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Those Destined to Hang Need Not Fear the Water

Updated: Jul 20, 2023

I remember my first morning as a stockbroker at Everen Securities, which was the old Kemper Securities before it got bought by First Union, and then Wachovia, and then Wells Fargo.

It was on the 14th floor of 620 Newport Center Drive. Most of the offices were along the outer perimeter with large floor-to-ceiling windows looking out over Newport Harbor. My office was on the far side of the building from the lobby, so I had to walk down two and a half office-lined hallways to get to my office.

The first morning that I made that walk was almost 23 years ago. The stock market was up big that day, and the office was like a circus. As I walked down the halls, people were shouting and high-fiving and straight-up getting loose at 6:40 in the morning. It was nothing like the stodgy Merrill Lynch office where I had just come from.

There were several personalities in that office who shall remain unnamed here in this column but who should be described for the purpose of providing scale to the situation. One guy was the very gruff old-school stockbroker who did no financial planning whatsoever for clients; he simply built positions in a few stocks. …And he would shout at his clients; it was very odd. There was the guy whose mom was his biggest client, and he gave her a 1% discount on all of her trades so that she would get trade confirmations that read “discounted commission.” There was the guy who got his shoes shined every day because the shoeshine guy, who was sending his daughter to USC, would return his shoes with an eight ball in the toe. Every day. There was the 82 year old guy with the sign on his wall that said, “Never trust a stockbroker who is out of breath.”

That first morning, in June of 1998, they were all hooting.


I recently wondered what that office would have been like in June of last year; I expect it would have been about the same. From the bottom in late March of last year, the U.S. stock market went up nearly 75%. It was the best 12-month return of all time. Nearly 96% of stocks in the overall U.S. stock market showed positive returns over that period, which means it was also the easiest period of all time to participate.

Most investors already intuitively understand this, but it bears repeating just how highly unlikely it is that we will ever experience a 12-month period of returns like that again in our lifetime. How unlikely? As illustrated by this chart of normalized S&P 500 returns, that result lies more than two standard deviations from the mean, so the answer is more than 99.9% not likely:

Tail-end trading strategies have perhaps only a very small place in most investors’ portfolios, though, and the stock market has already stopped being so easy in 2021 anyway. While the S&P 500 recently hit its 26th new all-time high just for this year alone, a large number of stocks are currently getting destroyed.

It’s not just any stocks, either; it’s many of retail investors’ 2020 darlings such as Virgin Galactic, which is off 67% from its high, Peloton off 49%, Teladoc off 48%, Zoom off 47%, Penn National off 37%, Twilio off 37% and Tesla off 32%. They have all been getting massacred while the S&P 500 index has continued to new highs.

I thought it was simply fantastic last week when ARK Innovation’s Cathie Wood said that she "loves the set-up" of being down 30% or more on some stocks. It reminded me of a coach who is down three touchdowns at the half and says, "Now we have them right where we want them."


The reality is that a rising appetite for risk across a variety of asset markets has been stretching valuations for some time, and the vulnerabilities associated with elevated risk appetite have understandably increased. The combination of stretched valuations with very high levels of corporate indebtedness may serve to amplify the effects of any given re-pricing event.

That re-pricing event could be anything (say, the hacking of a major pipeline?), although some suppose that it will be The Taper. Tapering is the gradual reversal of quantitative easing and refers to the reduction of Fed asset purchases. The central banks of Canada and England have already started to taper, and we expect the Fed to follow suit and to signal their intention by this summer. While we don’t expect the Fed to actually begin tapering until Q4, we expect a stock market correction once the Fed signals their intention, and for long-duration assets like technology stocks, it could be more than a little one.


The breakeven inflation rate implies what market participants expect inflation to be, on average, in the next ten years. The 10-year breakeven inflation rate is currently at its highest level since 2013. This is a much better representation of inflation concerns than the 10-year Treasury yield because the Treasury is artificially low due to the Fed buying $120 billion of bonds per month. Once the taper begins, that spread will likely tighten.

So why don’t we expect tapering to start until the fourth quarter?

Last Friday’s jobs report emphasized the supply and demand mismatches that may take longer to resolve before peak employment can be reached and the Fed gets started. In the previous week, April nonfarm payrolls were 266,000 versus expectations of approximately a 1.0 million gain, and March payrolls were adjusted downward by 150,000 to 770,000. We actually had slowdowns in the manufacturing, construction, and mining sectors-- which is crazy in a year where everybody on The Street is calling for 7% GDP growth-- and the unemployment rate increased to 6.1% from March’s 6.0% rate, versus forecasts calling for a decline to 5.8%.

Too much stimulus? No comment; that’s too politically hot even for this column. We’ll just point out that the data continue to reflect a lower labor participation rate than pre-pandemic levels, even after the slightly better weekly numbers from new filings last week.


Therefore, we continue to emphasize:

· Value-oriented cyclical stocks, especially in financials and energy.

· Complementing high quality municipal bonds with private credit for potentially attractive yield premiums and diversification benefits.

· Maintaining an increased allocation to commodities.

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