Hello friends, welcome to the July Market outlook. We hope this note finds you well, and you and your families enjoyed the Independence Day festivities. They were certainly welcomed after this past year, and many took advantage of the holiday weekend and gathered with friends and family for the first time in quite some time. Here in the U.S., it certainly feels as if COVID is in the rear-view mirror and this weekend was a prime example. Practically no hotels had vacancy, and many Americans took to the roads to cross state lines. For those of you who did, you probably noticed the high gas prices. Since last March, energy has clearly been one of the big winners. Probably the best analogy I’ve seen- it went from worst to first. Year to date, among the 11 S&P sectors, the Energy sector has easily led the equity market recovery, up 47.12%, as West Texas Intermediate Crude itself has recovered more than 54% of its value just since the end of 2020. Measure that performance against almost anything else in the equity space, and Energy wins. The second best performing sector, the Financials, are up 26.36% year-to-date, while the worst performing sector, the Utilities, are still up 3.6% for the year. But this shouldn’t come as a surprise as the world needs ample amounts of energy to reopen. More so than that, developing, frontier or underdeveloped countries need cheap energy, so of course we’re turning to fossil fuels and potentially coal. The bizarre part is that investors have been spoon-fed ESG and green energy for years, so most portfolios had shifted away from traditional energy investments. But as in any case, blink and you might miss the recovery. The point to contemplate after an exponential move like this is what comes next? Does oil continue marching higher and hit $100 per barrel or even higher? Or have we reached peak oil price, spigots open and then the supply side wins? We believe more in the latter, and the potential news this past weekend regarding the OPEC cartel somewhat confirms it. OPEC + might be fractured; most members wish to bring on more supply. If no agreement is reached soon within the cartel, all countries will cheat on their production- the Saudis start to cheat, then the Iranians and so down the Totem pole. The world needs cheap oil to make this recovery significant. On top of that, central banks need cheap oil to tone down the inflation narrative. If oil remains elevated and goes higher from here, the idea around “transitory inflation” might be with us longer than what’s being priced into all markets.
Looking at the market as a whole, it was a spectacular quarter. Last week, prior to entering the holiday weekend, the market followed history. Going into a holiday weekend, the market has 65% upside bias. Well boy did that play out, as we had 7 green days in a row, and each index hit an all-time high. Now as investors, we do believe this rally is overextended, and depending on how you view rates and inflation, it’s arguably overvalued by 10-20%. Anyone who is screaming stocks are cheap needs to explain their valuation method. Stocks aren’t cheap by any traditional methods, as we’re at the highest price-to-earnings ratio in history. However, bonds may be even more expensive. They’re also near an all-time high price with 10-year yields crashing to 1.37. After 12 years, investors are still being yield-starved. Oh, and don’t forget, 40% of the money printed in this country’s history occurred over the last few months. More dollars chasing fewer goods.. you know how the math works. The point we’re trying to make- the crystal ball is foggy. Those of you that have been reading this outlook as it’s published regularly should know that our thought process hasn’t changed. The summer lull we expected has played out perfectly. The (VIX) ultra-short volatility index is near at an all-time low, down days for stocks have become rarer than an oasis in the desert, and the markets continue to hit nominal all-time highs. This will continue until we enter the latter part of this year. The Fed spooked investors at their last meeting- they’re now telling us that they’re thinking about thinking about hiking rates sometime in 2023. They will echo those thoughts at the Jackson Hole Symposium in late August unless deflation rears its ugly head, and inflation becomes an afterthought. After studying the supply shortages facing the global economy, wage pressures persisting and the price of oil, we think that’s extremely unlikely, and that the Fed’s concern around inflation moves higher over the remainder of the year. On top of that, we’re about to go through earnings season again. What we hear from CEOs and CFOs is immensely important. Just this morning, we saw German factory orders collapse 3.7% in May, and it was export demand for cars that slumped. If you can’t make vehicles, you can’t sell them. Similar reports like this during earnings season will hurt earnings per share expectations, and can damage an already fractured market that’s priced for perfection. Keep your eye on the 10-year yield, that’s the only thing that matters to stocks right now, and as always, please reach out with any questions.
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