VTI - The TINA Market No Longer Exists

2023-08-28 15:22:52 ET

Summary

• The Federal Reserve reaffirmed that interest rates will remain "higher for longer" last week at Jackson Hole.
• Despite recent drops in inflation, the fight against inflation is not over, and investors should be concerned about the maturing debt and vulnerability of the commercial real estate market.
• The market's reliance on a few mega-cap companies for its rise raises concerns, and investors may start moving their money into safer short-term treasuries as an alternative to stocks.
• This could turn out to be problematic for the overall market as there is a real alternative to investing in equities for the first time since 2007.

Apathy, is the city in which most people live .”? Anthony T. Hincks.

Chairman Powell of the Federal Reserve cemented the fact that rates will stay " higher for longer" last Friday from Jackson Hole. The Fed Funds rate of 5.25% to 5.50% will remain in place, if not be bumped up one more time this year by 25bps, throughout the rest of 2023.

The fight against inflation simply isn't over despite some recent encouraging drops in the monthly CPI and PPI. The market reacted with a small relief rally on Friday after a " thumping" during the trading day on Thursday. My take is investors are missing two pertinent things they should be more worried about.

As I recently noted in my article ' The 'Soft Landing' Fallacy ,' monetary policy always has a large lag. The initial hikes from the most aggressive policy in the early 80s that started in March of last year, are just now filtering throughout the entire economy. The longer rates remain elevated, the bigger problem that maturing debt will become. It is quite possible that the federal government will be paying $1 trillion a year just in interest to service its massive and growing $32 trillion national debt in coming years as the ' chickens come home to roost '.

Outside of government debt service, one of the most vulnerable parts of the economy to higher rates is the commercial real estate {CRE} market. As I have noted recently, it seems we are on the precipice of a debacle as some $625 billion in debt needs to be rolled over just on office properties over the next three years even as the value on these assets plummet in many major cities like San Francisco, Los Angeles, Baltimore and New York. If one substitutes the CRE market for the residential housing market, whose problems triggered the Great Financial Crisis, an investor can be pardoned for seeing " Shades of 2007 " within the current credit markets.

The second factor I believe investors are not weighing correctly is that this is no longer a TINA (There Is Not Alternative) market anymore. Thanks to ZIRP (Zero Interest Rate Policy) that the Federal Reserve maintained for most of the period from late 2008 through early 2022, savers have consistently been punished via ultra-low rates for their deposits. This forced many into much riskier assets like equities, junk bonds and real estate.

That dynamic has quickly changed over the past 18 months. It is one thing to pay up for elevated valuations when the alternative is keeping money in a bank account that was paying less than a half percent of annual interest. It is quite another when short term treasuries are paying right at 5.5%. Not only is this return "risk-free," but it is also nicely above the current rate of inflation.

That could become problematic for equities given the nature of the rally in the stock market in 2023. Almost all of the rise of the overall market has been due to the huge movements of a few mega cap stocks like Nvidia Corporation ( NVDA ). In the first half of this year, the S&P 500 (SP500) rose 15.9%. However, if one takes out the " Magnificent Seven ," the S&P 500 actually would have fallen slightly just including the other 493 firms that make up the index. Although there has been some slight improvement in breadth in the second half of the year, the market's leadership hasn't changed much. In fact, while the NASDAQ moved up 2.26% in trading last week, the small cap Russell 2000 Index (RTY) fell by just over .3%.

At some point, investors are going to balk at paying more than 20 times forward revenues for Nvidia. Nor will they ante up over 29 times earnings for Apple ( AAPL ), which is projected to have a slight decline in both profits and revenues in FY2023. The stock has racked up a 43% return to date in 2023 despite that to this point.

Eventually we are going to see a real " hiccup" in the overall market. When that occurs, don't be surprised if a lot of investors move substantially more money out of equities into " safe" short-term treasuries offering their best rates since 2007. This is simply because there is a real alternative to equities for the first time since Irreplaceable by Beyonce topped the charts.

Prudence is the order of the day given the current trading levels of the markets. Fortunately, investors can be paid handsomely for their patience while they await lower entry points.

Note: Roughly 50% of my current portfolio is in 3-month and 6-month treasuries. 40% is within covered call holdings on names with rock solid balance sheets like Exelixis ( EXEL ) . The rest is primarily in cash with a few out of money bear put spread positions against overvalued names like Apple and the major indices like the Invesco QQQ Trust ETF ( QQQ ) .

Trying to have everything will often leave you with nothing .”? J.S. Felts.

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