FPC Market Outlook Summer 2023
My son, Nicholas, read a Tale of Two Cities this summer and I decided to read it as well. Most of you know the famous opening paragraph:
It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair...."
The first half of 2023 was a tale of two stock markets for the venerable S&P 500 index. The mighty 8 (Microsoft, Google, Amazon, Apple, Netflix, Facebook, Nvidia, and Tesla), had epic performance fueled by AI dreams (Artificial Intelligence) driving almost 80% of the index's first half gain. For the other 492 companies in the S&P 500 index, not so much. As value investors, we try to buy inexpensive quality companies and sell euphoria and overvaluation. Thus, it was pre-ordained that we would not participate in the AI fueled rally given the rather expensive starting valuations for 6 out of the 8 stocks (exceptions being Google and Facebook/META which we did own).
It's an interesting market, because while there are a lot of very expensive stocks, there are also pockets of value where we can buy solid companies with safe 6-8% dividend yields and modest growth rates at attractive valuations, something which, absent any recessionary fears, we would love to do all day long, and in recent weeks we have been adding to them opportunistically.
Recently, there has been a lot of talk about a soft-landing and speculation that the bottom for the US equity market happened last fall. Just to be clear, we do not believe this to be the case and we remain positioned for a recession and the strong likelihood of a significant market correction. Historically, it always looks like a soft-landing before it goes hard and it is always a dimming light before it goes dark. To be sure, if the facts change or growth solidifies, we will change our mind, agree with those that say we were too cautious (perhaps our nature) and adjust the portfolio accordingly.
Chekov's gun is a concept in playwriting where if a loaded gun is presented in the first act, it will discharge before the end of the play. In our economic story, higher short-term interest rates and higher inflation and "an inverted yield curve" serve as the gun, having reliably predicted every recession since the 1960s. In fact, there is usually a lag on average of 13 months or so from the first sign of an inversion and when the recession begins. That would put the recession on schedule to show up between now and Spring 2024.
If higher inflation/interest rates/yield curve are the gun, failing banks (like Silicon Valley e.g.) are part of the foreshadowing. If history rhymes, Bear Stearns failed in the Spring of 2008, the stock market rallied into the summer, and Lehman Brothers and AIG failed in the Fall 2008, the stock market did not fully bottom until March 2009 – almost six months later. All this suggests that we could be in for a turbulent stock market if market sentiment changes and if/when more recessionary data emerges. At the time of this writing, the third largest freight trucking company (Yellow Roadways) in the United States is preparing to file for bankruptcy – Chapter 7 – a full on liquidation, not exactly a strong sign of a healthy economy.
While it looks like short-term interest rates may have peaked with this latest Fed rate hike, usually the real destruction for the stock market takes place after the first interest rate cut.
Given our understanding of economic history and the preponderance of the economic evidence, we believe US Treasuries yielding 5%+, safe dividend paying stocks yielding in the 6-8% range, safe shorter-term bonds in the 7-9% range are suitable places to hide out and make a conservative return as the current drama unfolds.
In the play analogy, the early warning signs of the loaded gun give way to diversionary acts 2-3 with the introduction of compelling characters like Chat GPT, or Jay Gatsby or more ominously Madame Defarge and the French revolution in Dickens. However, by the end of the play, the gun will always go off.
Briefly, on the Flax Pond Capital front, we have been actively researching new software providers and are implementing a few new systems that can help us run more efficiently and effectively. They should allow us to better invest all our portfolios. In turn, this saves us time and will allow us to serve you better. More on all this and other investments we are making in the business in future updates.
Please contact Nancy to request a meeting or contact me with any questions about the portfolio. Enjoy the rest of your summer, go to the theater, see a play and rejoice with friends and family. Please know that we are working hard to protect and grow your financial well-being.
