The Week in Charts (9/24/23)

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The most important charts and themes in markets and investing…

1) Are Higher Rates Here to Stay?

As widely expected, the Fed held interest rates steady (5.25-5.50%) at their latest FOMC meeting. But all eyes were focused on changes to their economic projections, leading many to wonder if higher rates are here to stay.

Why?

Because the Fed raised their projections for interest rates at the end of 2024 (to 5.1%) and 2025 (to 3.9%). Not a huge difference from their June forecast, but certainly more hawkish than market participants were expecting.

If those current projections are correct, that would mean we’re still in the early stages of a long restrictive monetary policy regime (Fed Funds Rate > CPI). That would be an enormous shift from the ultra-easy policies that have prevailed since 2008.

But how accurate have the Fed’s projections been historically?

Not very accurate at all.

Exhibit A: their September 2021 forecasts when CPI was already above 5%. Back then the Fed was forecasting rate hikes to only 1% by the end of 2023, with inflation coming right back down to 2% (“transitory”).

And what actually happened? The highest inflation rate in the US since the early 1980s (>9% CPI) and a Fed Funds Rate above 5%. So even when higher inflation was staring them right in the face, the Fed didn’t see it coming. Which is why you probably shouldn’t put much weight on their current forecasts. They can’t predict the future any better than anyone else, even when it comes to their own policy rates.

The best we can say today is that the Fed wants to keep their foot on the brake as inflation remains the greater concern. But when the economic data starts to deteriorate, that narrative will likely change in a hurry, and with it the Fed’s forecasts about the future.

2) Good Times, Bad Times

These are good times for new bond investors, with the…

• Highest 1-year Treasury yields since December 2000 (5.47%).

• 2-Year Treasury Yields since July 2006 (5.12%).

• 10-Year Treasury Yields since October 2007 (4.49%) and the highest real 10-year yields since March 2009 (2.11%).

These are bad times for existing bond investors, as prices move inversely to yields.

• The 10-Year treasury bond is down 2.5% year-to-date, on pace for a record 3 straight calendar year declines.

• The longest duration bond ETF ($ZROZ) is now down 60% from its peak in March 2020.

Here’s a snapshot of bond ETF returns. Duration has been a killer over the past few years with the rise in interest rates, the opposite of what we saw during the previous three years. On the other end of the spectrum are leveraged loans, which are floating rate securities that benefit from higher yields.

They are also benefitting from the continued economic expansion and the fact that default rates remain low (<2%), at least for now.

3) Are Rising Rates Hurting or Helping Corporations?

That may seem like a ridiculous question as most assumed that the sharp increase in rates would clearly be a net negative for companies.

Thus far, however, that narrative hasn’t played out as expected.

Instead, we’ve seen the net interest payments of corporations actually decline since the Fed started hiking rates.

How is that possible? Many companies locked in low interest rates on their debt in 2020-21 and are now earning much higher yields on their cash.

Microsoft is a prime example. Its interest expense was unchanged over the last year at $492 million while its interest income jumped from $552 million to $905 million.

But many companies are not in the same position as the behemoth that is Microsoft. In terms of borrowing costs, rising interest rates have hit smaller companies much harder than larger ones.

This could be part of the explanation for the significant underperformance in Small Caps over the last two years, with the Russell 2000 ETF ($IWM) down 18% vs. a gain of 1% for the S&P 500 ETF. The ratio of US Small Caps to US Large Caps is now at its lowest level since January 2001.

The top 10 holdings in the S&P 500 now make up 30.5% of the index, the highest concentration we’ve seen with data going back to 1980.

4) Another Debt Milestone

US National Debt has has crossed above $33 trillion for the first time, just 3 months after hitting the $32 trillion mark.

Over the past five years, the national debt has increased by 54%, moving from $21.5 trillion up to $33 trillion.

National debt today is 123% of GDP, up from 63% fifteen years ago. How did we get there? Over the last 15 years, the US National Debt has increased at a rate of 8.5% per year versus an increase in economic growth (nominal GDP) of 4.0% per year.

5) Volatility Is Coming Back

Only last week I noted the lowest $VIX since early 2020 (12.82) and general complacency among market participants.

That seemed to change a bit during the week ($VIX jumping above 17) with fears over higher interest rates being the dominant factor.

On a closing basis, the S&P 500 is now down 5.9% from its high in July, which is the first pullback greater than 5% since March.

Small cap stocks have fared much worse, though, declining over 11% from their July peak and giving back most of their gains on the year.

Overall, its still been a relatively mild year in terms of drawdowns, with a maximum peak-to-trough decline of 7.8% in the S&P 500 versus a 13% in the median year since 1928.

While we saw a few large down days in the last week, the 21 declines of 1% or more this year is nothing compared to what we saw in 2022 (63, highest since 2008).

6) Would Stock Picking Be Easy if You Knew the Future?

If someone told you 5 years ago that there would be a global pandemic and Pfizer would be the leading manufacturer of a vaccine with sales of over $70 billion in 2021-22, you’d probably assume Pfizer would outperform the market.

What actually happened? A loss of 0.1% for Pfizer ($PFE) vs. a gain of 67% for the S&P 500 ETF ($SPY). Stock picking is not easy, even if you know the future.

7) The Other Side of a Mania

Peloton stock is now 97% below its all-time high of $171 from January 2021. Its IPO price in September 2019 was $29. Today it trades at $4.

Peloton had a market cap of nearly $50 billion at its peak in January 2021. Today: $1.7 billion.

In the midst of a mania, it can seem as if the “voting machine” is all that will ever matter, and you can safely throw caution to the wind. Investors in Peloton did just that, driving its valuation up to over 20x sales.

But inevitably, its growth rate began to slow in 2021 and turned negative in 2022. And then, suddenly, valuations began to matter again, with the “weighing machine” taking over. Today Peloton trades at a price to sales rate of 0.6x.

8) A Very Different IPO Market

The peak of IPO mania in early 2021 was something to behold, with a level of extreme euphoria that we had’nt seen since 2000.

The companies that did not go public during that window were experiencing a similar mania, just in the private markets.

Instacart was one such example, and it saw its valuation increase from $7.7 billion in October 2018 to $14 billion in July 2020 to $39 billion in March 2021.

While high growth tech stocks had a dramatic repricing after peaking in 2021, the private markets had yet to reflect this new reality. What was Instacart actually worth?

We found out this week after its long-awaited IPO (ticker: $CART).

Instacart’s market cap at the end of the week: $8.3 billion, which was 79% below is valuation in March 2021. Its price to sales ratio of 2.9x is in line with competitors (3.9x for DoorDash and 2.6x for Uber) and only a little above the broader market (S&P 500 @ 2.4x).

A very different IPO market indeed.

9) “Soft Landing”

There have been 144 references to a “soft landing” in the Wall Street Journal in 2022-23, which is now above the prior record of 143 mentions in the two-year period from 1989-90.

The soft landing hypothesis back then turned about to be incorrect, with a US recession starting in July 1990 and ending in March 1991.

Will the US be able to achieve a soft landing today?

The Conference Board continues to suggest that it won’t, and that a recession will soon take hold. Their Leading Economic Index declined in August for the 17th month in a row, the longest down streak since 2007-08.

For now, consumer spending remains strong enough to keep the US in an expansion. The fear, though, is that it’s only a matter of time before higher rates and tightening credit cause a slowdown. On that point: a recent New York Fed survey showed that almost 60% of households said it was more difficult to get credit today than a year ago. That’s the highest level recorded in the survey with data going back to 2013.

10) Fewer Houses Built, More Cancellations

The US Housing Market Index moved back below 50 in September, indicating a sharp decline in homebuilder confidence. Rising mortgage rates have crushed affordability and consumer demand. 32% of builders reported cutting home prices in September, up from 25% in August.

US Housing Starts hit a 38-month low in August, down 15% year-over-year and 29% from the cycle peak in April 2022.

60k US home purchases were canceled in August, which equates to 15.7% of all homes under contract. That’s the highest cancellation percentage since October 2022.

11) Commercial Real Estate Reset

Presidio Bay Ventures recently acquired the 60 Spear Street office tower in San Francisco’s financial district for $41 million, 62% less than it sold for in 2014.

The San Francisco office market has a vacancy rate of 31.6%, a record high.

12) A Few Interesting Stats

a) The US lost 4.1 million days of work due to strikes last month, the most since August 2000. And this doesn’t even include the recent UAW strike.

b) China’s office vacancy rate hit nearly 24% in June, due to a combination of overbuilding and a slowdown in their economy. This is worse than the 18% vacancy rate in the US.

c) Baruch offers the “best value” of any university in the country, according to the WSJ rankings.

d) Federal, state, and local governments have added 327k jobs thus far in 2023, representing 19% of overall job growth. This is the public sector’s highest share of new jobs since 2001.

e) The average price of a used Tesla is now over $27k lower than its peak price from July 2022. That’s a 40% decline to $40,878, a new all-time low.

And that’s it for this week. Have a great Sunday and week ahead!

-Charlie

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