Above the Noise: Focusing on the bigger prize

Key takeaways

Time for a pause?
This is the first time the Federal Reserve has continued to tighten policy after a financial accident has occurred.

Treasury rates
The 1-month Treasury rate has spiked as concerns of a debt ceiling default have risen.

Waiting for the X-date
If debt ceiling negotiations go beyond the X-date, the US Treasury is expected to place items such as Social Security and debt payments ahead of other line items.

These range-bound markets feel like one of those tight games of tennis.¹ Debt ceiling stalemate – advantage out. Bottoming manufacturing surveys² – deuce. Slowing inflation numbers³ – advantage in. I guess it makes it hard to love (see what I did there?) these markets. Fortunately, I’ve found that losing one of those tightly contested games in tennis doesn’t necessarily mean I’m going to lose the set or the match. The tight games often wear the opponent down, the same way that I believe declining inflation will wear down the short sellers. In the near term, markets could potentially retrace early-2023 gains as the economy slows, but I’m less inclined to focus on that game. History suggests that markets have tended to perform well in the years following peak inflation and the end of policy tightening.⁴ I’ll stay mentally tough and keep my focus on the bigger prize. I want to be preparing to win this set and the match.
 

A ’keep it simple’ strategy

We start with three simple questions.

1. Where are we in the cycle?

The guideposts to the end of the cycle are there (policy tightening, banks tightening lending standards, financial accidents), but it’s no surprise to markets. Investors have been talking about a recession for 18 months! Let’s look at it another way. These are also the guideposts on the path to a new cycle.

2. What’s the market telling us about the direction of the economy?

The market continues to point to weaker economic growth ahead. Higher quality stocks and bonds have generally been outperforming since the middle of February.⁵

3. What will be the policy response?

The end of policy tightening is here (or near)!

The view is to focus on higher quality stocks and bonds as the economy slows but to keep an eye out for indications that the market is getting out ahead of what may ultimately be an economic recovery.
 

It may be confirmation bias, but …

… it’s time for the Federal Reserve (Fed) to pause. In the past, the Fed has paused or eased when a financial shock has emerged. This is the first time the Fed has continued to tighten policy after a financial accident has occurred.⁶

Phone a friend

You may have noticed that the 1-month Treasury rate has spiked as concerns of a debt ceiling default have risen.⁷ I was asked if the Invesco portfolio managers are doing anything different as a result. I posed the question to Matt Brill, Head of Investment Grade Fixed Income. His response:

“Any Treasuries that mature before June 1 are being bid up. On the other hand, the yields on T-bills that mature in early June to July are going higher. This is because investors are seeking to avoid bonds that mature in June because they would not get coupon payments if the government was not able to pay their bills. Investors would likely get back their principal once the debt ceiling was raised, but there would be a cost of not generating income over that period.

As for us, we had bills that matured in the middle of May. Normally we would roll those bills to the middle of June. This year we rolled it all the way out to April 2024 because we don’t want to take any chances that the bonds would mature in a window during which the Treasury is not paying interest on the bonds. We believe that one year is more than enough time for Congress to figure it all out.”

One would hope!
 

Automate my job?

Each month I pose a question to ChatGPT — the artificial intelligence-driven chatbot — and assess the response.

Q: How does the stock market perform during a recession?

A: Here are some general trends that are often observed during a recession:

1. Initial decline: At the onset of a recession, stock prices tend to decline as investors become cautious about the economic outlook.
2. Industry-specific performance: Some industries, such as consumer staples, utilities, and healthcare tend to be more resilient because they offer essential goods or services.
3. Long-term opportunities: Recessions can present long-term opportunities for investors. Market downturns can be viewed as a chance to buy stocks at discounted prices, anticipating a recovery in the future.

Well done, ChatGPT. I particularly like point 3.
 

Since you asked

Here’s a question I’ve fielded recently: “You said that stocks have tended to perform well in the years following the peak in inflation. How can you be so sure that inflation has peaked when the median Consumer Price Index is still at 6.95%, down from 7.2%,⁸ the cyclical high reached only one month ago?”

First, I believe it’s better for investors to pick their preferred measures to assess the state of the economy and to stick with them. Jumping from one measure to the next (for example, Consumer Price Index to core Consumer Price Index to median Consumer Price Index to core Consumer Price Index ex-shelter to core Personal Consumption Expenditures) tends to not be helpful.

History shows that the median Consumer Price Index — the inflation rate of the component whose expenditure weight is in the 50th percentile of price changes — has always ultimately trended lower as the Consumer Price Index eases. Not once has it ever reaccelerated.⁹

One follows the other. Again, pick a preferred index and stick with it!
 

Everyone has a podcast

Jennifer Flitton, Head of US Government Affairs at Invesco, joined the Greater Possibilities podcast to assess the debt ceiling standoff in Congress.

Here are a few of Jen’s thoughts:

• Don’t be surprised if the negotiations go right up to the X-date or even a few days beyond it.
• The expectation is that if the negotiations go beyond the X-date, the US Treasury will prioritize spending, placing items such as Social Security and debt payments ahead of other line items.
• The framework of the deal will have the Biden administration and the Democrats agreeing to future budget caps in exchange for a lifting of the debt ceiling.
• Finally (because we had to ask), it’s not too early to be thinking about the 2024 election, but it is too early for predictions.

I was comforted by Jen’s belief that the debt ceiling will be raised and “the disastrous consequences” that the media keeps warning us about will not happen. Hopefully we will all be able to breathe a sigh of relief. That is, until the next time we approach the debt ceiling.
 

On the road again

My trip to Raleigh, North Carolina, was a challenging one, but the lesson learned serves as a good reminder for investors. My flight was delayed. I called the airline and switched to a later flight. Of course, the first flight was then quickly cleared to go, but I had just given up my seat. My action bias, or tendency to favor doing something rather than nothing, had been awakened. As usual, it failed me. It’s no different than trying to time markets. It rarely works out well.
 

Fatherly lessons

I’ll conclude this month with a new category in honor of Father’s Day. I once wrote a blog about lessons learned when my father won $10,000 in the lottery circa 1986, and it was the most read commentary I had ever written. (You can read the story on my LinkedIn profile.) It makes sense then to go back to the Bob Levitt well.

My father had a successful career in the retail sector. He did, however, lose his job in the 1991 recession, the year my sister was starting college. Unable to immediately find a job in the New York area, he accepted a job in Massachusetts and traveled back and forth for the year. When asked why we didn’t move he replied, “I didn’t want my misfortune to be disruptive to the family.” When asked if he was nervous about paying for college he replied, “Of course, but I had always lived within my means.”

Two things I carry with me to this day:

• Do what you need to do for your family.
• Save for a rainy day!

Happy Father’s Day to all the dads willing to go to the end of the Earth for their families!

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