March 10, 2023
By Steve Blumenthal
“It is not true that people stop pursuing dreams because they grow old, they grow old because they stop pursuing dreams.”
– The Gabriel García Márquez (March 6, 1927 – April 17, 2014)
This morning, February payrolls came in 85,000 jobs higher than expected at 311,000 jobs added to the market. The private sector contributed 265,000 (50,000 more than expected), and the government added 46,000 jobs. The current Fed Funds rate is 4.75%, but the Fed meets again on March 22 to determine the next (likely) rate hike. CME’s FedWatch Tool puts the odds for a 25 bps hike at 41% and the odds for a 50 bps hike at 59%. We’ll learn more on the 22nd.
The bigger news this week is the problems in the banking sector, which lost more than 4% in value yesterday, largely because of drama with Silicon Valley Bank (SVB). On Wednesday, SVB announced it sold $21 billion worth of securities to raise cash and reposition its balance sheet toward assets with a shorter duration, which are less exposed to losses due to rising interest rates. The bank’s stock fell 60% yesterday and another 60% premarket before trading was halted pending further news. SVB is now in talks to sell itself, sources told CNBC’s David Faber.
Rising interest rates, fears of a recession, and a slowdown in the market for initial public offerings have made it harder for early-stage companies to raise additional cash. This has apparently led companies to draw down on their deposits at banks like SVB. Is this a singular event? Wall Street is saying yes. I’m not so sure, though, as I note in the “Fed Rate Hike Cycles” section below.
We’ll look deeper into the banking sector next week.
This week, we’ll continue the hard vs. soft landing debate, but this time through the eyes of JPMorgan and Goldman Sachs. One sees a hard landing in our future; the other sees a soft one. I remain firmly in the hard-landing camp.
It was a “powder day” last Friday, and I invoked the skier’s code of “no friends on a powder day”—or at least “no writing on a powder day”—and selfishly, I’m glad I did. One last day of knee-high snow and smiles ear to ear. It’s a drug. I’m addicted. Hope you understand. Enough said.
Lest you think it was all fun and games, however, I did find my time engaging with smart people at the WallachBeth Annual Symposium in Park City, Utah, highly valuable. You never know where the next big idea may come from, and I walked away with a few. For example, QSBS! It stands for “qualified small business stock.” If you invest in the stock of a qualified small business, the first 10x of your return is tax-free. You can learn more here. I should have known about QSBS. Now you and I both do.
In that same vein, I really enjoy investing in venture capital. At my firm, we invest in a select few VC funds sourced through relationships we’ve established over the years. One is in biotech and healthcare, and the other is in AI and technology. We’re also interested in their high-conviction investment ideas, where we can invest directly.
Our objective is to receive a minimum 10x return on our money within ten years. Of course, there are no guarantees in this business, and some investments will result in a loss. So, we seek to size our risk accordingly—an approach to wealth that we call “CORE and EXPLORE.” The idea is you protect your core wealth (CORE) while seeking exceedingly large, risk-on opportunities (EXPLORE). How much one puts in each bucket depends on personal needs, goals, risk tolerance, and time horizon. If you’re interested in learning more about this approach, check out this paper John Mauldin and I wrote, “How We Think About Wealth.” Scroll part way down on the home page.
I also walked away from the WallachBeth Symposium with a few ETF ideas. For our CORE bucket, one we’re going to research further is “CTA,” the ticker symbol for the Simplify Managed Futures Strategy ETF. Another is a high-yield bond fund ETF from BNY Mellon.
The most important result of the Symposium—or any conference, for that matter—is the relationships that we developed. Those relationships are key because if we need help and advice in a particular area, we’ve got a trusted friend to call. Good people… a one-degree-of-separation thing. Plus, Park City is a great place to meet old and new friends in person, face to face.
Grab a coffee, find your favorite chair, and go to Spotify (or your favorite streaming service) to play some peaceful music. I’ve got the “Coffee and Piano” playlist playing softly in the background as I write to you. Love that playlist. Peaceful indeed.
Each week’s OMR is broken into sections. Feel free to read them one at a time or all in one sitting, but do listen to the Boockvar podcast episode I link below for a great discussion on inflation, interest rates, the Fed, and investment positioning. I’d love to hear what you think. Here are this week’s sections:
- Fed Rate Hike Cycles and Barry Habib on “Cracks”
- On My Radar Podcast: Peter Boockvar – Markets, Interest Rates, Economy and the Fed
- Conference Notes on the Hard vs. Soft Landing Debate: JPMorgan (hard) and Goldman Sacs (soft)
- Trade Signals: Supply vs. Demand
- Personal Note: Good to be Home
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Fed Rate Hike Cycles and Barry Habib on “Cracks”
Turn up the volume of that peaceful music, take a deep breath, and exhale—you’re going to need it before the next visual.
Below is the current rate hike cycle that started in 2022. Note the size and pace of this one versus past rate hike cycles. It’s not different this time. Something will break.
Silicon Valley Bank? SVB is unlikely to be the only stressed company out there.
A picture is worth a thousand words:
Now, zoom out. The graph below shows how the Fed raises and lowers rates over time. The gray bars indicate recessions. Just as night follows day, recessions follow rate hikes. And for what it’s worth, I think the 2020s will look more like the 1970s than the last 20 years. It won’t be the same but think a series of inflation waves. I’ve been wrong plenty of times before, and could be wrong this time, but either way, it’s still time for more defense than offense. The risk needle is pointing to red.
One last chart for this section follows next. I want to highlight that short-term buy signal in the 10-year Treasury yield. The green arrow on the far right signals a downward change in the trend for yields. The way the pattern is shaping up, yields have declined from 4% to 3.70% in just two days. I’d expect a retracement back up to 3.9% to fill the technical gap and then further declines in yields thereafter. We are on the backside of inflation wave number one.
Barry Habib and Team
Finally, my dear friend Barry Habib is an outstanding thought leader and my go-to for all things real estate. This list of his accomplishments should tell you why:
- 2017 – Zillow and Pulsenomics Crystal Ball Award for the most accurate real estate forecaster
- 2019 – Zillow and Pulsenomics Crystal Ball Award for the most accurate real estate forecaster
- 2019 – National Mortgage Professional Magazine’s Mortgage Professional of the year · 2020 – Zillow and Pulsenomics Crystal Ball Award for the most accurate real estate forecaster
- 2021 – The St. Armand Ventures Businessman of the Year Award
- 2021 – Mortgage Global 100 List
- 2022 – Named to the list of 100 People to Watch in 2023
- Finalist for the Ernst & Young Entrepreneur of the Year
Barry sent me the following short video this afternoon, in which he and his team review today’s employment numbers, the Fed, and the direction of inflation (declining) and interest rates (lower). He does a great job explaining things in a way more people can understand. Felt the flow is right on point with today’s piece and thought I’d share it with you.
What specifically caught my eye was his discussion on “cracks” in the system, saying “something will break.” Click on the photo for the video (his selection of music is fun):
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Peter Boockvar – Steve Blumenthal Podcast (Markets, Interest Rates, Economy and the Fed)
Plug your earbuds in and turn on the latest episode of the On My Radar podcast for my discussion (just 16 minutes!) with Peter Boockvar.
We talk about inflation, interest rates, markets, the economy, and the Fed. If the general average for bear markets is -35%, that takes us to approximately 3,000. However, the extraordinarily long period of zero interest rates and QE took the market to higher valuation levels than were justified. Peter says he wouldn’t be surprised to see a correction back to the mid-2,000 area in the S&P. He also noted areas where he sees value and opportunity.
Enjoy the discussion. Hope you find it valuable. Click on the photo for the link to Spotify.
Btw, if you’re addicted to Twitter like me, you can follow Peter @PBoockvar, or learn more by clicking on his photo below. He’s a rockstar.
JP Morgan (Hard), Goldman Sacs (Soft) – Bullet Point Notes From the Conference
Let’s begin with the argument for a “soft landing.”
John Townsley, Goldman Sachs’ Global Head of Macro Strategies – Wallach Beth Winter Symposium in Park City, Utah March 2, 2023
“In the last cycle, everyone got a participation trophy. All you had to do was get invested in stocks and bonds. In the next cycle, you have to be in specific investments. He mentioned he is now an empty nester, and he raised my children on this idea of participation trophies; they have a lot of trophies that they have in their room just for showing up. And what he learned is as my kids got older, they overestimated their athletic prowess. They were not as good as he thought they were. He thinks we’re in a market that’s going to unfold where he thinks it will be similar to what Buffett said, “When the tide goes out, you find out who’s swimming naked. I think that’s the kind of world we’re looking at where this is going to be a much more idiosyncratic and specific market.”
- “We think some of the investment strategies are going to be different in the next cycle because the next cycle is going to be different than the ones we’ve experienced before.”
- GS sees no sign of recession yet.
- Inflation is sticker than thought – sees three more tightening by June, taking the Fed Funds rate to 5.5%.
- He said ISM is the best indicator to watch. March 1 ISM was the fourth month in a row in negative territory. Not super negative territory, but it is contracting. This is one of the single best leading indicators in terms of recessions.
- He said if you asked him what he’s watching? It’s ISM, and it comes up first business day of every month… very important.
- The US has raised the debt ceiling 78 times. Of those 78 times, seven of them became a little bit politicized. One of them became super politicized, and that was in 2011. And when we look at the congressional makeup today, and the political backdrop right now, we are setting up in a way that looks a lot like 2011, and the 2011 stock market corrected 15%.
- Unlikely, we default, and all the hyperbole that gets thrown around about… we’re not paying our bills, and we’re gonna default. It will cause some volatility in the markets.
- After Tax Season in April, the Treasury should have a good idea as to when it runs out of money.
On Recession:
- The average forecaster model is still projecting a 65% chance of recession. And guess what they have on their side? History The Fed has never lowered core inflation by more than 3%, Without a recession. We are down from approx. 9% to now 6% on our way to ??? (SB here: I think we see 4% by the summer)
And here is the “soft” part:
- Goldman Sachs’s view is a 25% chance of a recession
- Here’s the soft landing narrative: More often than not, over the last 30 years, our recessions have not been cyclical. They’ve been financial. They’ve been asset bubbles, things that popped in the system, and everything converged at once. Let me go through a couple of reasons why it’s not all going to converge at once this time. My banking system, your banking system right now, is bulletproof. Tier one capital ratios, liquidity ratios, and financial system are bulletproof. So he doesn’t see a structural problem.
- He said consumers are starting to feel the pressure and we’ve got to watch it, but they have cushions we have never seen before.
- What causes defaults? The cost of debt or availability of debt? He asked. The answer is availability even if you can’t roll your debt; that’s when you have bankruptcy issues and solvency issues. (SB here: Being a High Yield guy for nearly 30 years, much of the HY debt refinanced maturities out to 2025. What he is saying is true in terms of refinancing. The can got kicked a little bit further down the road. The question will be the state of liquidity/ability to refinance the debt in 2025)
- His data tells him only 5% of US homes are on a fixed adjustable-rate mortgage, and only 1% of that 5% is subject to refinancing this year.
- And we are still in a world where there are more job listings than there are people looking for work. The unemployment rate is at its lowest level since 1969. The reality is, is the labor market feels pretty good, and consumers have reliable opportunities for employment.
- On inflation: He said you and your clients generally believe when it comes to inflation. This, too, shall pass. If at any point you believe this, too, is now going to continue… if you believe it becomes permanent, that’s a game changer. If so, the Fed’s not stopping at 5.50%; they’re going to 6, 7, 8, or 9%. When it comes to inflation, watch for this. Right now, we’ve kept that genie in the bottle, and that is a really good piece of news.
On GDP:
- Goldman sees 1.80%
In terms of market targets:
- I would say that we are in a trading range that will challenge investors in this market.
- If you look at the top line for the s&p 500, we are probably between 3,600 and 4,000 in terms of fair value.
- If we have a recession, earnings go down, and pe (forward estimates) multiples go down 14, which in his view, puts the downside target at 3150. (SB here: I like median pe vs. forward earnings estimates. I have fair value at 2,900)
- If we perfectly stitch together a storybook recovery and inflation continues to improve, and interest rates go down, maybe we get to 4400.
- So the challenge we have is there’s a symmetry in the market, even though we think we can work our most likely outcome as a soft landing.
Bottom line: The upside is just not that attractive relative to the downside. So we still think the best thing to do is manage risk.
SB Here again – I was going to add my JP Morgan (hard landing) notes this week, but I don’t want to overload you with too much in one sitting. So let’s bump them to next week. My overall hope is you take in various views and come to your own conclusions. For me, I end in the same place John ended up. As investors, we are looking at risk vs. reward. Keep your eye on managing risk.
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Random Tweets
The WOW of the week:
Powell says there is no problem and seeming no limit on government debt. I remember sitting with a former Federal Reserve Chief Economist at the Camp Kotok “Shadow Fed” fishing trip in August 2019. Then, the government debt was ~ $19 trillion, and the Fed owned about $4 trillion of it. I leaned across the table and asked my friend, “What’s the plan?” His answer shocked me. “On one side of the government’s balance sheet (Fed), there is an asset of $4 trillion, and on the other side (US Treasury), there is a liability of $4 trillion. He put his two hands up in the air and clapped them twice. Meaning they offset and cancel each other out. I was stunned. That’s what Powell is saying. That’s the plan.
Now, Congress must increase the debt ceiling from the current $30 trillion, and the money is desperately needed as the US government is spending $2 trillion more than it is taking in. Tax us more, spend less, or print the money out of thin air? This is not a good spot we find ourselves in. The interest cost on the U.S. debt is nearing a trillion. Baby boomers and those that remain with us from “the Greatest Generation” are stressing the system – think Social Security and Medicare. The pension system remains underfunded. The easiest path is to print. We’ll print and deal with the consequences later. The problem may likely arrive sooner than we think, sometime between 2025 and 2030. This is not new from a historical perspective (see Ray Dalio’s study on debt cycles). This is what has happened over and over again. It’s just new to most of us alive today. Could be wrong. Hope I’m wrong. Just want to make sure I have my defense on the field in case I’m right. There is much we can do!
This is why I believe inflation will hit us in a series of waves this decade. Leadership at the legislative level seems clueless about how economic systems work. Oh boy…
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Trade Signals: Supply vs. Demand Matters
March 8, 2023
S&P 500 Index — 3,987
Market Commentary:
“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
– Jerome Powell March 7, 2023, Congressional Testimony
Powell also acknowledged that recent economic data has come in “stronger than expected,” which implies the ultimate level of interest rates “is likely to be higher than previously anticipated.”
A headwind to equity and fixed income markets.
If you haven’t looked at it in a while, check out the subsequent annualized returns based on Shiller PE (below). Decile 1 are the most expensive PE levels dating back to 1909. The data takes each month-end Shiller PE and ranks it into ten categories that range from most expensive to least expensive. I show a red “We are here” arrow and a green “We’d be better off here” arrow.
If our current conditions offered better investment return potential, my advice would be to back up the bus and buy equities. That is just not the case today.
In this week’s Trade Signals, I highlight one of my favorite indicators – NDR’s Volume Supply vs. Volume Demand. Price direction combined with volume tells us what investors are doing with their money. It is a fantastic market signal chart. More sellers than buyers and price declines and vice versa. Currently in a sell signal.
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Personal Note: Good to be Home
I’m not sure about you, but I always crave home when I’m away. Being gone for one or two days is fine, but any longer than that and I miss Susan and the warmth of the home she’s created for our family. We have six wonderful children (ages 20-30) as well as a dog named Shiloh (half beagle, half terrier) and two cats.
One of our family messaging groups is titled “King Miles,” named after one of our cats, and we often use it to share pictures. This guy—Miles himself—gets most of the attention. He rules the house and keeps Shiloh in his place. (He keeps books in their place too, apparently.)
My step-son Tyler is flying to Germany today for three weeks of work training with a cyber-security tech firm with next-generation protection against quantum-computing bad actors—really quite interesting. Connor has been home this week for spring break. He heads back to Penn State on Sunday. Earlier this morning, I dropped Brianna off to catch a train to NYC. She was also home for the week, and we relished the time with them.
The end of the week, though, means it’s going to get quiet again. We like that, too, but we’ll inevitably miss our kids before long.
On the way to the train station, Brie asked me what I’m writing about today. I showed her the chart of the pace of Fed tightening and then showed her the history of the Fed Funds rate. “Stressful,” she said. “I’m just trying to point out the obvious,” I answered. Then she said, “You know what’s not stressful? Puppies.” That made me smile. Right you are, Brie.
As for me right now, I’m checking in happy. Ready for time with Susan, some yummy red wine, and our animals.
“Don’t grow old, and keep pursuing your dreams!” Let’s toast to that!
Wishing the very best to you, your family, and your unconditionally loving pets! (Well, sometimes Miles’ love is, in fact, conditional—but we love him anyway.)
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Private Wealth Client Website – www.cmgprivatewealth.com
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Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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