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Welcome To March

The month has ended with the financial landscape looking rather different than the end of January.  Just four weeks ago, disinflation was a major theme bringing with it the promise of lower interest rates and benign backdrop for the deployment of capital.

February looked very similar to 2022;  almost every asset declined from stocks, fixed income, commodities with the discussion focused on what asset group had the least bad performance…high yield bonds which only declined 1.4% according to Bloomberg.

This narrative started to unravel with January’s payroll statistics and has become almost completely unglued with data indicating strong growth and inflationary pressures.

According to Bloomberg, one month ago the market was suggesting the overnight rate would be 62 basis points lower by years’ end with a yield around 4.0%.  Twenty-nine days later it is now suggesting the overnight rate will 126 basis points higher than the 4.0% projection.

The market is now suggesting the overnight rate will be 5.42% in the July-September window.

Unfortunately, highly valued companies have just begun to discount this potential reality.

According to Barons, mega sized tech companies consisting of FAANG + MNT [Meta, Apple, Amazon, Netflix, Alphabet, Microsoft, Nvidia and Tesla] accounted for 3.05% percentage points of the 3.81% advance for the S & P 500. 

The other 492 companies have basically gone sideways.

An issue at hand, as an aggregate the seven stocks listed above trade around 45.3 times expected earnings versus an estimated 17.9x for the rest of the S & P 500.

Writing it differently, there is no margin for error for the eight companies that have constituted the majority of 2023 gains.  As stated many times, interest rates are a primary component of equity valuations and the expectations of this component has changed dramatically.

The popular 60/40 account [60% equity/40% bonds]  is on the brink of going negative for the year, the first such occurrence of back to back annual declines for this strategy in at least 50 years.

Bloomberg writes credit’s impressive rally at the start of the year has “quickly turned sour for high grade bonds…are on pace for the worst February in at least 30 years,”  declining in excess of 3.2%.

Perhaps the safest comment to make about March is that its direction may be dictated by the data and the potential direction of monetary policy.  In about three weeks earning pre warning season commences.  Analysts are now expecting profits to decline for 2023.  One month ago, consensus was the inverse.  Will the headlines validate or nullify current profit views?

Nominally changing topics, according to Bloomberg, cash is now paying more than the yields for a 60/40 portfolio for the first time since 2001.

Similarly, the yield on the S & P 500 is 1.69%.  The yield on the six-month Treasury is about 5.05%.  Bloomberg writes this is a third standard deviation trade. Writing it differently, it only occurs 0.003% of the time.

Either of one of the two events must occur; either Treasury yields decline or the yield on the S & P 500 rises either by dividend increases or a drop in value.

What will happen today?  Top tier data point ISM is released.  How will the data be interpreted?

Last night the foreign markets were up.  London was up 0.89%, Paris up 0.69% and Frankfurt up 0.57%.  China was up 1.01%, Japan up 0.26% and Hang Seng up 4.21%.

Futures are up about 0.25% after a slew of data indicated that China’s recovery is on track for a stronger recovery.   The 10-year is off 3/32 to yield 3.94%.

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Kent Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.