In Ernest Hemmingway’s 1926 novel, The Sun Also Rises, a character named Bill asked another named Mike “How did you go bankrupt?” Mike replied, “Two ways, gradually and then suddenly.”
In my last note to clients, I discussed the “old standby” 60/40 portfolio and how dismal it performed in the year 2022, but also, described the “magnificence” that we saw in the broader market’s performance in calendar year 2023. It was a banner year, right? Well, if you go back and re-read that January post (2023-Some Perspective on a Magnificent Year!), you’ll see again that all the “horsepower” behind the market’s tremendous move upward that year was triggered by only 7 companies, nicknamed “The Magnificent Seven” by an investment strategist from Bank of America.
That year, the Nasdaq soared higher by 43% and the S&P 500 rose 24% as both indexes rode on the backs of those Mag 7 stocks – BUT – without them, the remaining “not-so-magnificent 493” moved up by a meager 7.5% by comparison. Talk about the “haves” versus the “have-nots”, right? (Performance Source: Morningstar.com)
Now, in 2024, the markets have been kind to investors (so far at least), but do we have anything to worry about here? Is there any type of crisis on the horizon? Are we on the brink?
As the title of this post suggests, financial crises, recessions, market collapses, and economic failures have a tendency to show up very unexpectedly and can take some time to develop! Using history as a guide, we can look back at certain timelines where warning signs went from a slow drip to a steady flow and eventually, burst into an all-out flood. Remember the “writing on the wall” that lead the US and the rest of the world into the 2008-2009 Global Financial Crisis? At Capstone, we reflect on that time period as a complete and total global risk culture failure and an era that redefined our investment risk management process.
Ok, so what gives here? What’s the writing on the economic wall saying to us now?
Well, first off, the economy is slowing again and is expected to slow at a faster pace while, at the same time, the likelihood of a reacceleration of inflation remains elevated (The latest CPI print reassured us of that notion as core inflation moved up, not down).
Some other “wall messages” that we’re seeing as “gradual” here include the following:
- Yield curve steepening – the steepening (or normalizing) of the US Treasury Yield Curve has historically forecasted economic recessions.
- Unemployment on the rise – American workers, particularly those in manufacturing, instead of seeing their hours cut, are now losing their jobs. According to the recent unemployment numbers released by the Bureau of Labor Statistics in August, we lost 24,000 jobs in manufacturing while, ironically, government jobs increased by that exact amount – which is inflationary for sure. According to Jeffrey Gundlach, of Doubleline investments, the unemployment rate, at current levels, is above its 36-month moving average for the first time since 2020 and when that happens, he said, it’s strong evidence of an impending recession. (Source: Doubleline.com)
- Consumers are stretched – Consumer debt is skyrocketing, interest expense is killing them, and short-term confidence is waning as consumers have concerns about the labor market and job stability.
- Leading Economic Indicators (LEI) – According to The Conference Board, LEI continues to fall month-over-month which, needless to say, is very concerning but, what, perhaps, is even more worrisome from an economic perspective is that the only indicator that is up in any significant way, despite the slowdown in front of us, is the stock market.
- Federal Budget – The United States taxpayer is now on the hook for $1 Trillion (yes, with a “T”) of debt interest payments that now exceeds the cost of Healthcare, Medicare, and National Defense obligations, individually. Our spending deficit is now over 5% of GDP and as deficits like these worsen, it makes going into a recession more and more of a reality. (Source: CNBC)
- Federal Reserve Rate Cuts – Wall Street has been BEGGING for interest rate cuts and it seems the Fed will deliver on that promise as soon as this month. Most investors are asking, aren’t rate cuts GOOD for the markets? Don’t they stimulate asset prices? Why would lower interest rates qualify as a potential “red flag”? Well, it’s important to understand WHY rates are being cut in the first place. At Capstone, we’re skeptical for one primary reason: rates are not generally cut because we’re in a growth phase economically. The Fed typically cuts rates because they see a slowing, sluggish economy on the horizon and the potential for recession around the corner. Historically, if you compare rate hikes to rate cuts, it’s actually been more lucrative for investors to buy into rate hikes and sell into rate cuts, so caution is warranted here. I’ve written about the Fed in the past and shared my concerns about their ability (regardless of who the chairman is) to create “soft landings” in our economy and, for better or worse, those concerns aren’t any different this time around.
Are these “red flags” the “writing on the wall” that we need to read into? Do we interpret this data as we sit on the brink of some catastrophe coming our way and run for the hills?
Run for the hills? No. We don’t need to do that exactly but what we do need to embrace (as the advisors at Capstone have been for a while now) is the FULL economic, investment, and business cycle and recognize that the rate of change in our economy has been reflecting a slowdown for quite some time now – this is potentially, the “gradual” time.
Is there an “all of sudden” out there though?
Now that’s a tough question to answer with any amount of certainty as we all know. But what investors should be paying attention to and taking appropriate action on is prudent investment risk management especially as a “slow drip” possibly turns into a “steady flow”. We want to avoid the “flood” at all costs if we can and, at Capstone, our advisors have been making appropriate adjustments to client portfolios accordingly.
Proper risk management requires having the right portfolio to get through good and bad times successfully. If you’re a client of ours and need to speak with us about your investment nest egg, as always, just call.
If you’re not yet a client of Capstone’s and are wondering if the risk/reward balance in your portfolio is optimal to withstand a potential sudden shock, please contact our office to speak with one of our advisors at 888-587-7526 (toll free) or at (570) 587-7800 (direct).
We can help you read the writing on the wall.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.