October 2023
The global economy is uncertain due to the war happening in the Middle East, rising interest rates driven by the Fed’s efforts to lower inflation, and the dysfunction in the U.S. Congress related to budget resolutions. The 10-year U.S. Treasury yield reaching a 16-year high of 5% also magnifies the risk that the higher rates environment poses to the economy. Furthermore, U.S. consumers and corporations are facing higher borrowing costs, which dampens economic activity.
According to Sasan, earnings expectations for mega-cap companies may already be priced into the market, with interest rates and geopolitical factors acting as the main forces driving current market dynamics. He encourages listeners to diversify their portfolios and consider gold amid this uncertain environment. Private credit and lending strategies may also be attractive as they offer potential returns comparable to equities.
Watch previous episodes here:
Ep. 55 Embracing Uncertainty: Insights from Our Investor Symposium
Ep. 54 Navigating Financial Turbulence and Inflation with Gold
Hello everybody and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host Chris Galeski, joined by Managing Director of Investments Sasan Faiz, thanks for joining us.
Thanks for having me on, Chris.
Obviously, there's a lot to talk about with regards to what's going on in the world, how it affects people and potentially what they can do about it. It's hard not to kind of look out there with stocks and bonds and interest rates, inflation, taxes, all the millions of headlines going on without, you know, sort of talking about the elephant in the room.
And that's the atrocities that are happening, you know, overseas right now weighing in on on the global economy and creating some uncertainty. You know, what are your thoughts about kind of like what's going on in the world right now, how it's creating some of the uncertainty that we have and sort of what we do about it here?
Yeah, And I think as you mentioned, that's the big thing right now that's on everybody's mind. The Middle East war. And so year to date and the big headwind for the equity markets has been higher interest rates that the Fed is raising interest rates perhaps.
And that led to a bank failure, right?
Yes. And the Fed is trying to bring down inflation by raising rates. We can have a long debate on that as well. A lot of inflation is due to supply chain disruptions, which needs time to improve. But but that's what's been the yields going up. Interest rates going up has had has been a headwind for the markets.
And then we had the issue with the budgets that Congress kind of delayed it for another 45 days. So now there is not a speaker in the House. So we're going to have probably have to deal with this issue in another 30 days or so, which is a big uncertainty as well. If we're going to have a government shutdown and the the again, the the big thing that happened today is really the ten year yield kind of hitting 5%, which is the highest since 2007.
So almost 16 years. It's pulled back since a little bit. And there's a little bit of uncertainty as far as how the war is going to proceed. Is it going to be as large scale as everybody thought and hopefully and maybe a little bit more contained? And so I think those are those are the main things are happening.
Companies are reporting earnings right now. The third quarter earnings are coming in about 17%. S&P 500 companies have reported but they've reported better than expected earnings. A majority of the companies are going to report. Still. So if you look at how the equity markets have done year to date, then as of the close of Friday, S&P 500, which is dominated by the Mega-Cap technology companies, it's up about 11 and a half percent.
But if you look at the S&P 500 companies, equal weight. Yeah. So meaning that not necessarily overweight, they're larger market capitalization companies. That's actually down one and a half percent and smaller stocks measured by a Russell 2000 or even down more down, three and a half percent.
And that's a good point. I mean, if you had $500 invested in the S&P 500, the equal weight would mean that you've got $1 invested in all 500 companies equally. Right. As opposed to the S&P 500 that's market weighted. You might have $500 invested in the S&P 500, the top 500 companies, but the top eight or ten of them would represent, you know, a large, larger portion of that $500.
Then, you know, having the same amount, investing in each one. Rising interest rates. This is creating a problem not only here in the U.S., but globally. And companies are facing some slowdowns because it costs more to borrow money. Now, this is tough to fathom because for the 15 years prior when the Fed went through that zero interest rate policy that started post the financial crisis, they kept interest rates at zero to spur growth, to say, you know what, we need to stimulate the economy.
We need to come out of this recession or depression that we're in, and we're going to see how this goes. And during that time, they left rates at zero for 15 years and they were able to print trillions and trillions of dollars. But now that interest rates are the ten year Treasury, for example, now that that's at 5%, why is that such a big deal?
Why is that slowing things down? Because if you look historically, over the past 40, 50, 60 years, 5% doesn't seem that high, but it sure is creating some headwinds right now.
Yeah, I think, you know, we are going to be hitting a kind of a maturity wall in 2024 and 2025. What that means is that a lot of companies that had borrowed at much lower rates during, you know, post GFC, they're going to have to refinance that debt and whether they're going to be able to afford it or not, I think that's a big question.
But another headwind that we're seeing right now that's actually permeating in the economy is, as you know, the U.S. economy is 70% U.S. consumer. So consumption is a big part of the U.S. economy. And we are already seeing consumers falling behind on auto loans, on personal loans. So monetary policy works with the lag. And I think we're starting to feel the effects of higher interest rates right now.
So we're in an environment where the U.S. economy is going to be slowing down. Everybody has been talking about are we going to go into a recession or not? Nobody really knows that. But we are definitely slowing down here.
Yeah, I saw the reports recently about, you know, consumers falling behind on auto loans, sort of subprime auto loans that are defaulting at the highest rate since the financial crisis as of late. Obviously, some things are concerning and there are certain parts of our economy that are stretched thin because interest rates are higher. But now that interest rates are higher, there does create some opportunity.
The people that do have money or money in savings or investments, they're now earning a higher interest rate than they were before or there's potentially more opportunities for them.
Yeah, absolutely. I think I mean, you're looking at the Treasury market or the just the bond market in general. The composition of the market is changing a bit because the Fed that used to buy a lot of treasuries during their quantitative easing, which has just means bond buying, they're not letting those bonds mature and they're not reinvesting.
Go back to when those bonds mature, they're not reinvesting those dollars. They're just letting them fall off the balance.
So there's going to be more supply.
So there's a lack of a buyer out there. And so more supply means that interest rates could sustain.
Yeah. I think the second factor is large buyers of U.S. Treasuries, for example, of China, they're reducing their exposure. Yeah. So those are two headwinds. But the third one, as you mentioned, is that higher yields is not attracting buyers like individual investors, hedge funds, pensions, Insurers are starting to look at the bond market and at 5%, even on the 3 to 6 month versus the ten year, which is about similar now it's starting to look very attractive.
So there's going to be some demand, obviously. But also the U.S. government, as you mentioned, the interest costs are going up. So the U.S. government has to issue more bonds. I would say that the two factors of Fed letting their bonds mature, China not buying as much, but is the demand from individual and institutional investors going to be enough to kind of provide the supply demand balance, or would yields have to go even higher to attract more buyers?
Speaker 1
And so that's the point, is that even though the Fed might say, hey, right now we're going to hold off on raising rate, raising interest rates, that's just what they can control. They can't necessarily control what the open market does. And now you're seeing the ten year Treasury, you know, start to hit above 5% if they're all of a sudden becomes more supply and less buyers.
Those rates seem to go up a little bit more to attract investors. So even though the Fed might be hitting it, hitting the brakes on raising rates, that doesn't mean that they have control on what rates will actually do.
No, you're absolutely right. The Fed controls the policy rates, which are the short term rates. So they can move that up and down as they see fit. But the rest of the bond market is controlled by supply demand dynamics. And some of the factors that I mentioned, those are going to be the drivers of the yields on the bond market going forward.
And look, even though interest rates are higher, you're still seeing people where it makes sense for them to take out debt in this environment, but they're controlling those factors. They're making sure that they have it fixed for a certain period of time. They're not affected by floating rate, and they're being more thoughtful and strategic in terms of the types of debt that they're taking on today.
Then when interest rates are at zero, I mean, you could borrow money at 0% interest rates. How much are you going to borrow?
Exactly. Yeah, I think I think you're absolutely right on that. And I think sometimes people may look at the yields and say, it's 17, 16, 17 year high. It's going to have to come down. It may not. I think we are in a higher inflationary regime going forward for reasons that we've discussed in the past, and that may mean that we're in that higher for longer type of a rate environment going forward.
You know, I came across an interesting article over the weekend. It talked about the $109 trillion global stock market. Okay? U.S. represents about 42 or 43% of that share. But if I were to say to you, how many of the biggest 100 companies in the world are from the United States, would you say more than 30?
Less than 30. More than 50? Less than 50? What would you think?
I would say probably maybe even more than 50, more than you know, or more. Yeah.
I would probably fall that way, too. And I think that our home country bias and we think of Apple and Google and Microsoft and all the things that we feel in touch are are very real to us. But this article said 39 of the top 100 companies of the largest companies in the world are from the U.S.
That means that there are 61 huge companies outside the U.S. that we may not be aware of if we're only investing in the S&P 500.
Exactly. I think I think that we've made the case for international diversification. Obviously, there are great companies outside the U.S. Valuations are more reasonable. But again, there's something more subject to the macro environment. The U.S. dollar being strong, which has been strong, is always a headwind for international. But how do you get the properly diversified portfolio?
It makes a lot of sense.
As you talk about diversification. A couple of things that sort of made some big moves over the last week. Uncertainty tends to cause larger moves. Gold moved quite a bit in the positive direction over the last week and a half, obviously due to, you know, the uncertainty overseas and the war, but also the U.S. dollar not staying quite as strong.
Do you want to touch on anything?
Yeah, I think we talked about gold as really being a store of value and it's it's really a hedge against fiat currency or paper currency depreciation. So as we see the U.S. dollar maybe getting weaker, if interest rates maybe they have peaked, maybe they are not going to come down, but maybe they're not also going to go up as fast and and also the geopolitical tensions.
Always people are looking for a safe haven and and gold always shines in those kind of environments. And I think we've seen that against gold. We view it as a strategic asset in the portfolio. So it makes sense to have some exposure to gold as a hard reserve currency.
Yeah. Thank you, Susan. I mean, looked at this last quarter of the year is going to be really, really interesting because, you know, we are facing some headwinds with, you know, bank failures, inflation, higher interest rates, the fact that the S&P 500 got off to such. The U.S. markets and international, for that matter, got off to such a strong start at the early part of the year because they got beaten up a lot last year.
Companies are starting to report earnings. We've got headline risk with, you know, issues going on with higher interest rates and real estate, the war over across the seas. There's a number of reasons why not to invest and you can't just chase a higher yield or a higher interest rate now that rates have gone up and say, let me sell everything and go buy this thing x, Y, these x, Y, Z, that's going to pay me 7% a year.
It's really about having a diversified plan, making sure that you're being thoughtful. And right now is a time to take on calculated risk, revisit the things that you're exposed to, and ask yourself the question Am I getting paid adequately for the risk that I'm taking on today? And what alternative ways are out there for me to look at?
That would be a good place to start, would you say?
Yeah, absolutely. I think I'm being properly diversified, being truly diversified, which to us it means having some non correlated assets or asset classes in the portfolios, which they're not going to necessarily react the same way as stocks and bonds to general economy and the interest rates. And one area that we've been focused on that has done well and continues to do what is it in there in the private credit or private lending strategies?
These are mainly asset based lending strategies. So floating rate, senior secured, first name position and with proper assets as collateral to cover those loans. As the interest rates have gone up, we're seeing that those are actually on par with equities. In terms of return, are they going to be have it almost a lending tide profile with equity like returns?
So that's the area where we think we should be a little bit more focused on and we have focused on more now.
Sasan, thank you. Thank you for joining us today. Obviously, lots of headlines taking up the majority of, you know, our time and our consumption, very uncertain what's going on there. But there's still potentially some opportunities and ways to protect yourself. Is there anything that might come about in this current earnings reporting season that might surprise you?
I think, you know, obviously the market is expecting the higher mega-cap type companies to do well, but I think it's already priced in. So I think right now it's basically interest rates and the geopolitical situation that's driving the market. I think a lot of the earnings are going to come in line or a little bit better than they expected, and that's going to be a little bit of a positive for the market.
But there I think the macro drivers are already in charge right now.
Yep. Well, thank you so much for joining us, Sasan.
Disclosure: Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.
