Current Events

Commentary:

Domestic equities continued to rally in June after President Biden signed the Fiscal Responsibility Act of 2023, which raised the debt limit into law on June 3, 2023, ending the current debt limit crisis.[ix] On June 8, the S&P 500 rose, putting the index +20% above its October 12, 2022 low – possibly signaling the start of a new bull market.[x] A bull market is commonly defined as a +20% move in stock prices.[xi] The technology-heavy NASDAQ 100 index gained almost +40% for the first half of 2023 – its best first half ever.[xii] Crude oil regained some of May’s losses, advancing +3.8% for the month.[xiii]

Are we in a new bull market? Technically, when measured from the October 12, 2022 low, the answer is yes. However, the recent rally in stocks has not been broad based. A small number of mega-cap technology stocks have driven returns. Michael Hartnett, investment strategist at Bank of America, has referred to the biggest seven mega-cap monopolistic U.S. tech stocks – Apple, Amazon, Microsoft, Meta, Alphabet, Nvidia and Tesla – as the Magnificent Seven.[xiv] As seen in the following chart, year-to-date through June 30, 2023, the Magnificent Seven gained +61.2%.[xv] The S&P 500, a market cap weighted index, gained +16.8%[xvi] as the equal-weighted S&P 500 was only up +6.9% during this same period.[xvii]

According to J.P. Morgan Asset Management, the top ten largest companies in the S&P 500 accounted for over 95% of the index’s year-to-date return for the first half of 2023.[xviii]

Historically, when a small number of stocks dominate overall market performance, it is not automatically a reason to sell equities. Sometimes the rally will broaden out to stocks that have lagged in performance and sometimes the outperforming stocks will give back some of their returns. While we are hopeful the current rally will broaden out to lagging stocks, we are cautious as many strategists expect a recession at some time in the next twelve months. As we wrote about last month in Technology Bubble 2.0?, it is our opinion that the current outperformance of the Magnificent Seven has been driven by artificial intelligence (A.I.) mania and we are skeptical that the gains can hold. Six of the seven Magnificent Seven stocks are experiencing sharply declining sales and earnings growth this year.[xix]

CNN’s Fear & Greed Index has reached the “Extreme Greed” level as seen in the graphic below.[xx]

Source: https://www.cnn.com/markets/fear-and-greed as of 8:53am, 7/25/2023

We agree with legendary investor Warren Buffett’s thoughts on fear and greed. Buffett, in his 1986 Berkshire Hathaway letter to shareholders famously wrote, “What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”[xxi]

Many investors currently have FOMO – fear of missing out. We believe many investors are experiencing the disease of greed and it appears dangerous to chase the returns of the Magnificent Seven stocks. Some investors have suffered in the past when they chased returns for fear of missing out. Chuck Prince, CEO of Citigroup in July 2007 was interviewed by the Financial Times regarding his company’s investment exposure and said that global liquidity was enormous and, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”[xxii] As Prince was saying “get up and dance” in July 2007, Bear Stearns was bailing out two hedge funds with $20 billion of exposure to subprime mortgages. Many historians cite Bear Stearns as the beginning of the 2007-2008 Great Financial Crisis (GFC). During the GFC, stock markets experienced large drawdowns and it took years for investors to recover. We wrote about just how long it took markets to recover in What If the Bubble Bursts?[xxiii] Some stocks never recovered – Citigroup’s stock currently trades -90% lower than where it was in July 2007.[xxiv] Citigroup’s CEO may have better served his shareholders if he sat the dance out. Have investors already forgotten that earlier this year we experienced three of the four largest bank failures ever – First Republic Bank, Silicon Valley Bank and Signature Bank?[xxv] The Federal Reserve has not forgotten. On July 10, Michael Barr, the Federal Reserve’s Vice Chair for Supervision announced that he is advocating tougher bank capital requirements and tougher annual stress tests for U.S. banks.[xxvi] Will tougher banking requirements affect liquidity?

At CIG, we are not entirely sitting the current dance out. We are limiting our equity exposure. At the end of June 2023, our CIG Dynamic Growth Strategy held -29% less U.S. equities than the growth benchmark.[xxvii] We have taken this difference and put it into liquid alternative investments which helped us outperform the markets last year and aim to offer some protection again should markets sour in the second half of this year.

To attempt to strike the right balance in client portfolios, we think that we should be striving to reach the return necessary to meet the various needs of our clients’ financial plans while taking as little risk as possible to meet that goal. For many clients, now at mid-year, we are halfway there.

We would like to hear from you. Please reach out to Brian Lasher (BLasher@cigcapitaladvisors.com), Eric T. Pratt (EPratt@cigcapitaladvisors.com) or the rest of the CIG team.

Commentary:

The performance ratio of the S&P 500 Information Technology Sector to the S&P 500[i] (the blue line on the above chart) has hit an all-time high of 0.66. The ratio’s previous all-time high was set in March 2000 at 0.64. As we previously discussed in What If the Bubble Bursts?, from March 27, 2000 (a) to October 9, 2002 (b) the S&P 500 (black line) fell -49% and then it took over 7 years to recover its losses after the peak. This same ratio hit 0.64 again on December 27, 2021 (c) and was followed by a -25% drawdown in the S&P 500 through October 10, 2022. (d) Now, as of May 15, 2023, this important ratio has hit a new all-time high of 0.66. (e)[ii] Will history repeat? Are we currently in a second massive technology bubble? No one knows for sure – but we are very cautious.

The rally thus far year-to-date has been narrow and concentrated in a few names. Six S&P 500 stocks – Apple, Microsoft, Nvidia, Alphabet, Amazon, and Meta – have contributed 90% of the gains of the overall index year-to-date through May 18, 2023.[iii] Five of these stocks are working on incorporating artificial intelligence (A.I.) into their business models and product offerings. While A.I. could be disruptive in the long run, the euphoria in anything A.I.-related reminds us of 1999, when many of the dot-com stocks soared in value with the internet as we know it now was still in its infancy.

Consequently, we continue to attempt to optimize our client’s exposure to the information technology sector in our pursuit of navigating our clients’ investments through these potentially turbulent market conditions. It is impossible to predict where these developments will lead, of course, but periods of upheaval can create opportunities for transformative change. We stand ready to possibly increase our allocation to domestic equities should the market rally broaden out to other sectors that have not kept up with the mega-cap growth stocks that have led year-to-date thus far. If we experience a significant market drawdown, then great opportunities could exist in the market which we would endeavor to evaluate and potentially participate in.

While volatility has moved lower over the course of 2023[iv], we do not expect that to persist for the remainder of the year. Therefore, we continue to stay the course of risk-balanced investing. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets, the economy, and geopolitics.

Please reach out to Brian Lasher (BLasher@cigcapitaladvisors.com), Eric T. Pratt (EPratt@cigcapitaladvisors.com) or the rest of the CIG team if you have any questions.

Commentary:

The U.S. Dollar, as measured by the U.S. Dollar Index, reversed its gains in February and fell -2.5%[ix] in March 2023 and contributed to gains in gold and international equities – both are dollar-sensitive investments. Emerging markets equities, represented by the MSCI Emerging Markets Index, gained +3.0%. The S&P 500 Index advanced +3.7%, recovering the prior month’s losses and Fixed Income, as measured by the Bloomberg U.S. Aggregate Bond Index, gained +2.5%.[x]

Our two flagship strategies, CIG Dynamic Growth and CIG Dynamic Balanced, have captured a majority of their respective benchmarks’ gains during March 2023 and Q1 2023.

• The CIG Dynamic Growth Strategy Composite participated in 96% of the upside of the Growth Benchmark during March 2023 and has captured 69% of the Growth Benchmark’s return on a net basis year-to-date.[xi]
• Similarly, the CIG Dynamic Balanced Strategy Composite participated in 94% of the upside on the Balanced Benchmark during March 2023 and has captured 77% of the Balanced Benchmark’s return, also on a net basis year-to-date.[xii]

When we measure these strategies’ returns from January 1, 2022 through March 31, 2023, we were able to avoid 74% of the Growth Benchmark’s losses[xiii] and we were able to avoid 85% of the Balanced Benchmark’s losses.[xiv] As always, past performance is not indicative of future performance and is no guarantee of future results. Like many investors, we are happy to be up in the first quarter of 2023 after a difficult 2022.

Last month, we highlighted in our update four possible tail risks. Each day, we are trying to make sense on behalf of clients the rapidly changing market, including:

• We are encouraged that inflation, as measured by the Consumer Price Index, has fallen from 9.1% year over year in June 2022 to 5.0% in March 2023.[xv] Inflation is still 2.5x the Federal Reserve’s stated target of 2%.[xvi]
• If Banks were to increase rates paid on deposits to compete with a Federal Funds rate of 4.88%, it would cost approximately $839 billion annually[xvii], effectively wiping out 86% of the banks’ net interest income, which as of fourth quarter 2022 was $966 billion.[xviii] Lower net interest income will likely greatly affect the profitability of small to mid-sized banks and may influence them to tighten their lending to businesses.
• $1.4 trillion of U.S. Commercial Real Estate (CRE) loans mature by 2027, including $270 billion due this year. The availability rate of office space – vacant offices plus currently leased space that is not being renewed or listed for subleasing – hit an all-time high of 16.4% at the end of Q1 2023.[xix] As property values fall and more borrowers are defaulting on their loans, the CRE market could be the next big concern for banks, especially the smaller ones. Overall, banks represent 54% of the $5.7 trillion CRE market.[xx]

The world we live in is rapidly changing. Increased tensions over Ukraine and Taiwan raise the possibility of direct conflict between nuclear superpowers. We are continuing to deal with the aftershocks of the deadliest global pandemic in recent history. Climate change is rapidly impacting our environment.

Instead of some new perspective that clarifies all possible scenarios and a clear path forward, we are presented with two opposing visions of the future. One, a downside scenario where stocks may suffer large drawdowns and two, a progressive narrative centered around hopes of technological gains using artificial intelligence, or A.I. Both views are expressed in the stock market right now. On the progressive side, the rally thus far year-to-date has been narrow and concentrated in a few names. Twenty S&P 500 stocks have gained $2.05 trillion in market value year-to-date through March 31. This accounts for 87% of the S&P 500 Index’s $2.36 trillion of gains year-to-date through 3/31/2023. Four of these stocks – Microsoft, Alphabet, Meta and Amazon, are working on incorporating A.I. into their business models and product offerings and then there’s Nvidia that makes processing chips that power A.I., gaining +90% year-to-date through 3/31/2023.[xxi] On the other hand, many other stocks have underperformed the index. UBS has calculated that excluding the gains in these mega-cap growth stocks – the S&P only rose +1.4% in Q1 2023.[xxii] The euphoria in anything A.I.-related reminds us of 1999, when many of the dot-com stocks soared in value with the internet as we now know it in its infancy. As we discussed in November 2021 in What If the Bubble Bursts, a lot of the returns of those companies were wiped out from 2000 to 2002. Gold and many consumer staple stocks provided positive returns during the very negative period.[xxiii]

We persist in our pursuit of navigating our clients’ investments through these turbulent market conditions. It is impossible to predict where these developments will lead, of course, but periods of upheaval can create opportunities for transformative change. We stand at the ready to possibly increase our allocation to domestic equities should the market rally broaden out to other sectors that have not kept up with the mega-cap growth stocks that have led year-to-date thus far. If we experience an overall market correction, then tremendous opportunities could exist in the market which we would endeavor to evaluate and potentially participate in.

We continue to stay the course of risk-balanced investing – take enough risk at this part of the market cycle to reach your goals but not much more. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets, the economy, and geopolitics.

Please reach out to Brian Lasher (BLasher@cigcapitaladvisors.com), Eric Pratt (EPratt@cigcapitaladvisors.com) or the rest of the CIG team if you have any questions.

Commentary:

The U.S. Dollar, as measured by the U.S. Dollar Index, strengthened +2.9%[ix] in February 2023 and contributed to losses in gold, crude oil, and international equities – all are dollar-sensitive investments.[x] Emerging markets equities, represented by the MSCI Emerging Markets Index, lost -6.5%. The S&P 500 Index fell -2.4%, and Fixed Income, as measured by the Bloomberg U.S. Aggregate Bond Index, fell -2.6%.

Until the recent bank failures, markets appeared relatively calm on the surface, but many additional outsized potential risks remain lurking just below. In our risk-balanced approach to investing, we seek to avoid the big risks that could be detrimental to our clients’ financial well-being. Like a sherpa guiding a group of climbers up the mountain, we do all we can to avoid the hidden crevasse where, if one is not extremely diligent and cautious, a wrong move could lead to a very negative outcome.

We call these “very negative outcomes” tail risks which are defined in the industry as the chance of a large loss due to a rare event. Noted mathematical statistician, investor, and writer Nassim Nicholas Taleb has described this risk as a Black Swan – “a highly improbable event with three principal characteristics: It is unpredictable. It carries a massive impact, and after the fact we concoct an explanation that makes it appear less random and predictable than it was.”[xi] In addition to looking out for more instability in banks, we are currently keeping a diligent eye on four different areas with low probabilities but have the potential for some very troublesome outcomes – Option Market Risk, Higher Interest Rates, Student Loans and Geopolitical Risks.

Option Market Risk
The daily value of U.S. equity options set to expire at the end of the trading day, so called “zero date to expiry options” (0DTE), has suddenly risen to about $1 trillion according to JPMorgan strategist Mark Kolanovic. These extremely short-term options are highly speculative bets on stocks and now make up over 40% of the total dollar volume for S&P 500 listed stocks – three years ago they were only 15% of total volume.[xii] JPMorgan analysts Peng Cheng and Emma Wu wrote in a note that the estimated market impacts from unwinding of 0DTE options quickly could pose a potential risk to market stability and result in a decline that could eclipse the Black Monday Crash of 1987, where the S&P fell -20.5% in a day. According to JPMorgan, if the S&P 500 fell -5% in five minutes, it could trigger $30.5 billion in 0DTE option trading that could add an additional -20% to the index’s decline. If the S&P 500 fell between -1% and -5% in five minutes, it could translate to an additional -4% to -8.1% decline.[xiii] In 1987 it was portfolio insurance products that exacerbated the market’s decline.[xiv]

Higher Interest Rates
The average 30-year fixed mortgage rate was 7.06% as of the week ending March 3, 2023.[xv] One year ago, a home buyer could borrow at 3.76%.[xvi] A current home buyer with a $200,000 mortgage will have a monthly payment of $1,339 versus $927 if he purchased the house a year ago, or $4,944 more per year![xvii] Federal Reserve Chairman Jerome Powell in his testimony to the Senate Banking Committee on March 7 said that interest rates are “likely to be higher” than previously anticipated.[xviii] How will higher mortgage rates affect the critical March through June season for the housing market, when 40% of existing home sales typically occur for the year?[xix]

Student Loans
In March 2020, COVID-19 lockdowns negatively impacted the U.S. economy. Student loan payments were suspended and the government paid the interest on the deferred student loans. In November 2022 these deferrals were extended for the eighth time into the summer of 2023. The Supreme Court is currently hearing lawsuits challenging a plan by the Biden administration to cancel up to $20,000 debt per student. Repayment of student loans is now scheduled to resume either 60 days after the lawsuits are resolved, or 60 days after June 30, 2023, whichever comes first. The deferral could stretch into August, or it could end sooner if the Supreme Court acts swiftly.[xx] 10.75% of student loans were 90+ days delinquent before the deferral program began. In Q4 2022, this percentage has plummeted to only 0.87%. At the end of 2022 there was $1.6 trillion of student loan debt outstanding.[xxi] According to Forbes, the average monthly student loan payment is $393.[xxii] What will happen if borrowers need to resume monthly loan payments? Will delinquency rates soar back to pre-pandemic levels and lead to over $160 billion of student loans 90+ days delinquent?

Geopolitical Risks
Russia: We believe the fragile state of international affairs continues to be underappreciated by the markets. February marked the one-year anniversary of Russia invading Ukraine. Billions of dollars of military aid continue to be sent to Ukraine as the war rages on. Russia has warned NATO members of the threat of a major escalation if heavy weapons such as tanks and long-range missile systems are deployed to Ukraine. In January, President Biden announced he would send 31 M1 Abrams tanks to Ukraine. On February 23, Army Secretary Christine Mormuth said, “We’re looking at what’s the fastest way we can get the tanks to the Ukrainians.” Mormuth continued, “None of the options that we’re exploring are weeks or two months. There are longer timelines involved, but I think there are options that are less than two years, less than a year-and-a-half.”[xxiii] Will Ukraine be able to continue to defend against Russia’s attacks without tanks, and how will Russia respond once NATO tanks are on the battlefield? Currently the risk of the Ukraine/Russian conflict spreading to NATO member countries is low, but it would likely offer a very negative outcome should it occur.

China: China/U.S. relations worsened after the United States shot down a Chinese spy balloon on February 4. U.S. Secretary of State Antony Blinken warned China on February 28, “We will not hesitate, for example, to target Chinese companies or individuals that violate our sanctions, or otherwise engaged in supporting the Russian war effort.”[xxiv] On March 7th, In his first public comments as China’s new foreign minister, Qin Gang said, “If the U.S. does not hit the brakes but continues to speed down the wrong path, no amount of guardrail can prevent derailing, and there will surely be conflict and confrontation.” Qin also defended China’s friendship with Russia, saying the ties between Moscow and Beijing “set an example for global foreign relations”. He continued, “With China and Russia working together, the world will have a driving force. The more unstable the world becomes the more imperative it is for China and Russia to steadily advance their relations.”[xxv] In early 2022, Beijing ordered a comprehensive stress test to study possible implications of Russian-style sanctions on its economy.[xxvi] China bought 77 tons of gold between November 2022 and January 2023, its first reported purchases since 2019. These purchases were likely made to move out of U.S. dollars after the SWIFT payment system was used to impose sanctions on Russia.[xxvii] Is China preparing for an eventual invasion of Taiwan? The Carnegie Endowment for International Peace reported that some in the U.S. intelligence community believe an attack could come as soon as January 2024, around the time of Taiwan’s elections.[xxviii]

Market history has taught us to be very careful. We are focused on illuminating potential blind spots such as those above as we attempt to manage the risks of the market in our efforts to protect and grow clients’ assets. We scenario plan – we don’t forecast the market – meaning we are cognizant of the possibility of both continued upside and significant declines.

We are hopeful that none of the above risks come to fruition, but we are conscious of them and are watching closely as events unfold. We continue to have an overweighted allocation to gold and gold miners in our strategies as worsening geopolitical risks, inflation and possible longer-term risks of stagflation make gold attractive to us. Overall, we continue to stay the course of risk balanced investing – take enough risk at this part of the market cycle to reach your goals but not much more. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets, the economy, and geopolitics.

We would welcome the opportunity to connect with you via voice or email to discuss how active oversight of market and economic conditions could protect your portfolio during uncertain times. Please reach out to Brian Lasher (blasher@cigcapitaladvisors.com) or Eric T. Pratt (epratt@cigcapitaladvisors.com).