Macro Updates Archives - Aptus Capital Advisors

Aptus Musings: Biden Drops Out

David Wagner — Tue, 23 Jul 2024 22:13:33 +0000

Multiple clients have asked for thoughts regarding President Joe Biden’s exit from the upcoming election, and its effect on the markets (I hear that “investor” listed at the top is pretty cool). As many of you know, these musings are like a piano bar – requests are welcomed.

As always, when it comes to politics, I don’t think anyone should or would care what I think about anything – except perhaps issues that will affect the economy and the financial markets. This piece is not meant to offend or alienate anyone. But, I did watch the movie Dave over the weekend – all I can say is that I kept the popcorn close to me.

President Biden Bows Out of the Race

As of Sunday, Americans were only 106 days away from the election, and the nation was jolted with its 4th black swan event for the ’24 election, and to be honest, there will likely be another one before November 5th.

Black Swan Event #1: The Republican presidential nominee was convicted of felonious crimes.
Black Swan Event #2: The Democratic candidate showed severe signs of aging that raised questions of his ability to campaign and even govern.
Black Swan Event #3: An assassination attempt.

Fourth Black Swan Event #4: Americans learned this past weekend that power is never relinquished, it must be taken – and without full support from President Obama, it somewhat felt like current President Joe Biden was pushed out of the race. For many, it felt like it was only a matter of time for President Biden to exit the race, as he had lost support from key Senators in swing states – likely making a Democratic victory very difficult.

To be frank, this felt quite unprecedented given the fact that President Biden did not address the nation and basically only left a note (apparently there is a press conference on Wednesday). But, he did endorse Vice President Kamala Harris, which he likely had to, given that if he didn’t, it would have come off as if she wasn’t fit to be Vice President in the first place. Because, in a nutshell, the Vice President should basically be groomed as the next person to take office if something were to happen.

And with this, Vice President Kamala Harris has quickly emerged as the clear frontrunner for the Democratic nomination, with a number of potential rivals quickly endorsing her – cue Bill and Hillary Clinton, the majority of the House and Senate Democrats, and, importantly, CA. Gov. Newsom. She raised $81 million within 24 hours, putting to rest concerns about whether Democrats will have the resources to compete. While it’s true Harris is unpopular and we think she is an underdog to Trump, she has the opportunity to reintroduce herself to the American people and she could look a lot more politically formidable in a month than she has in the past four years.

There are likely two thoughts when it comes to a Harris candidacy: 1) She will run a more active and engaged campaign than Biden was running and will likely have better poll numbers against Trump, but 2) She has not proven to be an effective campaigner or manager. We will need to see a complete restructuring of her image before getting to a place where she can win the Electoral College.

History tells an unfortunate tale of VPs running for the presidency when their boss is ending his term. George H W Bush was the first sitting VP to win since Van Buren in 1836 — both following a popular president. Therein lies the tale. Sitting VPs lose because they are not viewed as strong enough candidates to win the nomination or, if they do win, they become a vote on the prior president in the general election, a president whom the public has tired of (Nixon ’60, Humphrey ’68). VPs who did win, Nixon and Biden, were four to eight years removed from office. Other VPs became president because the sitting president died and then won – Roosevelt, Coolidge, Truman, and LBJ.

That point brings me to the biggest weakness to VP Harris (in my opinion) is that she will have to defend Biden’s record – something that she cannot do a lot about. Not only that, she’ll have to answer questions about what she knew regarding Biden’s condition – and if I was a campaign manager, that’s exactly what I would target.

What Happens Next?

Per Raymond James, “…as for mechanics of what happens next, the delegates to the convention decide who the nominee will be. Biden’s delegates (he won 99% of the pledged delegates) become free agents at the convention. They can vote for whoever they want. As Biden delegates, though, they could be expected to give weight to who Biden endorses and have affection for Harris, too. About 14% of the delegates to the Democratic convention are superdelegates (party leaders) and they can support whoever they want, though whether they have a vote on the first ballot will depend on a ruling by DNC officials.”

Yesterday, it does appear that VP Harris obtained the needed delegates to win the Democratic nomination and it will likely get moved forward via a virtual nomination before the important August 7th deadline (to be included on states like OH’s election ballot).

Some of the biggest questions moving forward:

Will Democrats unite behind a candidate or will an anti-Harris faction cause further uncertainty for the nomination?
Does the ability to inherit the campaign funds and infrastructure force Democrats to accept a Harris nomination?
If it is Harris, does she select a swing state governor such as Shapiro (D-PA), Cooper (D-NC), or Whitmer (D-MI) to shore-up a key state?
Would a combination of two swing-state governors Whitmer and Shapiro give a bigger boost?
Will President Biden step down before his term ends to give a boost to VP Harris?

The good thing for VP Harris is that her approval ratings aren’t as locked in as Biden or Trump’s. How she handles herself on the stump, in interviews, and in a potential debate will be the key to whether she can convince voters she is up to the job and will govern as a mainstream Democrat.

The Market’s Reaction

What Has Happened: Since the recent June CPI report and the June Presidential debate, small caps and the average stock have had an extreme run. More importantly, technology stocks (or tech-proxies) have been the funding mechanism. The rationale is three-fold:

Investors have been expecting the Trump 1.0 investment playbook to mimic the Trump 2.0 playbook – given that he is currently projected to win. The expectation of corporate tax cuts and de-regulation of banks drove the small cap performance in late 2016 – we’ll see if that continues.
The flint to the fire that also started the small cap rally was the expectation of more rate cuts. Small Caps have a large amount of their debt in floating debentures and a maturity wall much closer in expiration that large caps.
There has been a pretty substantial unwind in hedge fund positioning. One of the most basic macro trades is: 1) If you believe the market is accelerating, investors should go “long small” / “short large”, 2) If the economy is slowing, investors should go “long large” / “short small”. And given the recent performance of large caps > small caps, the trade saw a large swap in positioning.

Hit me personally for a CNBC link of me talking about Small Caps the other night (we don’t own the rights to the video so I can only send it 1:1).

The Markets Moving Forward: The recent rally in the “Trump trade” and overwhelming view that Trump will win could see some reversal in this scenario or at least a stalling out of momentum. Should a Democratic ticket emerge that appears to tilt the race towards a Democratic win and/or sweep, we would likely see a market reaction – especially given the potential policy implications in 2025, with the December 2025 expiration of the Trump-era tax cuts for individuals more likely to expire. However, we would note that the policies of a potential Harris administration would largely align with those of President Biden.

What’s the Playbook?

If anyone has heard me speak over the past few months, I’ve mention the following fact:

The S&P 500 has increased in the past 13 presidential re-election years. In fact, the last time the S&P 500 fell in a presidential re-election year was 1940. And since 1940, there have been three years where the market fell during the election year – 1960, 2000, and 2008. The commonality of these three years is that there was an open election – JFK, Bush, and Obama. Furthermore, when the incumbent has been on the ticket, the average return of the S&P 500 during re-election years is 16%!

We no longer have an incumbent running for re-election. But that doesn’t necessarily mean that one should throw the playbook out the window. Yes; the incumbent is no longer on the ticket. BUT, the forces that drive the market in re-election years are still very much present. Presidents like to “prime” the economy into an election year to minimize an election fallout. Presidents know that if there is a recession in the third or fourth year of an election cycle, the incumbent is not re-elected. Given the fiscal stimulus and liquidity injected into the economy, stocks have historically responded favorably during re-election years, and 2024 has been no different.

Plus, it’s well known that market volatility tends to show its face ~August in election years. Remember, volatility and market pull backs are natural and healthy…

Luckily, volatility is VERY cheap right now to protect portfolios.

Simply said, it’s OK to toss the playbook out, but that doesn’t mean that the market is going to the proverbial “hell in a handbasket”. This is why we utilize volatility as an asset class to provide guard rails, at the allocation level, to protect the allocation in case there is another “Black Swan” event.

Please reach out if you have any questions.

Disclosures

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward-looking statements cannot be guaranteed.

This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.

Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2407-30.

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Aptus Musings: Can the Market Go Higher?

David Wagner — Thu, 08 Feb 2024 00:38:16 +0000

As many of you know, we have our ear to the ground with partners across the country – something we are proud to say. Another thing that we are very proud about is bringing Brian Jacobs, CFA on board to help lead us in client and fund development. In fact, today’s topic about current market momentum was based on a recent blog post by Brian so he deserves a lot of credit for this musing.

Continuing the context of talking to partners, there’s a general bias towards market skepticism. Whether it’s current equity valuations, slowing economic data, investors not believing EPS expectations, etc., most investors seem to doubt the amount of upside in equities.

We’ve continued to hear that “after last year, the market cannot go any higher”. Well, in years after an S&P 500 return of 20%+, the following year has an up frequency of 65% w/ an avg. return of +18.8%. In the down years (35% frequency), the avg. price return is (-9.1%). The weighted average return is +8.9% (i.e., very close to LT average for the S&P 500).

So, let’s look at the market’s tendencies after it hits an all-time high and see if there is anything that we can learn from the past.

Can the Market Continue Going Higher?

Simply put, new all-time highs have historically meant lower risk and higher returns.

The S&P 500 has been teetering at all-time highs for over a week now – now sitting almost 4% above the highs reached at the 2021/2022 turn of the year. As we stated in our Q4 Investment Presentation– How bad are things?

Stocks are at all-time highs,

Home values are at all-time highs,

Bonds were up 5% last year after a historical 2YR bear market,

Net wealth is at all-time-highs, and

Personal debt relative to income is nowhere near historic highs.

When put in this context, the current market price of ~4940 may be more believable, but what does this say about the market moving forward? As Brian said in his blog post:

“Contrary to common concerns, approaching or hitting new all-time highs in the equity markets may not be the harbinger of impending downturns that some perceive. In fact, historical data reveals an intriguing trend: stock markets around the globe have generally exhibited stronger performance and lower risk when scaling new heights.”

Source: Aptus via YCharts

How cool is that chart?!

This empirical evidence challenges the notion that market peaks should evoke caution or a move out of return-seeking investment strategies. It signals an opportunity for investors to reassess their perspectives on all-time highs and view them not as warning signs, but rather as potential indicators of continued growth and stability in the markets.

Let’s broaden out this data set by another 40 years to 1950. The results are the same à the market’s forward 6- and 12-month returns have easily beaten historical averages, but the risk is surprisingly lower with smaller drawdowns and muted volatility. Bloomberg did a study where they analyzed months that made new highs after a large market drawdown, specifically the years of: 1958, 1963, 1967, 1972, 1980, 1982, 1989, 2007, 2013, and 2020.

Lower Volatility

Over the following 6-months, the average volatility had an annualized value of 11.92%. This level is much lower than the 14.56% annualized volatility for the market on a monthly basis since 1950. If you analyze the data for the next 12 months, instead of 6 months, the results are quite similar.

Higher Returns

But, the most surprising aspect of the data was that even the worst performance period wasn’t that bad. Of those aforementioned years, the worst period of time (on the 6-month data) was after the May 2007 peak and the market fell by only (-2.23%). Again, if we widen the data out to the following 12 months, the worst period, which was also during May 2007, witnessed a market down only (-6.63%).

While we know the importance of lower volatility at Aptus, we understand that clients want higher compounded returns. JD has done a great job reminding us that clients do not care about your Sharpe Ratio if you don’t meet return targets. We think about volatility differently – we want to excel at reducing volatility during down markets (doing better in the left tail), without compromising upside potential (doing better in the right tail).

During times like these, investors need to remain balanced – don’t get too bullish, and don’t get too bearish.

Disclosures

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Aptus Musings: Can the S&P 500 Win if the Mag 7 Loses?

David Wagner — Tue, 12 Dec 2023 18:34:15 +0000

Quick CPI Inflation Thoughts: Simply put, the last mile of bringing inflation back down to the Fed’s long-term target will be difficult – most likely due to the continued strength in the job market, i.e., Friday’s NFP is a prime example. I think J. Powell will take the stance of: “Where is the recent progress of inflation coming down to a point where we are comfortable with a policy shift?”. Reach out if you’d like to talk more about this.

Right now, the most common questions that I’m receiving from partners are:

If the Magnificent Seven Falters, due to their valuation, will the market crash?
Why Don’t We Own More Bonds in this Environment – All of our Clients Want More Bonds, Why Not? What are the Risks to this Thinking?

These are very important questions, both of which can have lengthy responses, so let me focus on the first one, and if I get enough positive feedback, I’ll write a musing on the latter.

Can the S&P 500 Win if the Magnificent 7 (Mag 7) Loses?

First, let’s set the stage. It feels like everyone I speak to believes that there is a tremendous risk in the market capitalization indices, given the concentration in the largest stocks. Almost 30% of the S&P 500’s weighting is comprised of the top 7 stocks. Then, investors couple this with their performance year-to-date, making them heed to the wisdom of Isaac Newton: “What goes up, must come down”.

Basically, many investors are very happy with YTD returns but are highly skeptical that they can hold.

For reference, the Mag 7 has driven 70% of the S&P 500’s year-to-date return.

Now, let’s play Devil’s Advocate with this argument of skepticism. If the Mag 7 —which accounts for almost 1/3 of the S&P 500— can drive YTD returns of 20%+, while the average stock basically endured a technical recession (a peak-to-trough drop of 20% or greater), then why can’t the remaining 493 stocks insulate the market cap weighted index if the Mag 7 performance mean reverts?

Let’s Look at this dilemma in two different parts + a conclusion: where we’ve been, and where we are going.

Where We’ve Been

Let’s take a step back and look at what has happened this year. We’ve covered the narrow market leadership that’s been observed in our work extensively throughout the year but thought it may be important to provide context for just how tough it has been for the average stock. Using the S&P 500 equal weight index (ticker: RSP) as a proxy for the average stock, this has been the worst relative performance year to the cap weighted index since 1998. It should be noted that the equal weight index underperformed handily again after this in 1999 but then went on to outperform the cap weighted index for almost the entirety of the 2000s.

This performance discrepancy was born out of the earnings stability and growth from these mega-cap companies. The market’s return has been driven in part by soaring valuation multiples in the largest names – but is it justified? That is a matter of opinion, but the earnings story seems to say “yes.” As seen below, negative 2023 year-over-year earnings for all stocks outside of the Magnificent 7 reflect the dour economic picture that so many predicted this time last year. It was those seven names, aided by strong demand, cost-cutting measures, and no small part from the renaissance in artificial intelligence (“AI”), that carried the brunt of the earnings load.

We know that one of the market’s best factor indicators of presaging long-term performance is earnings growth, and the Mag 7 has consistently given it to investors.

But none of this is groundbreaking news.

Where We Are Going – The Devil’s Advocate Perspective

Now, let’s look forward and develop on my musing around the “remaining 493” potentially insulating the market if the Mag 7 were to witness some negative volatility. I do believe that the breadth of market leadership will expand and that the market can rally without the Mag 7 leading the way.

Now, everyone who reads these Musings knows that we think about total return in terms of Yield + Growth +/- Valuation. If the Mag 7 stocks flatline over the next 12 months, and if the multiples on forward earnings for the rest of the market flatlines, at about 15x on average, forecasted EPS growth will be the return of the market. If this were to occur, the average stock would remain below its post-COVID highs.

This tells me that concerns about narrow breadth this year could be misplaced, given that, except for the Tech Bubble, bull markets since the 1980s ended with far better breadth than today’s market. Only 24% of stocks in the S&P 500 trade within 10% of their all-time highs (vs. 28% historical average), much lower vs. prior bull market peaks. Stated another way, bull markets tend to end with much better participation.

Let me say that line again: Despite the S&P 500 being within 5% of its all-time high, only 24% of stocks are within 10% of their all-time high. This tells me that if we get a Goldilocks scenario, the average stock has a runway of future returns that could buoy the S&P 500, without any help from the mega-caps.

Remember that this is a market of stocks, not a stock market, and the majority of stocks remain quite cheap:

Conclusion

As I’ve told many of you before, I would not short the Mag 7 under the threat of violence. The importance of owning straight beta, i.e., not taking substantial tilts, reduces the equity volatility tax underneath the hood. This is where investors need to be focusing. Yes, I understand that many investors are worried that the top 7 stocks, which comprise 30% of the S&P 500, appear to be overvalued. But do not discount that there is still 70% of the S&P 500 Index that trades at reasonable or cheap valuations (in my opinion). And financial textbooks taught many of us that cheap stocks tend to do better on the downside, which could help support the index during a bout of volatility. This comment sparks up an old analogy that I used to state: If you are skiing down a double-black diamond trail on a mountain and were to fall down, I’d rather fall if I were 4ft tall instead of 6ft. This is true in investing — the smaller valuations should fall less.

Our brains are trained to focus on the worrisome aspects of the market and the valuation of the 30% does grab your attention, but it shouldn’t solely drive an investment thesis on Large Caps. Don’t forget about the 70%! In large-cap land, you can own an index that is comprised of 30% in stocks that have generational technology that can change the world through productivity and 70% that appear quite undervalued. When framed in this context, give me all the growth (stocks) that you can (obviously with guardrails).

While picking investment styles can be fun, the more value-additive factor at the asset allocation level is minimizing the equity volatility tax that can drive ill-timed and uninformed financial decisions. The past 23+ months have been a prime example of this behavior. Not many investors wanted to own Value in ‘22 and not many wanted to own Growth in ‘23. Investing is hard – when in doubt, just be the market.

Disclosures

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Aptus Musings: Q3 ’23 Earnings Season Review

David Wagner — Thu, 16 Nov 2023 04:02:53 +0000

I want to start here:

“Given that the stock market tends to go up more than down (60-70% of the time), odds are the current trading range is a prelude to another advance. Corrections can be in the form of price and/or time, and this one seems to be both. Usually, the P/E part of the market return does the opposite of the earnings part. This is what makes market timing so challenging, especially around cyclical inflection points.”

– Jurrien Timmer

Let’s say that again. ” Corrections can be in the form of price and/or time, and this one seems to be both”. This is a very important line because I know that many folks are having difficult conversations with their clients, given that their account values have not increased in value over the last two years. For reference, the S&P 500 (which has been one of the best-performing asset classes) has not had a positive return (cumulative) in over 2+ years.

If you’d like to talk more about that, please feel free to reach out.

Q3 2023 Earnings Review

The biggest surprise to me during earnings season: I’ll admit that this is anecdotal, but from CEO commentary, they are acknowledging macro difficulties, but not many CEOs mentioned the word “recession” during their earnings calls. Interesting.

It’s official; the earnings recession is over. With the majority of the S&P 500 done reporting, it looks as if after three quarters of negative earnings growth, the earnings recession is over – Q3 ‘23 earnings growth is coming in at ~5.7%. Estimated revenue growth also came in stronger than expected (+1.2%) and, at the same time, appears to have found an inflection point. Both earnings and revenue growth outpaced the expectations set out by analysts at the beginning of the quarter (in early October).

This data was reaffirmed by the fact that the market witnessed the highest percentage of companies beating estimates since Q2 ’21. Around 82% of companies beat expectations this quarter, which is well above the historical beat rate of 66% (data since 1994). Overall, lower EPS revisions are well above the historical trends, suggesting that the earnings deterioration that is often talked about did not materialize. Even looking out to ‘24 shows that the -1.9% decline is not yet concerning and normal for this point in the earnings revision pattern.

If earnings for 2023 finish in the $218 to $221 range, it would equate to flat earnings compared to 2022 and the estimated earnings growth rate of 12% for 2024 would result in a 2-year CAGR that is in line with the long-term CAGR of S&P EPS going back to 1950. Obviously, the growth asymmetry between ’24 and ’25 is unusual, but no need to focus on that right now because the market isn’t focusing on it.

Let’s look at earnings from a different focal point. The Magnificent Seven continues to hold up earnings for the index. Looking at the change in net income shows that the Mag Seven returns this year are likely justified (I know I’ll catch flak for saying this).

As shown below, the “Magnificent 7” EPS growth trend has been divergent from the rest of the equity market in three of the last four years. This year is no exception for “the Magnificent 7”: the ~27% weighting in the S&P 500 has had material double-digit EPS growth this year, while the rest of the S&P 500, Mid-Cap 400, and Small-Cap 600 have EPS down ~5% to 15%.

This corporate earnings weakness has occurred even as the economy has, in our opinion, been far better than expected. More evidence that nominal GDP is probably more impactful to corporate EPS trends than real GDP, and nominal GDP has been slowing consistently all year on a year-over-year basis.

For 2024, consensus expectations are for EPS growth to be double-digit across equity indexes and the Mag Seven. This looks aggressive to us in a world where the Fed remains very restrictive, and the slowing of consumer spending and nominal GDP is likely to continue. Luckily, P/Es across most of the equity indexes excluding the Mag 7 are well below “normal” under anyone’s definition, so investors are clearly prepared for some kind of further EPS weakness.

Big Point: This is probably the chart that I am focusing the most on because it shows the cadence of earnings expectations for future quarters. As I stated above, ’24 growth expectations have only come down slightly, but the quarterly data is starting to trend lower. The outlier here is this past quarter, Q3 ’23 (Brown line) trending higher:

As always, reach out with questions!

Disclosures

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Aptus Musings: Q3 2023 Earnings Preview

David Wagner — Wed, 25 Oct 2023 11:35:42 +0000

Catching up

This past weekend, Aptus held our 4th annual Uncle Rico 2v2 Basketball tournament. As many of y’all know, we have a slew of former college and professional basketball players on our investment roster — it gets pretty competitive. We have tons of videos and photos if anyone wants to see them. JD came out victorious this year with a new Aptus CFA addition, Brett Bennett (lives in Denver), as his partner. Luckily for me, there was no repeat of last year’s best photo (JD dunking on me). We won’t be re-circulating that photo.

Before getting started, this is my favorite investment image from over the weekend. Many of y’all have heard us spend much of our commentary over the last year pointing out the record losses in the bond market (red) in ‘22. However, the reversion to the mean that many expected in 2023 never materialized (blue) – just think of the amount of flows into TLT this year. The Bloomberg U.S. Aggregate Index is now down 3.42% YTD on a total return basis and is within striking distance of becoming the second-worst total return year on record (data goes back to 1976).

Q3 2023 Earnings Preview

If you’ve read our content from the past year, you’d know that one of our themes for ’23 was that inflation was going to transition to growth frustration. In a nutshell, inflation and growth frustration have been the two hurdles to clear for more people to start believing in the market. First, inflation needs to be perceived to be coming back down to 2%. It feels as if we are getting there fast, barring a supply shock across the economy. EPS expectations will become increasingly important to be able to keep the rally going. If you’re keeping score at home, we’ve been partially correct; the market has stopped worrying about inflation and has started focusing on earnings – the direction of earnings hasn’t happened yet.

Earnings season is already underway and with so much uncertainty in markets today, Q3 earnings releases are a hot topic of investors. Personally, it feels like headwinds are brewing for earnings as expectations appear elevated, especially if you look into the future. I think that there are legitimate concerns of economic slowing (higher rates, student loan payments, geopolitical fear, global weakening) with the reality that GDP accelerated meaningfully in Q3 ‘23 and consensus EPS expectations that look like a “breakout” over the next few quarters after being range bound since early 2021.

Since last earnings season, we’ve continued to see the US Dollar climb alongside interest rates. This has been a popular topic among investors and news outlets alike and is likely to continue to put pressure on EPS estimates well into the future. Bottoms-up consensus EPS estimates are still highlighting 12% growth for 2024 and 2025, without seeing ANY growth so far this year.

But, if expectations do come to fruition for Q3, the S&P 500 will report year-over-year (YoY) earnings growth of 0.1%, which would mark the first quarter of year-over-year earnings growth reported by the S&P 500 since Q3 2022. This figure is well below the 5-year average earnings growth rate of 10.6% and below the 10-year average earnings growth rate of 8.4%. Next quarter, the market is expecting 7.5% YoY growth.

Over the past 5 quarters, the market has rallied into or during earnings season. We’ll see if that streak continues.

Disclosures

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Aptus Musings: Come Monday

David Wagner — Tue, 12 Sep 2023 14:01:25 +0000

The world lost a great icon the other day; Jimmy Buffett. And in honor of the man, the myth, and the legend himself, this Musing is dedicated to him. For those that don’t know, his loyal followers were called the Parrot Heads – a term coined in 1985 in Cincinnati, OH, my hometown. To make the connection even more apparent, Jimmy was born in Mississippi, but spent most of his childhood in Fairhope, AL, Aptus HQ.

In today’s musing, we’re not going to talk about our normal market commentary, but one that is a bit more nuanced: When Does that Market Actually Derive its Returns? What many investors do not know is that much of the returns from the S&P 500 occur outside of market hours, i.e., over the weekend and/or in-between market close and market open on the weekdays.

In honor of Jimmy B, this Musing is entitled Come Monday, his first ever hit in 1974, because Come Monday, investors have already received their returns. So, sit back and literally make money while you’re sleeping or relaxing on a hammock while drinking a margarita / eating a cheeseburger in paradise.

Come Monday

We’ve talked about a phenomenon that a good chunk of the stock market’s returns has come after the market is closed. For example, if the market closes on a Friday at $100 and opens the following Monday at $102, then there was a 2% gain that occurred outside of the normal market hours. Below are the returns, by year, of “intraday return” versus “non-conventional hour returns”:

If you look at it by year, the data isn’t that clear, but if you break it down over a longer period, the results are much more impactful.

Most of the gains over the past few years look to have come when the market was closed but going back to 2009, the data shows the majority of gains have come during market hours.

The biggest question one should be asking themselves is – does this even matter? Not if you’re a LT investor. If you are a short-term “trader”, it may matter. If you’re trying to buy every single dip and sell every single rip and time the intraday tops and bottoms, sure, this could have an impact on your bottom line. This basically tells me that the market has a hard time making up its mind in the very short-term. It had no memory from day-to-day and can reprice itself literally while you’re sleeping. But for normal, long-term investors it doesn’t really matter all that much. The day-to-day, week-to-week or even month-to-month movements in the stock market shouldn’t have that much of an impact on your results if you have a time horizon measured in years or decades.

Moral of the Story: Stay invested over long periods of time and you may make money while you’re sleeping → WORK SMARTER, NOT HARDER

Disclosures

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Aptus Musings: Why Rates Haven’t Had a Material Impact

David Wagner — Fri, 25 Aug 2023 12:03:19 +0000

We’ve been fielding a few questions as to why higher rates have seemingly had no collateral damage on the economy except for a few banking failures back in March. Let’s hit on a few talking points.

The data on the investment side of the economy tells a story of strong balance sheets and wages enabling consumer spending to sustain despite higher rates, while tremendous government spending and a number of “mega projects” (think EV supply chain and semiconductor fab builds) are enabling investment growth to remain relatively strong despite higher yields.

How long this resiliency can last is unclear, but the bond market started shifting its view over the last two months. Bond yields surging has been the story of the past two weeks as the 2-year Treasury yield rose to 5.03%, and 10-year Treasury yield approaching cycle highs of at 4.32%. But then again, maybe the bond market is just being whipped around by the giant financial experiment being run by Japan and China – I’ll let John Luke answer those questions.

Nonetheless, the market is witnessing the highest rate levels since 2007.

Let’s break this musing down into two segments:

Corporate Implications
Consumer Implications

I think that I could create a third section on “government implications”, but the message is quite clear. Given that almost 50% of Gov’t debt is coming due in the next 3 years (current coupon ~2%), the government may be in a difficult spot as interest expense on the income sheet is approaching the current defense spending budget. But all of this is a topic for another day (and we covered it quite a bit on our debt ceiling musings back in April).

Why Rates Haven’t Had a Material Impact

Corporate Implications:

It’s no secret that consumers are generating more income than ever from their cash and the same holds true for corporations. Given the rise in rates, companies are generating roughly $6.6B/month. This is the highest level on record (previous record was in ’97 at $3.0B/month) and is likely a contributing factor to the labor market holding up better than many anticipated, as companies can afford wage hikes more easily.

But not only does it help offset wage gains, its starting to help offset higher interest expenses. Originally, the inclination of higher rates on corporate debt was that it was going to degrade profitability. Currently, S&P firms are paying around 3% on debt while treasuries are yielding 4%. Below is a great illustration of the incredible lags that have been created via ZIRP post GFC.

Said another way, looking at interest expense less the income generated on cash for the S&P 500 ex. Financials shows that the income generated on their cash has more than offset the higher interest costs.

This story gets even more interesting if you look at it by sector. Perhaps not all that surprising is that the technology sector has benefitted most from the higher returns on cash. What may be less known is that energy and industrials have also benefited. On the other hand, utilities and real estate have been hurt the most. It is not much of a secret that companies like Apple Inc. (AAPL) and Microsoft Corp. (MSFT) are heavy contributors to the Tech space.

Consumer Implications:

Simplistically speaking, where do rates affect consumers the most? Mortgage rates. Yet, if a person isn’t looking to buy a home, then they aren’t affected by rates. In fact, only 9% of all existing mortgages in the U.S. were taken out with a rate of above 6%, according to data from the Federal Housing Finance Agency. Moreso, 80% of the U.S. mortgages have a sub-5% rate. Basically, homeowners are locked in place by their mortgage’s “golden handcuffs”.

Even more so, millions of homeowners took advantage of ultra-low rates during the pandemic to lower their monthly payments. A recent study by the New York Fed found that 14 million outstanding mortgages were refinanced during the pandemic years. The typical homeowner who did so during this period saw their monthly payment fall by $220, the study showed. But today’s homebuyer is facing a much more expensive path to homeownership: Mortgage rates have surged since, and the 30-year is almost 8%….unless an individual must move, many folks have been staying in the same house, leaving them unaffected by current rates.

Given Macy’s earnings announcement the other day, which saw an increase in credit card delinquencies, consumers could be affected by their credit card rate increasing. Yet, consumer credit remains strong, but delinquencies are rising. However, looking at a broader set of data which was published by the Federal Reserve this past week shows that credit card delinquencies may simply be normalizing to pre-pandemic levels. At 2.6%, the latest reading is in line with the average for 2011-2019 but remains well below the 4.4% data average from 1991 to 2007.

Conclusion

In a nutshell, the rise in rates has done more to help investors from a nominal return perspective than hurt them, as the liability aspect of rates have been irrelevant to most people as they remain put in their current dwelling.

Disclosures

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Aptus Musings: Q2 2023 Earnings Recap

David Wagner — Tue, 15 Aug 2023 20:09:08 +0000

Last week, President Biden signed an executive order limiting US investments in China for advanced semiconductors, quantum computing, and Artificial Intelligence (AI) systems. While the executive order was narrow in scope, trade data released this week shows that a long-term shift away from China is underway, with US imports from China hitting their lowest level since 2004. In fact, trade with our neighbors (Canada and Mexico) is at its highest level since 2002.

One more thing….the 10-Year U.S. Treasury hit 4.2% today.

Q2 2023 Earnings Recap

As it has been for the past five earnings seasons –and now that most of earnings season behind us– it is clear that EPS expectations have maintained better than most (including us) would have thought. Looking at sales growth, analysts expected -5.7% decline, while actual numbers only showed a decrease of -3.8%. The continued strength allowed 2023 EPS expectations to increase, approaching $221.50. However, 2024 remains unchanged over the past several weeks which is lowering the 2024 growth rate to 11.4%. This is still elevated relative to history and remains a challenge to achieve from our perspective but it’s still a long way away from recessionary type earnings numbers.

The chart below shows the shape of seasonal EPS in the S&P 500 in 2021 (big recovery year), 2022 (slowing economy year) and 2023 (better-than-anticipated), which so far has seen worse EPS seasonality in Q2, but consensus shows a rebound in Q3/Q4, unlike 2022, and more like 2021. The 2H ramp is still alive and well in consensus estimates. This sentiment has continued to drive the market higher.

As it goes for the bottom line (earnings / net income) – close to 81% of companies beat on the bottom line. This is above the 72% average beat rate since the end of the Great Recession.

The biggest surprise to me has been the median T+1-day price change post reporting is -60bps, which is the lowest price reaction since 2020, and one of the lowest since the early 2000s. This is driven by a combination of negative price responses post both EPS beats and misses. However, the bigger outlier of the two outcomes from a performance standpoint appears to be the median price change post earnings beats, which is one of the lowest we’ve seen historically. This tells me that a lot of the positive sentiment is already priced into the market.

Alright, hot topic here: Tech investors are struggling. Not with investment returns, but with justifications for ever higher price targets. Shortly before Q2 earnings season, with much of tech straight up and to the right, I started having conversations with clients in which I detected a ‘struggle’ to take numbers and/or multiples higher. As such, it’s not a huge surprise that Q2 earnings season has been somewhat disappointing as even big beats/raises (e.g. META) have been met with muted stock responses (which coincides with the above paragraph).

I don’t want to highlight this notion to suggest that investors are ready to bail on the sector en masse, but rather I think that a pullback/breather in the QQQ’s is probably healthy for tech stock returns over the coming year. Another way to characterize the current situation: It may be the middle of the summer, but I think it’s becoming increasingly clear that tech investors got over their skis a bit too much headed into Q2 earnings season.

Overall, the S&P 500 has taken a roundtrip to January 2022 levels on forward earnings ($227 – next twelve months, not to be confused with ’23 expectations of $221.50) and on its multiple of 20x – a lost 18 months. But bonds and inflation have done a lot since then – the 10-yr yield jumped from 1.8% in Jan 2022 to 4.2%, real rates from -0.7% to 1.8% and Fed Funds saw the quickest ascent in history. Visibility on Fed policy, lower rates volatility, inflation cooling from 7% to 3%, and a pickup in GDP (+2.6% q/q SAAR vs. -1.6% in 1Q22) are all equity positive. And productivity gains (+3.7% YoY in Q2) could at least partially offset higher borrowing costs.

Conclusion: As earnings revisions go higher, so does the market.

Disclosures

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Aptus Musings: Why Has the Market Been Resilient?

David Wagner — Tue, 08 Aug 2023 21:29:12 +0000

I understand that a lot of y’all have upcoming client meetings, so I wanted to take more of a high-level approach to this Musing, instead of focusing on a single subject. Please find our quarterly presentation here. This presentation is meant to be a universe of slides for our partners to use with clients. We’ve had a lot of good feedback on this presentation.

Let’s try to answer the following question: Coming off the worst year for the 60/40 portfolio since 1937, coupled with the fact that the perceived nature that a lot of the sins of the market have not yet been atoned for in ’23, many are asking why the S&P 500 is up almost 20% this year – a level that is only 7% from all-time highs.

I’m not going to dive into the “sins of the market” because the Wall of Worry is plastered all over TV screens.

Where is the Recession?

Many of y’all have heard John Luke and I say, “An inverted yield curve has preceded almost every recession, though it has difficulty on properly calling the timing.” Right now, many people are recognizing the difficulty in the latter part of that statement. But why has a recession not shown its face yet?

Honestly, one of the most surprising things to me this year has been the 180-degree change in investor sentiment. If you look at many of the popular sentiment indicators like the VIX (lowest level since pre-covid), the Put/Call Ratio, and AAII Bullish Sentiment readings, all suggest that investors are, at a minimum complacent, if not outright giddy. I don’t want to fully go out on a limb here and say that’s a contrarian indicator, but it is one that should be paid attention to.

Think of the investor sentiment heading into this year… it was completely bearish. For example, just last fall, 100% of economists surveyed by Bloomberg forecasted that the U.S. would be in a recession within 12 months. Now, nine months later, we are still not in a recession and only 58% of economists surveyed think that a recession will occur in the near future. We can still spin that comment in a different way – a majority of the economists continue to believe that a recession is around the corner.

Why? Let’s Walk Through the List

Labor Markets Remains Resilient: Profit margins have declined for the S&P 500, but not enough to prompt companies to lay off workers. According to the JOLTs data, 9.8 million job openings remain in the United States. This is why the market has seen a 5.6% wage growth rate YoY (ATL Fed Reading).

Consumer Spending Remains Resilient: Relative to 10YRs ago, the avg. “U.S. Household Net Wealth” is 120% higher. A lot of this boost is due to higher home prices, lower rates, and asset inflation.

Savers Now Have Income on Savings: Even though real rates are only slightly above 0.0%, consumers think and spend in nominal terms. Per Strategas, using money market fund data, they estimate that monthly income from savings is running at more than $20 billion per month. This has led to more consumer spending, making earnings more resilient thus driving stocks higher.

Reduction in TGA Accounts: At the same time the Fed’s balance sheet was expanding from the Banking issues, the Treasury Department drew down its General Account from $580 billion in January to roughly $20 billion by June 1st. The Treasury spent down accounts due to the gov’t shutdown. This liquidity was injected directly into the financial system.

2023 & 2024 Expectations Earnings Remain Resilient: Everyone has heard me talk on this subject, and you’ll hear it again in my next Musing that will provide a recap on Q2 ’23 earnings season. Estimates for S&P 500 earnings per share (“EPS”) next year rest at $245, or a 12% increase over today’s current expectations for 2023. The median decline in earnings during a recession is 22%.

The Fed put the Kibosh to the Banking Crisis?: The Fed quickly stepped in during the March Banking problems – will they always be there as a backstop?

Yet, there remain numerous outstanding questions:

How resilient will the US consumer remain, i.e., how much excess cash do they still have from the pandemic?

What happens if inflation turns back up as we pass easy YoY comps? Could the current Energy problem exasperate these figures?

How sustainable is an expansion in the business cycle when the economy is already near full employment?

Can investors continue to rely on multiple expansion to fuel equity gains?

Will the Fed always be there to backstop the market, much like it did in March, even with inflation still running high?

There’s been a package of worrisome data more broadly. Will that have an effect on the domestic economy?

Here’s an updated table of Returns, as of Monday, August 7th:

We don’t have a metaphorical crystal ball as to how this year will end up (even though we did have a close partner send our HQ a literal crystal ball). If you’ve heard us speak about the structure of allocations lately, specifically to our own, you’d know that we are highly convicted in how we are positioned.

We really could care less if the market goes up or down from here, given that we can own more stocks and volatility as an asset class. We are prepared for either.

Disclosures

VIX of VIX (or VVIX) is a measure of the volatility of the Chicago Board Options Exchange (CBOE) Volatility Index (VIX). The CBOE’s VIX measures the short-term volatility of the S&P 500 indexes, and the VVIX measures the volatility of the price of the VIX. In other words, VVIX is a measure of the volatility of the S&P 500 index and alludes to how quickly market sentiment changes.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 11.2 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 4.6 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

The Nasdaq Composite Index measures all Nasdaq domestic and international based common type stocks listed on The Nasdaq Stock Market. To be eligible for inclusion in the Index, the security’s U.S. listing must be exclusively on The Nasdaq Stock Market (unless the security was dually listed on another U.S. market prior to January 1, 2004 and has continuously maintained such listing). The security types eligible for the Index include common stocks, ordinary shares, ADRs, shares of beneficial interest or limited partnership interests and tracking stocks. Security types not included in the Index are closed-end funds, convertible debentures, exchange traded funds, preferred stocks, rights, warrants, units and other derivative securities.

The Dow Jones Industrial Average® (The Dow®), is a price-weighted measure of 30 U.S. blue-chip companies. The index covers all industries except transportation and utilities.

The S&P SmallCap 600 Value Index is a market capitalization weighted index. All the stocks in the underlying parent index are allocated into value or growth. Stocks that do not have pure value or pure growth characteristics have their market caps distributed between the value & growth indices.

The MSCI EAFE Index is an equity index which captures large and mid-cap representation across 21 Developed Markets countries*around the world, excluding the US and Canada. With 902 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI Emerging Markets Index captures large and mid-cap representation across 26 Emerging Markets (EM) countries*. With 1,387 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. This includes Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities, and collateralized mortgage-backed securities

Investment-grade Bond (or High-grade Bond) are believed to have a lower risk of default and receive higher ratings by the credit rating agencies. These bonds tend to be issued at lower yields than less creditworthy bonds.

Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

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Aptus Musings: Q2 2023 Earnings Preview

David Wagner — Thu, 20 Jul 2023 17:07:59 +0000

Before we dive in, if anyone needs any of our quarterly newsletters, presentations, updates, etc., feel free to reach out. Also, if anyone would like a quarterly market update call – hit me directly (david@apt.us). We have a lot of very thought-provoking commentary on how allocators should be handling this current environment – especially as benchmarks, such as the iShares Core Aggressive Allocation ETF (“AOA”), are in the top 1% versus managers on performance YTD. Many of the other benchmarks are in the same company.

Let’s hit earnings.

Q2 2023 Earnings Expectations

If you’ve read our stuff from the past year, you’d know that one of our themes for ’23 has been that inflation is going to transition to growth frustration. In a nutshell, these have been the two obstacles for the market to clear for more people to start believing in the market. First, inflation needs to be perceived to be coming back down to 2%. It feels as if we are getting there fast, barring a supply shock across the economy (if one excludes shelter from core CPI, y/y increase is only 2.6%). Earnings per share (EPS) expectations will become increasingly important to be able to keep the rally going. If you’re keeping score at home, we’ve been partially correct – the market has stopped worrying about inflation and has started focusing on earnings but the direction of earnings hasn’t happened yet. However, remember perspective; we are only one quarter in on the ’23 expectations (of four) and we are just starting Q2 earnings season.

That takes me to the surprising aspect of S&P 500 12-month forward earnings per share expectations – it has been increasing. But the increase in the next twelve-month (NTM) expectations have basically all come from Q1 ’24 (which is now included in the formula and you can see the uptick in the below chart), as ’23 expectations have partially come down.

Is this growth sustainable? Possibly. But we’ve continued to see deceleration across the spectrum… on a nominal basis. For example, savings rates for consumers have begun to normalize, but I believe, still have more room to go. Savings rates in May were 4.6%, up slightly from April, but generally has been 4-5% all year, up from a low of 2-3% last summer. Personal income increased +6.0% y/y, generally the same rate as last month, as personal consumption slowed from 8.1% in January. Per Raymond James, if savings rates were to normalize by end of 2024, consumer spending would slow ~-4% y/y from today’s levels to ~+2%-3%.

We are about to learn a lot over the next few months as earning season progresses and we watch consumer’s willingness to spend, as their year-over-year (YoY) purchasing power has turned negative – which tends to coincide with a recession.

Focusing on Q2 ’23 Earnings

S&P 500 Q2 consensus EPS was cut by just 2% since March, half of the typical pre-season 4% cut, with the heftiest downward revisions in Energy and Materials. Expectations now stand at $52.88 (-8% YoY). The macro environment in Q2 was much stronger than expected heading into the quarter. Despite the banking scare in March, the economy proved to be more resilient, with incoming macro data topping consensus expectations by the biggest margin since Q3 2020 (per BofA). While banks are tightening, structural shortages (e.g. housing), ample liquidity from private markets, and lower sensitivity between earnings and credit post-GFC are pointing to some earnings resiliency – for the fifth straight quarter. The market has a recent track record of rallying during earnings.

The reason for the majority of index EPS cuts have come from the Energy sector – which means that there has been a lot of resiliencies elsewhere; think Industrials. The S&P 500 Energy sector is expected to report an outsized negative earnings growth rate of -46% for Q2 ’23. The caveat here is the difficult comps from elevated commodity prices due to the onset of the Russia/Ukraine conflict that sent WTI crude oil over +$100 bbl. On an index basis, the disparity between Ex-Energy earnings is +500 bps with the S&P 500 expected to report -8.1% earnings growth (as mentioned above) but the S&P 500 Ex-Energy at just -2.6%. So, the -8% may not sound great, but is it really bad?

I know that I’ve sounded very negative here, but there are definitely some positives. Just look at S&P 500 margins, as they have somewhat stabilized. It’s no secret that margins have been in a precipitous decline after peaking in Q1’22 as inflation continues to take a larger portion of the bottom line of operators. However, we’re finally starting to see signs of stabilization after +15 months of declines. Guidance will be key this earnings season to determine the durability of the stabilization we’re seeing on the margin front.

Profitability of the S&P 500 has been at the forefront of the AI-revolution and they have been moderating, even before the market has witnessed any tangible effects from this innovation.

Overall, macro uncertainty remains, but it appears that investors are expecting Q2 ’23 to be the trough in YoY EPS expectations, which could remain a catalyst for risk assets. Momentum has continued to build, as May was better than April, June was better than May, and this has continued in July. As always, I’ll be focusing on management commentary that could potentially sound more upbeat than previous quarters. Companies are likely to highlight bottoming process in business conditions and building momentum throughout the quarter and into July. And if that’s the case, keep your head on a swivel because the pain train could be coming – Terry Tate Linebacker style.

Disclosures

Projections or other forward-looking statements regarding future financial performance of markets are only predictions and actual events or results may differ materially.

The S&P 500® Index is the Standard & Poor’s Composite Index and is widely regarded as a single gauge of large cap U.S. equities. It is market cap weighted and includes 500 leading companies, capturing approximately 80% coverage of available market capitalization.

The Core Consumer Price Index (CPI) measures the changes in the price of goods and services, excluding food and energy.

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