Economic Update

February 2024 Investor Report       

Published: May 6, 2024Updated: May 6, 2024

The AI rally continued through February as the handful of stocks led higher headline indices. The technology-heavy Nasdaq Composite Index appreciated 6.1% for the month. The Dow Jones Industrial Average and S&P 500 Index gained 2.1% and 5.2%, respectively. The precious metal gold ETF (Ticker: IAU) increased in price by 0.42%. Market enthusiasm right now is high as the Investors Intelligence, AAII Survey, CNN Fear/Greed Index, and Citi Fear/Euphoria Index all report bullishness, “Extreme Greed,” or Euphoric levels.

On February 1st, the Federal Reserve Chairman appeared on ’60 Minutes’, where he continued walking back interest rate cuts in the face of a couple of stronger-than-expected inflation reports. The hawkish stance continued to push interest rates higher, while retail sales were weak for January, falling the most we had seen in almost a year (March 2023). Retail sales growth (year over year) has contracted three out of the last four months, but perhaps the most worrisome development was how broadly the retail sales declined. Nine categories saw decreased lead by building materials and auto dealers. These decreases should not be surprising as many borrowers are becoming delinquent on debt obligations. You pair the accelerating amount of delinquencies with a historically high nominal outstanding debt (over $1 trillion), the situation makes that consumers would pullback the reigns on spending and save a little more to either become current on their debt payments or start to pay down the outstanding debt growing at over 20%, on average. Towards the end of the month, we received a surprisingly weak Conference Board consumer confidence survey. The surprising weakness in the Conference Board reading, which focuses more on the labor market, was tied to the noticeable negative shift in employment expectations from participants. We have written on several occasions the differences between the University of Michigan Consumer Sentiment and the Conference Board Consumer Confidence survey. Over the last year, the University of Michigan survey, which focuses more on the individual household, has been noticeably weaker than the other popular survey. Now, the Conference Survey is reporting a material uptick in the number of people struggling to find new jobs. We have written about our concerns with the labor market and their readings and thought we might have reached an inflection point last summer. This Conference Board survey could be the first concurrent data point confirming that the leading labor indicators flashed red the previous summer. 

Meanwhile, capital inflows into artificial intelligence companies have increased headline indices in the stock market. As the capital flows into these historically significant weighted companies, more distortions between the haves and have-nots have grown. For example, in the Nasdaq, we are witnessing a period where the Nasdaq is hitting all-time highs but at a time where there are 50% more companies hitting their 52-week lows than compared to companies hitting 52-week highs. We last saw a cluster of these occurrences in November of 2021. At the same time, in the S&P 500, the top ten largest companies are currently valued at an eye-watering 30 times 12-month forward earnings. We have never seen this level of extreme valuations at the top before. Torsten Slok, the Chief Economist at Apollo Global, has recently called the current AI Bubble bigger than the Internet/Dotcom Bubble of the late 90s. Does this mean the market is going down in the near term? No, but it behooves us to be mindful of where we are and, more importantly, where we go before we put new capital to work. In the lead-up to their 4th quarter earnings release, the big winner of the AI run, Nvidia, saw their most open interest in call options, where the bettor needed the stock price to increase by 87% in 72 hours to just be in the money. These types of derivative positions are the type of speculation we are witnessing in AI and are unsustainable. Even with the admittedly good 4th quarter and 2024 guidance, the call options expired worthless after the stock price missed the strike price by 70%. 

Please see the following updates on existing positions held at the firm:

Short-Dated Investment Grade Bonds- As rates on the yield curve have risen, we have slowly started to see more opportunities in this asset class. As stated before, the minimum annualized interest rate we target is 6%. We are solely focused on quality credits as we are still in the early stages of a broader default cycle. Additionally, we are focused on short terms to limit interest rate risk. There are risks that longer-dated corporate bond rates could increase as U.S. Treasury rates increase. Increasing rates mean decreasing bond prices for fixed-rate bonds. We also have the chance that spreads between corporate bonds and the U.S. Treasury will widen. 

Peoples Financial- (Ticker: PFBX)- The Biloxi-based community bank announced its annual meeting on April 24th. As we mentioned on a couple of occasions in the last few months, we intend to support the activist investor Joseph Stilwell. He only seeks one board seat so that the existing leadership will maintain control. This vote will help remind leadership that the previous results from the last decade are unacceptable. We have already seen a shift in shareholder friendliness, but more is needed. As a firm, we control just over 3% of the shares outstanding, so while we are not in a control position by any means, we hold a material amount of shares. 

EOG Resources Inc. (Ticker: EOG)- The large independent E&P company issued downside guidance to their 2024 projections. EOG estimates that capital expenditures will range between $6.4 – $6.6 billion, higher than the $6 billion estimate 90 days ago. Additionally, the company projects that production will fall below the initial projections of 496,000 bbl per day at 486,000 – 492,000 bbl per day. EOG’s estimates were not unique, as we have seen a majority of significant independent E&Ps issue production estimates below expectations. These muted production estimates could set a high floor in energy prices in the coming 12 months as supply could struggle to keep up with demand.

FirstSun Capital (Ticker: FSUN)- We sold out of our position in the Colorado and Texas-focused bank after FSUN announced the merger with Seattle-based HomeStreet. We wanted to lock in our gains as we were left unsatisfied with the reasoning of the deal. While FSUN is buying HomeStreet at a significant discount to tangible book value, HomeStreet is an inferior bank. The merger with HomeStreet was done mainly to create liquidity for the large FSUN institutional investors. We are concerned that in the intermediate term, the flaws in HomeStreet impair the combined bank. 

During the first week in April, Michael Berkhahn and I will host our live quarterly video call. We will send a notice in a couple of weeks to allow our client partners to sign up. We look forward to discussing the latest developments in artificial intelligence companies, the Federal Reserve’s next step in their battle against inflation, and where long-dated interest rates go for the rest of the calendar year.

Best regards,

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Stash J. Graham

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