The final month of the first quarter ended on a strong note, with equity prices continuing to rise. Momentum continues to grow. The S&P 500 Index had an impressive month, appreciating by 3.10%. The Dow Jones Industrial Average and the Nasdaq Composite also showed positive gains of 2.08% and 1.79%, respectively. Precious metal gold emerged as the top performer, with our gold position (ticker: IAU) increasing in price by 8.69% during March. Despite the underperformance of the equal-weighted S&P 500 compared to the capital-weighted (headline) S&P 500, the market’s overall performance was encouraging. The ‘average stock’ (equal-weighted S&P 500) does have some catching up to do, as its performance is lacking compared to the headline index, which has reached its second widest gap since 1958.
The March Federal Open Market Committee meeting ended generally with the status quo. Markets participants concluded the meeting, projecting three rate cuts before the end of the calendar year. Upward revisions to growth and rate forecasts beyond this year suggest more policymakers now believe the neutral interest rate has moved higher — which means it will take a higher fed funds rate to achieve a given level of restrictiveness in the economy. If policymakers saw “unprecedented” deterioration in the labor market, Fed Chair Powell did not dismiss the possibility of a rate cut by the FOMC as soon as May or June. As of March 28th, the Bloomberg Financial Conditions Index was 1.1, the highest level since December 2021. This high reading speaks to how loose financial conditions currently are. Also, it explains why the FOMC participants decided to shave a rate cut-off in 2025. While the inflation data for the last couple of months has been higher than expected, we are concerned about the last quarter of the year. As we mentioned in our 2023 recap call in January, our inflation-leading indicator economic indicators (LEIs) bottomed back in October. Concerns over the U.S. fiscal trajectory is understandable, especially in sticky inflation and “higher for longer” situations. Financial repression, supported by our structural preference for real assets such as materials and commodities, will be the path of least resistance in the face of high inflation and rising deficits and debt.
Due to the excess cash on hand and the expectation of further loosening of financial conditions, investors in corporate bonds have accepted the least amount of default risk compensation since the global financial crisis. When the “everything rally” ends, the overpriced credit markets are ready for a sudden correction. Investors’ additional compensation for lending to US corporations, rather than the government, is diminishing as the outlook for the economy improves and monetary policy appears to be softening. As a result of the 150 basis points of the Federal Reserve’s projected cuts, credit spreads started to fall by the end of 2023. The spreads continued to tighten even as traders reduced their forecasts. Risk premiums on corporate bonds are rapidly converging, even if you don’t notice them.
Market momentum continues to be the stock market’s best friend. As of March 25th, the S&P 500 has had 100 consecutive trading without correcting 2%. Going back to 1950, the eight other times that this has happened, the S&P 500 was higher six months later (median return was 6.8%). Additionally, going back to 1965, when we add that more than 10% of this 100-day rally has experienced 80% of the trading volume flowing into advancing company stock, we also notice a 100%-win rate in the 23 times this has occurred. On the other side, going back to 1985, the net position of small traders in S&P 500, Nasdaq 100, and DJIA index futures, full contracts, and e-minis are at all-time highs. Investor sentiment is at extremely bullish levels. Smaller traders experienced similar extreme bullish sentiment in May 2001, March 2005, May 2007, August 2021, and now, March 2024. At these points in history, the stock market has shown resilience for the coming 3-6 months, but the 12-month time frame is ugly. The poor one-year returns make sense, considering how the highly bullish sentiment is associated with market tops. In summation, the short-term momentum for the stock market is still favorable (this is why we have not sold out of a material amount of equity positions). Still, the sentiment is at historically worrisome levels, which can be a problem for the end of the year.
Please see the following updates on existing positions held at the firm:
State Street Series D Preferred (Ticker: STT-D) and Wells Fargo Series Q Preferred (Ticker: WFC-Q)- As predicted, on March 15th, trust company State Street and systemically important bank Wells Fargo called their Series D and Series Q preferred stock, respectively, before the dividend rate was allowed to float higher. The annualized yield on the STT-D investment was just under 7%, while the annualized rate on the WFC-Q position was 6.8%. All dividends received by both preferred stocks were qualified (QDI).
Equity Commonwealth- (Ticker: EQC)- According to the Wall Street Journal, activist investor Land & Buildings, led by Jonathan Litt, has accumulated a 3% stake in Equity Commonwealth and is considering a proxy fight, which cited a letter the activist sent to the board. The activist investor would like the REIT liquidated promptly and all proceeds returned to shareholders. If this were to happen, the Series D preferred stock (EQC-D) would be called at par value plus accrued dividends. We estimate the liquidation price for the common equity shareholders to be around $20.50.
Kinetik Holdings (Ticker: KNTK)- The Permian-focused midstream has had a nice run over the last six months. We still have a high probability of a sale occurring in the coming years. The large institutional shareholders that comprise a significant portion of the shareholder count are selling. Apache Corporation filed a secondary offering of 11.37 million shares of its Class A common stock at $33.75 per share. Apache has been selling its position in KNTK to simplify its structure and pay down debt. We continue to like the underlying operations of Kinetik.
Franco Nevada (Ticker: FNV)- The royalty company has found solid footing after a difficult six months for the stock price. We initiated our position in the company earlier this month on the prospect of the royalty company’s biggest project, Cobre Panama. A secondary consideration we witnessed in the last couple of months is the rise in gold prices. Gold is the most significant precious metal FNV has been exposed to, and its rise has helped Franco Nevada find a floor. We look forward to a resolution in Panama, which will be the next catalyst for the stock to rise.
During the first week in April, Michael Berkhahn and I will host our live quarterly video call. Please feel free to call the office if you need help signing up for the call. 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,
Stash J. Graham
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