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The divergence can be mainly attributed to a flight to \u201csafety\u201d in mega-cap names. Investors saw the world\u2019s largest companies as a safe place to park their dollars while maintaining their equity exposure. Now that markets have stabilized and the Fed is concluding its rate hiking campaign, the flight-to-safety benefit has diminished, and we believe the rest of the index should begin to close the gap.<\/p>\n
Will SMid-caps get their revenge?<\/em><\/strong><\/p>\n While the largest names in the S&P 500 have been the stars of the show year-to-date, we believe many Mid Cap and some Small Cap companies (SMid Caps) will see a resurgence in the back half of the year. Valuations for these companies remain low compared to the Mega Cap names while earnings have come in attractively so far this year \u2013 leaving room for significant price appreciation. There are areas in the SMid space we prefer to stay out of \u2013 banks and commercial office space in particular, but we believe there are many companies in Energy, Industrials, Materials, and other sectors of the market that remain very attractive.<\/p>\n Does the S&P 500 Market-Cap-Weighted Index Actually Offer Diversification?<\/em><\/strong><\/p>\n The top 5 companies in the S&P 500 now make up roughly 24% of the index, which begs the question: does the index truly offer diversification? <\/em>With so much concentrated company-specific risk, the index offers the lowest diversification since the dot-com bubble. At the sector level, diversification is even worse. Energy, Materials, Industrials, and Real Estate \u2013 four of our preferred sectors \u2013 only constitute a combined 17.3% of the index. Compare this to Information Technology\u2019s 28.1% share and it\u2019s easy to see how sector weights have become lopsided over recent years. Twenty years ago, these weights were roughly 22% and 14.3%, respectively. Then, the index offered more proper diversification among companies and sectors.<\/p>\n As active and diversified investors, we believe differentiating from the broader index is becoming more and more important. There are valuable companies in all sectors of the market, but traditional index investing is no longer proving to be a proper diversifier.<\/p>\n At the June Federal Open Market Committee meeting, the Fed decided against raising rates for the first time in 15 months. After 500 basis points of hikes, we believe the Fed is at (or very near) the end of its rate hiking cycle. All of 2022 and YTD in 2023, the macro narrative has been extremely Fed driven. Market swings have occurred in both directions given the relative dovish or hawkish sentiment that has come across the tape. It is at this point, we believe the pendulum swings to a more dovish (and positive) sentiment as the Fed concludes its rate hike journey. We are within 0-50bps of remaining rate hikes which bodes well for assets across the spectrum \u2013 from equities to fixed income and REITs.<\/p>\n Why is the Fed Done Hiking?<\/em><\/strong><\/p>\n In a word, Disinflation<\/em>. Meaning, a decrease in the rate of inflation. Disinflation is prevalent in the market: from wall street to main street, prices are rising at more modest rates than they have in months. In 2022, the market peaked at a Consumer Price Index (CPI) inflation rate above 9.1% YoY and we have steadily declined to what is now only a 4% YoY rate. We have reason to believe inflation rates will further decline because Producer Price Inflation (PPI), a measure of prices paid to U.S. goods and services producers, has declined even more drastically than CPI. PPI is typically a leading indicator for CPI as producers\u2019 input prices eventually dictate what we all pay as consumers.<\/p>\n Headline CPI has fallen dramatically over the last year, but the change is even more pronounced when Shelter prices are excluded. By observing current market prices \u2013 rents and home listing prices \u2013 it is clear to see that prices have declined from their peaks in early 2022. The housing market has cooled with the lifting of mortgage rates and higher apartment availability has led to rent competition. Traditional Shelter inflation in the CPI report is skewed, because rather than using the most recent prices and rents, the data observes a 12-month average, effectively creating a 12-month lag in the data. Accordingly, inflation ex-Shelter has almost reached the Fed\u2019s target range of 2%. We anticipate Shelter prices to drive the CPI lower in the months ahead, rather than serve as a headwind to disinflation as it has thus far.<\/p>\n Why Does Disinflation Matter?<\/em><\/strong><\/p>\n The Fed has a dual mandate: to foster economic conditions that achieve both stable prices <\/em>and maximum sustainable employment.<\/em> Since the beginning of 2022, the Fed has almost exclusively focused on the price stability facet of its mandate, increasing interest rates to quell the tide of inflation. As inflation subsides, the Fed no longer must continue raising rates. Higher rates discount equity prices and hurt fixed-income valuations. Once we witness stable rate policy (or even declining rates), there is runway for equity prices to lift again and fixed income to maintain a stable valuation. Lower rates should make it easier for companies to borrow and relieve debt burdens, leading to greater economic activity and brighter earnings outlooks.<\/p>\n The rapid rate hikes of 2022 and 2023 have presented us with new and higher-yielding opportunities to generate cash income after years of near-zero interest rates. Bonds, REITs, and similar fixed-income-like assets got crushed as the Fed aggressively raised rates to pull their yields up above the Fed funds curve. Now that the pain has stopped, we can start to take advantage of once-in-a-decade rates.<\/p>\n Real Estate Investment Trusts<\/em><\/strong><\/p>\n As the Federal Reserve closes out the fastest rate-hiking cycle in over 40 years, REITs are once again well-situated to provide current income and capital returns after being sold off during the interest rate run-up. Agency MBS and property REITs have repriced, presenting similar, yet differentiated, opportunities. Both generate cash while positioning the portfolio to take advantage of the stabilization and subsequent lowering of interest rates – just like bonds, as the reference rate drops, the security’s price increases to bring yields back to equilibrium. <\/em><\/p>\n Mortgage REITs, especially Agency MBS, are very attractive in the current market environment, as they’ve repriced to yield high single to low double-digits on government-backed mortgages. This stands in contrast to corporate debt, where it\u2019s necessary to move out on the risk curve into B and CCC-rated corporate debt to achieve comparable yields while having limited potential for capital appreciation.<\/p>\n Property REITs have reacted similarly, but their price is anchored by the value of their underlying property, making them relatively less volatile and lower yielding. In the 4-5% range, they might not offer a high yield, but because their stock price is closely related to their NAV, they provide the asset appreciation and inflation hedge that real estate offers.<\/p>\n REITs can take many different forms, and in this market environment, it’s more important than ever to be selective about which areas of the market you’re investing in. We prefer to stay out of office real estate, for example, as it\u2019s too far out of favor with the market and rare to present opportunity. Similarly, Multifamily REITs have been historically compelling, but given the considerable supply of multifamily coming online, it isn\u2019t our preferred segment.<\/p>\n Multifamily starts are now running around 1.7x their pre-’08 levels.<\/em><\/p>\n Given current market conditions, we’re looking for extended lease terms on quality properties operating in non-cyclical sectors; this pushes us towards ideas such as medical properties like hospitals and industrial properties like data centers. Similarly, Grocery-anchored shopping centers have long lease terms on key properties and high occupancy rates on auxiliary stores, despite relatively higher turnover.<\/p>\n Private Credit<\/em><\/strong><\/p>\n The opportunity presented by elevated rates doesn’t end with Real Estate; Private Credit is an increasingly popular way to take advantage of elevated rates and tightness in the banking system.<\/p>\n At a time when banks are defensively repositioning their balance sheets, many large, credit-worthy companies are finding themselves in need of capital from non-traditional sources as their existing loans come due.<\/p>\n Here we can see the credit tightening from large banks for Commercial and Industrial loans to small firms as a key example. The charts of other credit lending look similar. There isn’t a preferred sector or project type, just a blanket tightening of balance sheets.<\/p>\n COVID and the Global Financial Crisis are the only other times in recent history that compare to this level of credit tightening; however, this time, it’s occurring during a period of elevated interest rates, which private credit companies can take advantage of.<\/p>\n Just at the beginning of June, the CEO of PNC bank expressed a desire to lend but an inability to, saying, “We’re not going to add to office [loans]. There’s actually a lot of office deals I’d like to do, but the headline number of “Hey, your office exposure went up” isn’t worth it, which is kind of the unfortunate truth about banking, right?”. When banks aren’t willing to lend, it allows private groups to pick up quality loans at above-market rates; Private Credit has expanded beyond small or credit-risky companies in recent months and years, with blue chips like AT&T recently taking advantage of the liquidity to pay off and refinance their existing debt obligations.<\/p>\n The final place we’re seeing opportunities to generate cash is within the Energy sector. As we’ll cover in the next section, we’re bullish on Oil for a number of reasons, but one aspect that often goes overlooked is the large dividends that can be captured from many Exploration and Production (E&P) companies and others in the energy sector. With increased scrutiny from the current administration, oil companies have slowed reinvestment in drilling new wells, opting instead to distribute their cash flows to shareholders. Many companies, well positioned to participate in an oil boom, are delivering high single and low double-digit dividends, even with oil trading around $70 a barrel<\/p>\n Our U.S. sector tilts haven\u2019t changed materially year-to-date as we watch our investment thesis play out. We remain highly convicted in the Energy, Industrials, Materials, and Real Estate sectors, as well as areas of Technology, Healthcare, and Consumer Discretionary. We are still highly selective when it comes to the companies we purchase in the portfolio \u2013 favoring quality companies with positive earnings, cash flow generation, low debt, and strong economic outlooks. As the macroeconomic picture continues to develop, we are making tactical allocations among these sectors based on which companies we view to be the biggest beneficiaries.<\/p>\n Energy<\/em><\/strong><\/p>\n Our energy investment thesis rests on supply and demand-side factors, both contributing to what we view as a bullish outlook for crude oil prices and the companies that sell it. On the supply side:<\/p>\n Several factors support our demand-side oil thesis:<\/p>\n Industrials & Materials<\/em><\/strong><\/p>\n Several macroeconomic trends are driving demand for industrial products and the raw material inputs required for their production and complementary applications.<\/p>\n International Exposure<\/em><\/strong><\/p>\n A new introduction to our portfolios this year has been increased international exposure, specifically to India and Mexico. These two emerging economies are experiencing impressive economic growth and are seeing increased rates of foreign investment.<\/p>\n India<\/em><\/strong><\/p>\n India presents an attractive investment market for several factors:<\/p>\n Mexico<\/em><\/strong><\/p>\n Mexico\u2019s status as a critical trade partner of the United is nothing new, but we believe Mexico will increasingly benefit from its close ties with its Northern neighbor.<\/p>\n The AI hype train has left the station and has reached full speed over the past few weeks. Initially launched by a blowout Nvidia earnings call, it was further accelerated by a litany of AI-related announcements, both for real, game-changing applications of this exciting technology and for exaggerated use cases that are better classified as run-of-the-mill data science projects by overzealous execs looking to cash in on the excitement.<\/p>\n Not unlike the “Dot Com” craze of the late ’90s, we’re seeing incredible new advancements in technology that are being driven by a relative minority, with many companies participating “in name only”. We can see below that the mentions of “AI” in earnings calls have increased dramatically over the last earnings season as companies from all sectors feel obligated to comment on their actual or perceived Artificial Intelligence applications.<\/p>\n Over a fifth of the S&P mentioned AI on their first-quarter earnings calls, while only 64\/500 are in the Technology sector<\/em><\/p>\n It’s relatively easy to filter out the noise, however, and we can focus on the many winners we expect to see in the space. Nvidia is already making significant revenue gains by selling the ‘picks and shovels’ everyone needs to implement AI and will be one of the most notable near-term beneficiaries as companies build out the necessary infrastructure to support this shift. Microsoft, Amazon, and Google have begun implementing AI to improve their products, including generative AI in Bing, better inventory management & logistics for Amazon, and Google’s new AI assistant, Bard. Perhaps the longest-running mainstream AI application comes from Tesla, which will benefit from both hardware and software improvements to hit CEO, Elon Musk’s goal of fully autonomous driving by the end of this year.<\/p>\n Adobe using AI to generate photos and simplify photo editing<\/em><\/p>\n As shown below, Bloomberg expects the market for AI to balloon to $1.3 Trillion in the next ten years, and each of these companies is well situated to benefit from it.<\/p>\n Gains will extend beyond just the tech sector, however, as companies using AI will benefit from operational efficiencies and product improvements, from replacing call centers with generative AI bots and using it to identify bottlenecks in complex production lines, to using AI in the development of new drugs that would be impossible to design manually. Meta (Facebook), as an example, is already using AI to serve ads to users more tactically and drive additional clicks and revenue.<\/p>\n With the Fed at the end of its hiking cycle, we believe there are many compelling investment opportunities in the current market. While we think it remains critical to stay selective in the assets we invest in, from REITs and fixed-income-like securities to Tech Sector beneficiaries of the recent AI craze, we expect to find attractive prospects for our portfolios. This remains a precarious investing environment, but as the narrative becomes less Fed-driven, we are excited to return to a more fundamentals-based investing world where quality, cash-flowing companies are the ones reaping rewards. Here\u2019s to an exciting (and hopefully fruitful) back half of 2023.<\/p>\n <\/p>\n Disclosures<\/strong><\/p>\n This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.<\/p>\n Nothing contained herein is to be considered a solicitation, research material, an investment recommendation or advice of any kind. The information contained herein may contain information that is subject to change without notice. \u00a0Any investments or strategies referenced herein do not take into account the investment objectives, financial situation or particular needs of any specific person. Product suitability must be independently determined for each individual investor.<\/p>\n This document may contain forward-looking statements based on Beck Capital Management\u2019s expectations and projections about the methods by which it expects to invest.\u00a0 Those statements are sometimes indicated by words such as \u201cexpects,\u201d \u201cbelieves,\u201d \u201cwill\u201d and similar expressions.\u00a0 In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements.\u00a0 Such statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict.\u00a0 Therefore, actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors.<\/p>\n Diversification does not guarantee a profit or protect against a loss in a declining market.\u00a0 It is a method used to help manage investment risk.<\/p>\n A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.\u00a0 There are risks associated with these types of investments and include but are not limited to the following:\u00a0 Typically no secondary market exists for the security listed above.\u00a0 Potential difficulty discerning between routine interest payments and principal repayment.\u00a0 Redemption price of a REIT may be worth more or less than the original price paid.\u00a0 Value of the shares in the trust will fluctuate with the portfolio of underlying real estate. There is no guarantee you will receive any income. Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.\u00a0 This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein.\u00a0 The offering is made only by the Prospectus.<\/p>\n Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.<\/p>\n The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.\u00a0 It is a market value weighted index with each stock’s weight in the index proportionate to its market value.<\/p>\n Past performance is no guarantee of future results.<\/strong>\u00a0 The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.<\/p>\n There is no guarantee that companies that can issue dividends will declare, continue to pay, or increase dividends.<\/p>\n","protected":false},"excerpt":{"rendered":" Q3 2023 Market View \u2013 Fed at the Finish Line Introduction In this newsletter, we will address the advance in markets year to date, the inevitable end to the Fed\u2019s rapid rate hiking campaign, equity market macro themes we are watching and believe will outperform in the second half of the year, and the AI […]<\/p>\n","protected":false},"author":12,"featured_media":17740,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"content-type":"","footnotes":""},"categories":[23],"tags":[],"coauthors":[118,119],"acf":[],"yoast_head":"\nIs the Fed Finished?<\/h2>\n
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<\/p>\nIncome Generation<\/h2>\n
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<\/p>\nEquity Themes<\/h2>\n
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Artificial Intelligence Revolution<\/h2>\n
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<\/p>\nConclusion<\/h2>\n