Carson House Views Spotlight: Financials Posted on March 15, 2023 Due to a stable economy, higher interest rates, and low investor expectations that have become even lower, Carson Investment Research is upgrading the financial sector to overweight. We feel that the recent volatility ignited by a handful of regional banks is probably not over. However, we feel that investors searching for the next “big short” could come up empty-handed in this area as crises tend not to repeat in the same form and fashion. Today’s banks are much different from those during the Global Financial Crisis some 15 years ago. In fact, we would argue that the top firms in this sector are probably more beneficiaries of this current stress rather than a victim of it. Carson’s House View is our transparent way of communicating to advisors the consensus of our Research Team’s perspective. These underpin our investment recommendations and are conveyed through our pro-sourced House Views models. Our partners who prefer to co-source model management can express these views with ETFs available on our curated platform. The top bank components are “too strong to fail.” While the Global Financial Crisis coined the term “too big to fail,” this latest stress may show that the major financial components are “too strong to fail.” According to the Financial Select Sector SPDR fund (XLF) that seeks to replicate the financial sector of the S&P 500, banks represent about 31% of ETF. Smaller regional banks are only 7.5%, while the top four major banks account for ~24%. These top four face more stringent capital regulations and are subjected to rigorous stress testing that is passed without issue. Also, the top banks have consistently been gaining share for the past five years, which may now accelerate due to the recent failures of several regional players. The remaining subsectors look to be fairly insulated from the recent stresses that regional banks are facing. Sure, there are a few areas within insurance and capital markets that may have some duration mismatches and unrealized losses, but that doesn’t become problematic unless there are liquidity issues. Of course, this could change, but at this moment, the remaining subsectors of the XLF look to be beneficiaries of a healthy economy and interest rates higher for longer. Already low investor expectations have become even lower for financials We’re well aware that our overweight rating on financials is a contrarian call, even before this recent flare-up. However, therein lies the opportunity. We feel that many investors are expecting a repeat of the Global Financial Crisis. With a healthy economy, beefed-up capital requirements, and a higher for longer rate environment, we don’t see the same parallels. Currently, the Financial Select SPDR ETF (XLF) trades at a forward P/E multiple of 11.5x. This is down from ~15x at the beginning of the year and nearing the pandemic-lows of 9.5x when the economy was shutting down for an unknown amount of time. If we’re right that this isn’t GFC part II, we believe that there is a material upside from current levels. We also point out that the financial sector has been a major laggard in the S&P 500 since 2008. This made sense, considering that earning power of these firms was constrained by regulatory and capital restrictions coupled with a repressed interest rate environment. Instead, these conditions were conducive for technology firms, which have been the dominant outperformers over recent years. As Bob Dylan sang in 1964, we think “The Times They Are a-Changin’.” We expect higher rates for longer which will benefit the financial sector Carson Investment Research expects the Fed to hold rates higher for longer to combat persistent inflation. Most components of the financial sector businesses tend to benefit from rising interest rates. Banks earn attractive spreads on lending because the rates paid on loans are rising faster than the rates paid for deposits. Insurers earn higher yields on their float (the money collected for premiums upfront, which are used to pay claims later). Even when the rate hikes stop, the sector should generate attractive returns going forward. The economy is healthy The financial sector will continue benefitting from higher interest rates as long as the economy remains healthy, which we believe it will. Economic growth generates more business for the sector and requires additional borrowing. Importantly, the rate of late payments and defaults is within historical standards and should remain stable. The money banks set aside to cover bad loans increased over the past year as the world normalized. While this spooked some investors, it’s important to consider the unusual circumstances preceding the increase. Stimulus payments, eviction moratoriums, and student loan forbearance led to unusually low levels of missed payments. Further, rapidly rising home and auto prices enabled banks to sell defaulted assets at a profit! The industry is returning to business as usual – that’s not a bad thing. Bottom line We think the outlook for the financial sector is attractive, and we’ve upgraded it to overweight. These companies will benefit from rising interest rates and a stable economy. Valuations are attractive, and the outlook calls for double-digit earnings growth. Partners interested in increasing exposure to this sector can do so using the Financial Select Sector SPDR® (XLF), which is available on our curated platform. The XLF yield, share price, and/or rate of return fluctuate and, when sold or redeemed, investors may receive more or less than your original investment.
Did the Fed Drink Green Beer? Posted on March 16, 2023 What a wild ride it has been the past few weeks in markets, but one thing we can’t deny is the calendar. We are in the thick of March Madness season, and today officially kicks off the First Round of the NCAA tournament. Odds are, if you are reading this, you are probably sneaking off early to watch some basketball. I’m not judging, I might do the same thing. By the way, I’m an Xavier fan, so I’m pulling for them to go all the way, but that’s using my heart, using my head, and I’m saying UConn is the team to beat. With all of that, what also is the calendar saying? Well, for the past 20 years, stocks have bottomed around the middle of March. Could we be looking at another major low in March? Time, of course will tell, but the economy remains strong, the Fed is doing all it can to calm the fears, and various signs of sentiment are flashing levels of worry we’ve seen at major lows before. Here’s another way of looking at March for the past 20 years, but zooming into only the month of March. In like a lamb and out like a lion? Something else investors need to be aware of here is that March is a very strong month for stocks in a pre-election year, but April is even better. In fact, 17 of the past 18 pre-election years saw stocks higher in April and up a very impressive 3.5% on average. We don’t expect that impressive trend to change in 2023. We will leave you on this note, and you can’t make this one up; stocks love green on St. Patrick’s Day. Seriously, the S&P 500 is up 0.38% on average on this day of green, putting it in the top five days of the year. Believe me, we don’t think you should ever invest based on one day of likely randomness, but this has to be one of my favorite market stats. The bottom line, though, is that the Fed is doing a lot to instill faith in the system, and should they be able to pull it off, coupled with the economy that simply won’t slow down, be open to the potential of more green over the coming weeks.
Claims Come in Strong Thu, Mar 16, 2023 After disrupting the trend of lower readings last week, this week's reading on initial jobless claims returned to improvements as the print totaled 192K. That means eight of the last nine weeks have seen claims come in below 200K as the indicator continues to show a historically healthy labor market. Before seasonal adjustment, claims are sitting at 217.4K. That marked a slight decline from 238.8K the previous week and little change versus the comparable week last year. From this point of the year, based on seasonal patterns claims are likely to continue falling through the spring albeit at a slower rate than what has been observed over the past few months. Not only were initial claims strong, but so too were continuing claims. The seasonally adjusted number fell back into the 1.6 million range after topping 1.7 million (the highest level since mid-December) last week. Like initial claims, continuing claims remain at healthy levels consistent with the few years prior to the pandemic.
Today is all about FRC finding interested suitors to purchase the company, and ECB raising 50bps. The latter really lit the morning fire today. My expectation, stated to market buddies in text in January, is for a lot of chop first half of year. Brian Shannon has been saying "if they didn't scare you out in 2022, they'll wear you out in 2023." Boy has that been true. I've been happy to see volatility re-inflate lately. That should keep going through the reaction to Fed meeting next week and possibly longer.
Nasdaq Leaves the S&P in the Dust Mon, Mar 20, 2023 Looking at the major US index ETF screen of our Trend Analyzer shows just how disconnected the Nasdaq 100 (QQQ) has become from other major index ETFs recently. As shown below, as of Friday's close, QQQ actually finished in overbought territory (over 1 standard above its 50-DMA) whereas many other major index ETFs were oversold, some of those to an extreme degree. On a year to date basis, the Nasdaq 100 (QQQ) has rallied more than 14% compared to low single digit gains or losses for the rest of the pack. Historically, the major indices, namely the S&P 500 and Nasdaq, tend to trade at similar overbought and oversold levels. In the chart below we show the Nasdaq 100 and S&P 500's distance from their 50-DMAs (expressed in standard deviations) over the past five years. As shown, typically the two large cap indices have seen similar albeit not identical readings. That is until the past few weeks in which the two have diverged more significantly. On Friday there was more than 2 standard deviations between the Nasdaq's overbought 50-DMA spread and the S&P 500's oversold spread. As shown in the chart below, that surpassed recent highs in the spread like the spring of 2020 to set the highest reading since October 2016. Going back to 1985, the spread between the Nasdaq and S&P 500 50-DMA spreads diverging to such a degree is not without precedent, but it is also not exactly common. Friday marked the 16th time that spread eclipsed 2 standard deviations for the first time in at least 3 months. Relative to those prior instances, the current overbought and oversold readings in both the S&P 500 and Nasdaq are relatively middling. However, only the instance in early 2000 similarly saw the Nasdaq technically overbought (trading at least a standard deviation above its 50-DMA) while the S&P 500 was simultaneously oversold (at least one standard deviation below its 50-DMA).
Carson House View Spotlight: Overweight Industrials Posted on March 20, 2023 Carson House View Sector Rating: Overweight Carson’s House Views are the foundation of our asset allocation recommendations. Our partners and clients can utilize these directly through our proprietary House Views models or expressed independently using various ETFs available on our platform. Currently, we’re overweight the industrial sector due to a favorable economic and fiscal policy backdrop, solid fundamentals, and reasonable valuations. While this area outperformed in 2022, falling about 5.5% compared to an 18.1% decline in total return for the S&P 500, Carson Investment Research believes that industrials are positioned to continue performing well over the coming years. Fundamental growth is expected to remain healthy It’s been interesting times for the industrial sector recently. While demand has rebounded strongly since the pandemic, but supply chain bottlenecks have moderated sales growth and margins for many. However, these now appear to be lifting. This, coupled with the movement to re-shore manufacturing, favorable fiscal policies like the 2021 Infrastructure Investment and Jobs Act, and rising military budgets from the Russia/Ukraine war, bodes well for future growth. Industrials contain many subsectors Industrials are somewhat of a catch-all collection of firms that don’t fit neatly into other classifications. There are 12 subsectors that comprise this area ranging from machinery firms like Caterpillar to database companies like Verisk Analytics. That said, manufacturing and transportation are the underlying commonality for most of these companies. The largest subsector is Aerospace & Defense, which not only includes military equipment but also production for commercial aviation. Due to the war in Ukraine, global defense budgets are on the rise with the European Union expected to increase its related spend by over 35% and Japan’s expenditures doubling over coming years. Machinery is the second largest subcomponent. It’s the most diverse subcomponent with 17 stocks. However, Caterpillar and Deere represent nearly 40% of it. Currently, there’s a mix of headwinds and tailwinds. On the positive side, there’s increased fiscal spending, higher commodity prices, and China’s re-opening. Headwinds include higher financing costs for construction financing and continued supply chain issues. That said, this is an area that will be a long-term beneficiary of technology adoption as tractors and bulldozers are being covered with sensors that help automate operations and throw valuable data into the cloud. Railroads is another area that we favor. These are inherently great businesses with strong competitive dynamics, pricing strength, and high operating leverage. Re-shoring manufacturing back to the US should be a tailwind for this subsector as well as autonomous trains since labor is one of their biggest expenses after fuel. Bottom Line Carson Investment Research is overweight industrials due to our expectations of continued healthy economic growth, constructive commodity prices, rising defense spending, and favorable government programs that are encouraging re-shoring manufacturing back to the US. Valuations aren’t demanding, especially considering the expectations for double-digit growth in earnings and free cash flow over the next three years.
March Seasonality Prevails, Banking Fiasco Be Damned It’s encouraging typical March seasonal patterns have overcome recent bank failures, recession talk and fearmongering. The early March pullback was steeper than normal, but the usual mid-month rebound appears to be materializing. Last week’s gains could be an indication we have seen the worst of the banking fallout and the end of the pullback. Triple Witching Weeks have tended to be down in flat periods and dramatically so during bear markets. Positive March Triple Witching weeks in 2003 and 2009 confirmed the market was back in rally mode. The week after March Triple Witching is notoriously nasty. S&P is down 27 of the last 40 year – and frequently down sharply. Positive or flat action this week would be constructive. In the old days March used to come in like a bull and out like a bear. Nowadays March has evolved into an inflection point where short-term trends often change course. The market is clearly at an important juncture and it’s a good time to remember Warren Buffet’s wise words to “Be greedy when others are fearful.” Bank failures are never a good thing, but the swift actions of regulators likely prevented further damage to the industry. At the least, the banks are likely to be under even greater scrutiny going forward. In the near-term we expect more volatile trading. Further out we expect the market, and the economy will recover like they both have historically done.
S&P 500 Up 5 of Last 8 Fed Rate Hike Announcement Days In the chart above the 30 trading days before and after the last 119 Fed meetings (back to March 2008) are graphed. There are four lines, “All,” “Up,” “Down,” and “Rate Hike Days.” Up means the S&P 500 finished announcement day with a gain, down it finished with a loss or unchanged. In 119 Fed meetings, there have been just 17 rate increases. These 17 increases are represented by Rate Hike Days. Of the 17 hike days, S&P 500 was down 10 times and up 7 times with an average gain of 0.19% on all 17. On the day after the last 17 rate hike announcements, S&P 500 has declined 0.74% on average. Eight rate increases have occurred during the most recent tightening cycle that begun a little more than 1 year ago. During the current cycle S&P 500 has been up 5 times on announcement day and down 5 times on the day after. Of the 16 days examined, all but two had moves more than 1%. This would suggest more volatility is on tap for Wednesday and Thursday.
FANG+ Flying Wed, Mar 22, 2023 As we noted in today's Morning Lineup, sector performance has heavily favored areas like Tech, Consumer Discretionary, and Communication Services in recent weeks. Playing into that sector level performance has been the strength of the mega-caps. The NYSE FANG+ index tracks ten of the largest and most highly traded Tech and Tech-adjacent names. In the past several days, that cohort of stocks is breaking out to the highest level since last April whereas the S&P 500 still needs to rally 4% to reach its February high. Although FANG+ stocks have been strong recently, that follows more than a full year of underperformance. As shown below, relative to the S&P 500, mega-cap Tech consistently underperformed from February 2021 through this past fall. In the past few days, the massive outperformance has resulted in a breakout of the downtrend for the ratio of FANG+ to the S&P 500. More impressive is how rapid of a move it has been for that ratio to break out. Below, we show the 2-month percent change in the ratio above. As of the high at yesterday's close, the ratio had risen 22.5% over the prior two months. That comes up just short of the record (22.6%) leading up to the pre-COVID high in February 2020. In other words, mega-cap Tech has experienced near-record outperformance relative to the broader market. However, we would note that this is in the wake of last year when the group had seen some of its worst two-month underperformance on record with the worst readings being in March, May, and November.
What Now? An Update on Recent Bank Stress. Posted on March 22, 2023 It’s been less than 2 weeks since Silicon Valley Bank’s stunning 48-hour collapse, and a few more banks have been caught in the fray. New York regulators closed the doors on Signature Bank on Sunday, March 12. A week later, US banks injected $30 billion into First Republic Bank to keep it afloat, and UBS acquired rival Swiss bank Credit Suisse in a government-brokered deal. In the midst of the chaos, your Carson Investment Research team was there for you with client-facing content, professional advice, and investment solutions. In fact, we think this event presents an opportunity to invest in the more stable large-cap financial companies and recently upgraded the sector to overweight in our House Views Advice. Why is this happening? The rapid hike in interest rates caused an asset and liability mismatch for banks. Due to many years of low-interest rates, banks invested assets in interest-earning loans and bonds that would be repaid over the next five-plus years, which at the time was a logical way to earn a higher yield. Regulators considered government bonds to be among the safest ways a bank could invest its capital. As interest rates rose, bond values dropped. Interest rates rose at the fastest pace in history, and the safe assets that banks invested in lost value to the tune of more than $620 billion in unrealized losses as of the end of last year. This decline in value left weaker banks underwater and, when coupled with depositors pulling money out, caused them to collapse or seek costly capital raises. Why this matters to investors? The weakness in the banking sector will likely lead to tighter lending standards, potentially slowing economic growth. The reason we’re in this mess, to begin with, is that the Fed hiked interest rates to slow the economy because inflation was rising too quickly. Perhaps the 16% drop in oil prices over the past two weeks reflected this slower growth and bodes well for continued falling inflation. Thus, the Fed is closer to achieving its goal. Maybe it’s an overreaction as “banking crisis” headlines stir painful memories of 2008. Either way, an environment with slower growth and lower inflation isn’t a bad time to invest. Bonds and stocks could both perform well, especially stocks of companies with the ability to grow earnings. We also reiterate our House Views Advice overweight on the large-cap Financials sector. The largest US banks are well-capitalized and are gaining market share from the smaller regional banks. We believe this calamity provides an opportunity for stronger banks and investors to capitalize on.
Good article on inflation being driven by corporate greed/profits This article from April 2022 helps to substantiate why Fed may be doing the wrong thing in trying to tame inflation. It could lead to a sudden and uncontrolled demand destruction (rates too high to borrow, demand collapses due to overpriced goods and services) so we could end up with stagflation easily - negative GDP possibly in the face of persistent high interest rates and stubborn inflation.
April 2023 Almanac: DJIA’s Top Month April is the final month of the “Best Six Months” for DJIA and the S&P 500. The window for our seasonal MACD sell signal opens on April 3, the first trading day of the month this year. From our Seasonal MACD Buy Signal on October 4, 2022, through the close on March 27, DJIA was up 6.98% and S&P 500 is up 4.92%. This is below historical average performance largely due to persistent inflation, a tightening Fed, regional bank uncertainties and Russia’s ongoing invasion of Ukraine. But before the “Worst Months” arrive, April’s solid historical track record could help reignite the market. April 1999 was the first month ever to gain 1000 DJIA points. However, from 2000 to 2005, “Tax” month was hit declining in four of six years. From 2006 through 2021, April was up sixteen years in a row with an average gain of 2.9% to reclaim its position as the best DJIA month since 1950. DJIA’s streak of April gains ended in 2022’s bear market. April is now the second-best month for S&P 500 and fourth best for NASDAQ (since 1971). Typical pre-election year strength does bolster April’s performance since 1950. April is DJIA’s best month in pre-election years (+3.9%), second best for S&P 500 (+3.5%) and third best for NASDAQ (+3.6%). Small caps measured by the Russell 2000 also perform well (+2.9%) with gains in eight of eleven pre-election year April’s since 1979. S&P 500’s and NASDAQ’s single losing pre-election year April was in 1987.
Last Day of Q1: Small-Caps Best, NASDAQ Second Best Over the last 33 years small-cap stocks measured by the Russell 2000 have advanced 72.7% of the time on the last trading day of the first quarter with an average gain of 0.27% in all years. Compared to DJIA, S&P 500 and even NASDAQ, Russell 2000’s performance on the day is a standout. Over the same period DJIA has advanced just 36.4% of the time with an average loss of 0.29%. S&P 500 has a similar record to DJIA. NASDAQ takes the middle ground between DJIA and Russell 2000, up 57.6% of the time with an average gain of 0.16%.
