if either of you want to touch on that or if you just want to skip past the whole discussion of an election, but it’s upon us.

Dave:

I feel like I’m the pseudo DC guy here unfortunately where I have to talk more about this, but I think the best way to state, because obviously, a lot of people try to bring politics into markets. But I’ve only used this analogy once. So I’m going to butcher it here, but it goes back to this movie that came out in 1979 with Bill Murray and called Meatballs, I think. And there’s a point he’s given a pep talk to the camp counselors or whatnot, they’re about to play their arch nemesis, but he goes back and forth and he starts to scream, “It just doesn’t matter,” and he keeps saying it throughout his entire pep, “It just doesn’t matter.” And when it comes to politics, to me, it just doesn’t matter that this market and election cycles are the…

There’s always some theories there. You have the January anomaly with markets on an annual basis, but then there’s other theories out there like this presidential election theory where the market tends to do well in the third year of an election cycle because the amount of fiscal policy really being injected into the economy by the current or incumbent present is quite substantial because whenever there’s been a recession in the year four of an election cycle, the incumbent has never won. So obviously, they’re trying to prop up the economy heading into some type of election, which has followed through with some pretty strong returns in year three. And depending on who has the highest propensity of winning, whether it’s a Democrat or Republican, if there’s going to be strong returns in the beginning part of the year four of election cycle or in the second half of an election cycle. But when it comes, boils all down to, and I think this table on the right side of this slide does so many wonders. It’s really showing that, hey, whatever political regime is in office, the market tends to do quite well.

John Luke:

All I can think about is back at the end of 2020 and that election cycle, everyone was very fearful, and what happened in 2021, one of the record market years to the upside. So it’s costly to try to time politics.

Dave:

John Luke, question for you on the spot. Since 1960, how many presidential election years, how many times has the market been negative in the fourth year of an election cycle?

John Luke:

I think it’s been low, zero

Dave:

Two, and it’s always been when the incumbent has not been running for election.

John Luke:

Yep.

Derek:

Well, I can use my 52 years to confirm that it was Meatballs and it was in quite a run for Bill Murray between Stripes and Caddyshack. I think that was the stretch in that late 70s. So some classics there.

Dave:

quite strong there, D. Hern.

Derek:

All right. So one thing that I think is always in these annual reports is really quarterlies, I guess you do, but good, bad, and ugly. What are the things that should be at least just kind of be thinking about? Because for our clients, the advisors, it’s possible that their clients are either reading about some of this stuff or is going to be hearing about it on CNBC or Bloomberg or wherever. So you’ve got a few things here, a couple in each category. I’m curious if there’s any that really stick out to you as important over the next couple of months.

John Luke:

I can take first swing and then Dave can roll. So like Dave said, he’s the optimist, but I’m trying to be more optimistic. But I think really the biggest takeaway is that as long as the consumer continues to have jobs and get the type of wage growth and have this tight labor market that we have, it’s just going to be really hard to see a big degradation in earnings at the corporate level. And so without a spike in unemployment, without a real fear of what’s going to happen, I think markets can probably digest a lot.

And on the other hand is the Fed’s got a pretty substantial war chest behind them now following this rate hike policy to sort of have activity and action in the face of any market turmoil. And that’s a key difference. They could cut rates, they could stop QT, they can create these facilities like they did following the banking crisis. So there’s just a lot of things that, I think, can be done that could pad sort of a rough patch in economic data that people aren’t really thinking about. And so that sort of turns in ugly and a bad into potential good.

Dave:

John Luke, you took the optimist side of the good, the bad, and the ugly. You’re throwing a wrench in the spook of the tires. I don’t know how to react to that. So I guess I’ll have to take the pessimistic side since you’re the optimist here.

John Luke:

Well, you don’t have to.

Dave:

And I think the point that John Luke made, it all comes down to the resiliency of the consumer and that is very hinged to wages and the labor market remaining strong. If you look at historical data from the period time zero of the first pause by the Fed, the market doesn’t tend to see job cuts or job losses until about 18 months into that cycle. Right now, we’re just sitting closer to five months since the original initial pause back in July. So I think that’s one thing I’m going to be really focusing on this year is how well that labor market can hold up because we’re just really starting to see some of the initial ramifications of the tightening cycle itself. But it all comes back down to our outlook here is, “Will consumers shrug?”

John Luke:

Yep.

Derek:

Awesome. Well, I mean, I think you guys have brought up a lot of things that could occur over the course of the year and back to the quarter. I guess in January, there’s a couple of economic reports, there’s earnings will be kicking off in a week or so, Fed’s not till the end of the month. So we’ll start to get some stuff. But right now, it seems like people are still probably going to be digesting all of this. We’ve had a huge move, obviously, in the last couple months. So I don’t know if you have anything else that you think warrants notice at this point.

Dave:

What I would say because we always end these calls as like, “Hey, what’s the one thing that we’re focusing on that maybe not a whole lot of other folks are focusing on?” And we can kind of go around the table, but mine coincides with one of my initial comments on the necessity for allocators to remain nimble, but more importantly to remain balanced. Don’t get too bullish or too bears because I think that a lot of people have a lot of pessimism in this market right now just given the price movement driving the narrative that the market’s up 15% off of its October 27th bottom. It was up over 26% just in the year 2023 alone driven by the Mag Seven there.

So I think a lot of people are becoming a little bit more bearish at the beginning part of this year, but if you look at the S&P 500 on the following year after it returned 20% or higher, 65% of the time, the market’s been higher in the following year. Obviously, that means the residual 35%, the market’s been lower. The average return for all of those periods was about 8.9%. The average return for the periods where the market was positive was up to 18%. And when the 35% of the time when the market was down, the average score was down 9%. So it just shows you that you can have conviction in this market. You may think it’s ahead of itself now, you may be a hard landing campsite, you may be a soft landing campsite, but there’s just a lot of reports remain invested in following the structure of your investment philosophy. And that’s how you’re going to be very successful in a year that probably, you can see a whole lot of volatility, especially where we stand in the election cycle.

John Luke:

I have two points. One’s a little self-serving and I’ll hit with that one first is just the price of hedging portfolios right now is back down at levels we haven’t seen in years. And I know we beat the table with this at the end of Q2, beginning of Q3 on a lot of calls that we had. But I just think the injection of volatility into portfolios based on how it’s priced, and then also based on the alternative, which I’ll get to in a second, it just makes the ability to own more stocks and sort of ride the potential for momentum higher easier.

And then the second piece is that after we’ve seen this pretty gargantuan move in rates, it just takes away some of the defensiveness of long-term bonds in terms of their ability to hedge portfolios or really create the diversification that people have kind of expected the last 20 years. And so in light of that, the Fed, the Treasury, excuse me, has a number of bonds to refinance this year at much higher rates. We’re also still running deficits. And so you’ve got this dynamic of the potential for a ton of supply of treasuries on the market on the back half of the year.

And so when you sort of can weigh your options of well buying long-term bonds to hedge a portfolio at 150 basis points more expensive levels now than they were two months ago, or buying volatility to hedge portfolios, it just really isn’t a no-brainer to me that if you’re scared of something crazy happening, volatility right now is really priced attractively to incorporate into your portfolio. And I think that’s one thing that I’ll kind of sit my hand on here at the beginning of the year as we kind of figure out what happens.

Derek:

Awesome. Sounds like a little more on the side of preparation, a little less on the side of prediction. So that’s probably a good way to survive in the market. So-

John Luke:

Yeah-

Derek:

… appreciate you all coming on. What’s that?

Dave:

Well said.

Derek:

Yeah, every now and then. Appreciate you all coming on. And I know there’s a lot to get ready for as some of this data comes in January, but we look forward to answering any questions that come up either from here or something else you’re thinking about or that clients are asking about. We’re always up for answering them. So appreciate you all and hope it’s a very prosperous 2024 for all of us.

John Luke:

Yep. Thanks everybody. We appreciate you guys. Happy New Year.

 

 

 

Disclosure

The opinions expressed during this Webinar are those of the Aptus Capital Advisors Investment Committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.  More information about Aptus investment advisory services can be found in its Form ADV Part 2, which is available upon request. ACA-2401-16