Given the popularity of our weekly Market in Pictures, we started the habit of picking out a few and going into more detail with our PMs. In this edition, John Luke and Dave spend a few minutes on each of the following:
- August: In Like a Lion, Out Like a Lamb
- Growth Through the Pandemic
- Election Season
- Government Spending
- The Fed
Hope you enjoy, and please send a note to [email protected] if there’s a particular chart/topic you’d like to see covered next month. Time to swing it around!
3 Minute Read: Executive Summary
Full Transcript
Derek
Welcome to the first market day of September, post Labor Day weekend. Hope you all got nice energy from the extra day. Derek here, and I’ve got Dave Wagner, our Head of Equities, John Luke Tyner, our Head of Fixed Income, and we’re going to run through the month of August, as we do every week. Thanks for coming on guys.
John Luke
Thank you, Derek. Always fun.
Derek
Let me do a little disclaimer. 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 Two, which is available upon request.
August, I guess, is kind of in between. We had the earnings season, now we got the Fed, and then in between was just a lot of speculation, and obviously the election, a lot of speculation about all the above. So we can kick into a little bit of a recap, if one of you wants to run through this.
David
I think that August, obviously everyone’s out for vacation, everyone’s out for summer vacation before they send their kids back to school, but it’s just a great microcosm just not to fixate and focus on the market on such time intervals, especially when you’re investing for the long-term aspects to compound capital efficiently for all of your clients. Because if you just took a month long vacation in August, you would have had some pretty stellar returns.
But there’s a lot of fireworks at the beginning of the month. Obviously, all of us who remained invested survived the recession or technical bear mark, or whatever you call it, of August 5th when the Japanese yen carry trade really started to unwind. We had VIX start the month at 16, it peaked close to, what? 65, John Luke? And it ended the month at 15. So if you just threw a blanket across August as the month as a whole, you would’ve recognized that there’s a whole lot of volatility because returns were pretty good.
But that just shows you that you can’t fixate on the short term, you can’t overreact to certain market movements, because August was just an unbelievable month. I think that the expectations of a soft landing, given the core PC data, given the CPI data, really is what catapulted this market higher. And obviously you had a pretty strong earnings season, so I think those were the two linchpins or the two rationales as to why you had a market return of 2.4% in August itself.
August, from a seasonality perspective, it’s not one of the best months out there, but it’s not a terrible month either. But this month really bucked that long-term seasonality historical trend with returns that we saw here domestically, especially on the large cap, but even more so on the small cap and the more undervalued areas of the market, so small caps and international as a whole.
But if I was looking at this chart and table, I think two things would really stick out to me. The first is going to be breadth, and the second is going to be duration. Let’s start on the latter before the former, so let’s talk about duration, because everything we talk about at Aptus is we want to unhitch the wagon of owning and being dependent on fixed income. And I think a lot of people want to be creative in the space of fixed income of trying to call a duration play as a whole, but through our allocations, as many of the listeners know here, is the best way to play duration is just through overweighting stocks. Stocks and equities, growth assets. They’re just such a heavier duration play than anything else out, especially on the fixed income side.
And during a month where we saw pretty great returns for the Bloomberg USAG, close to about 1.5%, I think they’re up about 3.8, 3.9% on the quarter. So when you’re getting such a bullish market for fixed income, just look at the returns, it still pays to own the longer duration of everything, and that’s stocks, and that’s why I love how our models are created. More stocks, less bonds, while remaining risk neutral, unhitching the wagon to fixed income, which hasn’t had a great real return over a longer period of time, and even more so here lately. And this is just another great example of where you’re getting a positive correlation between equities and fixed income, but also the aspect of the best way to play duration is through owning equities.
The last thing I would like to say on this table here is we are starting to see a little bit more breadth in the market. I know anecdotally if you’re watching the news, or you’re sitting on the edge of your seat on August 28th when the video came out with pretty good earnings, you’re actually starting to see some breadth, that the market’s not fully being driven by the Magnificent Seven. Yes, year to date, about 60% of the total return of the S&P 500 has come from the Mag Seven, but that was really more so at the beginning part of the year. If you look underneath the hood of the S&P 500, you’re actually starting to see financials outperform, you’re starting to see utilities outperform, staples, reach. So more of the average stock type of exposure is outperforming from a sector perspective within the S&P 500. And that’s why you’re getting pretty strong returns in the S&P 500 equal weighted index, which is going to be the ticker RSP, or even in small caps that had a return closer to maybe about 6% during this period itself.
So I really like the underpinnings that we’re seeing in the market right now because, we’ll touch base upon here in just a few short sizes, there’s just so much liquidity out there in the market that’s just driving the S&P 500 and domestic stocks much higher.
Derek
It’s funny, two things. For whatever reason, my eye always catches stuff that’s flat. So it’s funny to think of the NASDAQ being actually right at 0.00 for the quarter through two months with all the action that we saw, like flat line. And then the other one on here is the five-year number for the AG is pretty much flat, which is crazy. It’s provided not only no protection in the downturns, but nothing, just squat for return.
John Luke
And you still pay tax on that income.
Derek
This is true. Yeah, you factor that and inflation, it’s pretty negative.
David
It’s just cool to see a lot of the stuff that we’ve been talking about, not just for the last one year, three years, but 5, 6, 7, 8 years, really come to fruition. And not just over a short period of time, because you’re exactly correct, the five-year number on the Bloomberg US AG is flat. And so it’s really cool to see the proof in the pudding that we really have strong conviction in our investment philosophy and it’s really coming into play. But Brian Jacobs on our team, he’s one of the newer CFAs in the last year. He’s had so many great charts for anyone out there to, if they want to dig a little bit deeper into the environment for fixing them, obviously John Luke had a fixed and he touches base it on all the time, but Brian Jacobs has put up some pretty cool charts from a real return perspective on fixed income, really just not hitting the mark here.
Derek
Yep. All right, so let’s dive into a few of the charts that have been making the rounds within the Aptus team and I’ll let you start here.
John Luke
Yeah, so this chart is basically showing the economic growth versus the CBO’s projections, and it’s a little bit cherry-picking the data starting right before COVID, but what it’s showing, it’s basically the green line, it’s real growth, real GDP growth has been higher than what was forecasted by the CBO. And a lot of that has come from this huge amount of fiscal policy that’s been put into place. There’s massive amount of manufacturing and industrial and infrastructure spending that’s going into the economy, and that’s provided jobs, that’s provided a lot of buoyant growth to the underlying assets that we have here in America.
But I think one of the things as it comes to interest rates and policy that’s important is you’ve basically seen an environment where the Fed has been hiking rates. So monetary policy has been tightening for the last two and a half years, and hopefully we’re ending that cycle, but fiscal policy has been extremely loose.
And so my argument, and I’ve said this over and over again, it’s that the government measure of inflation, it’s understating your actual household inflation, in pretty much all different ways that you can drum it up, it’s definitely higher. And so this chart is encouraging from a high level because it looks like the economy’s growing at a stronger rate. And if that’s the case, I think that the projections for rate cuts might be a little too aggressive and we’ll talk about that on the next one.
But the other side is if this chart is correct in terms of the growth, which obviously the numbers are real, but if it’s understating the impact of inflation, that means that real growth has been less than what the chart’s saying. And so this is more like a philosophical back and forth that we’ve had with the team, but it’s fun to look at it. All in all, I think it just points to the fact that we have to modify the asset allocations to be able to accommodate and to position for this type of structure, for this type of movement of what’s going on underneath the economy. You have to have things that can grow.
Derek
Dave always talks about the growth is really all that matters going forward. All this talk about what the Fed’s going to do and all the other stuff, that’s where we get in trouble is if the growth goes away.
John Luke
Yeah, if growth stays at the levels that stand, it’s going to be hard for the Fed to cut rates 10 times over the next 14, 15 months, like the market’s pricing ends.
Derek
So that plays into this one. Speaking of government spending.
David
The no-hitter has ended. We’ve tried to go a very long time on our Aptus Three Pointers really not talking politics. We always joke at the end that we didn’t talk politics and we’re very happy about that. You’ve seen a lot of my musings out there. You’ve probably seen a lot of market charts that the market starts to focus on the election starting after Labor Day. Historically, if you look at the VIX, the measure of volatility on the equity side of things during election years, volatility doesn’t really start to show its space until end of August, and more importantly into September, October, and a little bit into November. And that’s me saying, “Hey, that’s when the market starts to focus on the election as a whole, and that’s why we finally have to start talking about the election,” so I do apologize.
But I think the story is very simplistic here and it actually just goes back to the slide that John Luke was just speaking to that the necessity for growth and the necessity to use fiscal policy or monetary policy as stimulus or liquidity boom to continue to drive the market higher is like, that’s the playbook. We know that’s the playbook. And everyone on this call has probably heard me say multiple times that there’s a lot more emotional volatility during election years than actual volatility by the market. There’s no surprise in that, absolutely not.
But we do know that during market reelection years, which for the majority part of this year, the market had the incumbent president, President Joe Biden, running for reelection, and we all know the stats regarding market election cycles that when the incumbent’s running for president, the S&P 500 tends to have an average annualized return during that year of 15.8%. Not only that, the market hasn’t been negative when the incumbent’s been running for reelection since 1944. No one’s fighting historical data there than itself, but obviously in July we had the rinse thrown between the spokes of the tires when current president incumbent Joe Biden decided to step back and actually say, “Hey, you know what? Kamala Harris, my vice president, I endorse her to run for president.”
So that changed the statistic that I just mentioned there, that the S&P 500 tends to have very, very great returns when the incumbent is running for reelection. And I would actually state no, under one pretense, as long as the current vice president tries to run a platform that’s a referendum of choice versus a referendum on the previous tenure in their post as vice president. And historically speaking, that when the vice president or when the incumbent decides not to run, the market still had very strong returns. So it doesn’t contradict what I was saying before, that when the incumbent’s running for president, there’s strong returns. Even when the incumbent is not running for president.
So when John Luke and I were speaking about this a month ago, we were trying to figure out why. Do you have to toss a playbook out, or do you enter stage up the same exact playbook that you have as if Joe Biden was running for president? And the conclusion that we came to is you stay the course, because the amount of liquidity being pushed into the market right now, I don’t want to say it’s unsustainable, but it’s astronomical. The strategist did a great study that when you look at the TGA account, which is basically the checking account of the government, the reverse repo aspect for the Fed, or even the Fed balance sheet, you gauge how much liquidity is being pushed out into the market, and they state that when liquidity being injected in the market is greater than $150 billion, to the upside or downside during a specific month, that’s going to drive the market higher or lower.
Well, two weeks through August, we actually were able to recognize that there’s been about $256 billion worth of liquidity injected into the market from a positive standpoint. Potentially higher than that, the $150 billion line there that I just spoke about as being the line of demarcation. So this should be of no surprise that given the amount of liquidity in the market, the market and the economy is going to react very positively to that. And just because the incumbent isn’t running for president, Joe Biden, his vice president Kamala Harris, I don’t think that liquidity boom is going to stop really anytime soon. I think that we have another chart here talking about fiscal policy and monetary policy as being the linchpin of what could actually drive liquidity in the future and we can talk about a few examples on that slide.
John Luke
You didn’t hit on the API either, Dave, with just the gaming of treasury bill issuance, which is basically recession or war level, and it’s been like that for the last 10 months. And I think really this ties back to the driver of that growth from the first graphic. A lot of it has come from the fiscal policy backdrop. Obviously there’s been improvements in the labor force where you’ve had more people join the labor force, especially post the COVID stimulants running off. You’ve had a lot of migrants that have joined the labor force which has helped actually pushed up, or maybe not helped, but it has pushed up the unemployment rate lightly, and that’s caused some room for concern. We discussed that last month.
But at the end of the day, when you look at what the government has done over the last couple of years, they’ve drastically probably borrowed from the future to finance the growth coming out of the pandemic. Obviously debt to GDP grew, which has then, as rates have risen, increased interest expense in terms of the total number, and also as the percentage of GDP. And while this chart and what I said is maybe somewhat negative, I think there’s two big things to take from it.
Number one is a major positive of we have to outgrow the debt problem and we have to make the investments to do that. And if we get the productivity and the growth, that’s ultimately a very strong thing for America, and that’s probably a reason for the strong currency, that’s probably a reason for the resilience in the economy, especially relative to the rest of the world. So that’s all good things.
But also this is very good for the asset owner who has benefited drastically from a lot of the spending and where it’s blown through. So I think as you look at the percent of the fiscal bets that which is around 7% of GDP, two things. First, it’s really hard to get a recession or a big drawdown in the economy when you’ve got that amount of stimulus because public sector deficit means private sector contraction or addition to the private sector, and so it’s hard to see things move downward.
But the second coin is from a fixed income perspective, especially longer-term bond, who in their right mind is going to lend money to the government when they basically… Just look at the graphic since 2015, it’s basically a stair step up. That continued pressure is going to hurt bondholders and it’s not a new playbook. This playbook has happened many times over history. We’ve just been fortunate to not see it be so negative over the last 30 or 40 years.
David
And that’s really before. We’re just talking about fiscal policy being the liquidity bazooka to move the market and the economy higher. We haven’t even touched base on the monetary side of things and what the Fed could be doing here just in the next few months. Obviously I don’t want to open up the can of worms here. Obviously when you talk about government spending, you think about it from the additive side here on this slide on how it can benefit the marketing economy, but it also calls into question the debt profile for the US government as a whole. And I don’t want to fully get into that, but I did read a pretty cool statistic, and John Luke, I don’t know if you heard this earlier today, is that obviously we’re at $35 trillion in US debt. What is it? Over 50% of our debt obviously is coming, just in the next three years, due to the gamification of what the US Treasury is doing, exactly what John Luke started his recent commentary on.
But if you do strip out what’s held by the government, what’s held by the Fed, our $35 trillion debt, it’s close to about 27 trillion, and our current annual GDP is give or take 28 trillion. So our debt to GDP ratio, whether that’s the right way to look at things or wrong way, I know John Luke has a lot of thoughts there. Maybe it’s not as bad as what you initially think, but could it be a problem into the future? Absolutely, absolutely. And I do think it’s something that you can’t make any investment decisions here on in the near term, but what we’re doing at our allocation level to protect capital in case something does happen from a debt perspective, whether it’s just from the debasement of your US dollar, I think that’s probably one of the most pronounced aspects that investors need to be focused on here in the short term, what we’re doing at the asset allocation level. No one else out there is doing that, nor are they even talking about that.
Well, they might be talking about it. They just don’t know what levers that they have to pull to negate that risk out there. Our simple structure of more stocks, less bonds, or remaining risk neutral, directly attacks a lot of the problems that we’re seeing on the fiscal side of things, and even a little bit of the monetary side of things.
Derek
And on the monetary side of things, we always do these calls in the first, either the last day of the month or first or second day of the first month, of the next month, meaning jobs data hasn’t quite come out, and last month’s was pretty meaningful. That’s really where we kicked off into this confirmation, I guess. The market decided, “Oh yeah, they’re definitely cutting,” and that’s when we had the two-day beat up of the markets. But this, JL, is one of yours from Bloomberg. You might want to talk through it. Obviously there’s a lot of numbers in there, but maybe you can talk through what this says the Fed is up to.
John Luke
Yeah. So little messy here, I would probably just focus on the bottom half with the bar chart, but basically this is looking at where the market is pricing the Fed fund rate into the future and it’s looking to see what or how many cuts are priced in per each Fed meeting. And so it’s looking all the way out to 2027. Obviously that means nothing because this changes so frequently. So really we’re looking at the next 12 to 15 months.
We’ve got a meeting on the 18th of September. Everyone’s anxiously waiting for this first cut. The question is, is it 25 basis points? Is it 50? My thought is it’s probably going to be 25 because I think 50 would probably signal that the Fed’s already behind the curve. So 25 is probably what we get later in this month. But what this is looking at that I think is more relevant, it’s how many rate cuts by the end of the year, which the market, if you look at that December bar, it’s on the left hand of the bar chart. It’s basically saying four cuts by the end of the year. And if you stretch that out all the way to December of next year…
Derek
Yeah, there’s another four.
Derek
There you are. You’re back.
David
I didn’t mute you, John Luke, I promise.
John Luke
My fault, my fault. My audio got cut off. But what it’s saying is another four for 2025, so that’s eight total cuts that gets the Fed fund rate about 200 basis points lower than where it is expecting, in increments of 25 basis point cuts. And at the end of the day, I would not be surprised if we do get three or four cuts by the end of this year. The real question is, what’s the durability of the economy? If we don’t see a big recession, I think it’s pretty unlikely that you get a very aggressive Fed cutting cycle. My bet would be that we see probably three cuts going into the end of this year. The market, or as Fed fund pricing, is typically a little bit more dovish in terms of the actual number of cuts because remember, there’s a market premium that’s basically baked into interest rates, because if something bad does happen, especially now with where the Fed’s at, they’re going to be able to really cut interest rates pretty drastically just given the level of buffer that they’ve built in.
And so what you see in these Fed fund pricings is a little bit of premium. So while it reads four, it probably really means more like three. But I think the bigger question is what is that terminal rate? The Fed has said 2.8 within their last summary of economic projections. They’re coming out with another one this month and the market expects them to raise it a little bit. And so if that means that the Fed fund rate is more like 3 to 3.5, instead of 2.5 to 2.8, then that has pretty big implications on longer term interest rates. It has bigger implications on nominal growth. And so I will be very interested to see what happens.
But at the end of the day, whether the Fed cuts four times this year, whether they cut two times this year, which in that range is what’s expected, unless you see a big degradation to earnings, it’s not going to impact the market very much. And I think that’s ultimately what’s actually important. Now remember, the Fed was actually cutting in additional hikes back in April, and now we’re at the point where we’re getting closer to the finish line, we’re getting closer to getting the cuts. And so at the end of the day, unless earnings deteriorates, unless you see a bigger spike in unemployment, I think that the Fed has the leeway to, not be lackadaisical in the cutting cycle, but not to be crazy and start going with 50 basis point cuts.
David
We always talk about how the Fed is data dependent, and I don’t think a lot of people assimilate the non-farm payrolls market that we just mentioned over the labor market as a whole, they don’t assimilate that with growth, but I fully do because the direction and the helpingness of a labor market from a jobs perspective, but also from a wage growth perspective, directly affects growth as a whole.
But one of the most simplistic ways to think about the Fed and the cadence of their cutting process and system that John Luke just awesomely walked through is I think that inflation, it’s going to set this trajectory of the easing cycle, meaning can the Fed go or not? While the growth data or, said another way, the labor data, that’s going to set the pace and the magnitude of cuts. So think of clip size and the frequency. And that’s why the market’s going to remain highly sensitive to any type of activity indicators from core PCE, VPI, non-farm payrolls, wage data. That’s why the market focuses on that stuff so much, because it’s important to the Fed not, just on when they’re going to cut, but the magnitude of how they’re going to cut. And the last magnitude of how they’re going to cut, it’s just so important to the overall growth numbers that John Luke was just alluding to. Everything always comes back to growth.
John Luke
And remember, inflation, data is still above target. Now there is arguably some kinks that you could throw into it with shelter and lagging and things like that, but at the end of the day, it’s still above target. So hard to see them get stupid aggressive unless we see some really big deterioration, which I don’t think we’re necessarily expecting that by any means.
David
Awesome. But again, what’s the best asset class, John Luke, inflation’s between 2 and 3%?
John Luke
Stocks.
David
Stocks.
Derek
Well, obviously this month is Fed month, so we’ll get the big jobs report on Friday, but I think Thursday you get the preliminary what people look at to just get the clue on it, and then the Fed is, what? Another two weeks out? Less? Two weeks out from tomorrow?
David
Yeah, two weeks out.
John Luke
They’re on the 18th, so two Wednesdays from tomorrow.
Derek
And who knows about the election? But earnings are non-existent, so Dave hands over the baton a little bit to JL and let him focus on Fed and the jobs. And then when we come in next month, it’ll probably a lot more clarity on jobs and growth in the Fed and going in earnings season, what do things look like?
David
All about margin profile, my opinion here, moving forward on the earnings side.
Derek
Awesome. Well guys, thanks, always appreciate it, and I know our advisors appreciate having a chance to hear from you, and we look forward to doing it again shortly.
John Luke
Thanks guys.
David
Thanks y’all.
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security.
The opinions expressed are those of the Aptus Capital Advisors Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed.
Aptus Capital Advisors, LLC is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Fairhope, Alabama. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call (251) 517-7198. ACA-2409-5.
