Private Wealth

Weekly Research Briefing: Safety of the Port

June 22, 2022

A ship in port will not catch fish, but it also won't sink during stormy seas. You have probably noticed that the recent market movements have been among the most violent ever recorded. The last two weeks have seen some epic swells that even broadsided the leading groups, like the energy sector. This is what bear markets do. They roll through and hit everything. Valuations have declined across the board as uncertainty for the global economy increases. Rising prices and rapidly tightening financial conditions have thrown the economic throttle into reverse with nearly all U.S. GDP outlooks increasing their likelihood of a recession. The big question now is how severe could a recession be and how badly will it damage the credit and bank lending markets?

The FOMC gave us some clues last week. Jerome Powell noted that they are most focused on getting inflation under control and restoring price stability. While Fed Funds rate hikes will continue, they did note that the markets are doing much work for them right now. We are seeing this as the capital markets grind to a crawl and consumer borrowing rates have surged causing a pullback in demand. Not much to do on the cost of energy with Kuwait thinking that the war in Ukraine has added $30 per barrel to current prices. A global economic slowdown will help prices ease as we witnessed last week, but there is not that much that can be done to end the war and reverse the energy drilling underinvestment that occurred during 2020. It could take years before oil prices settle back into the $60-80 range again which explains the ramp in the 'F-150 for Prius' trade.

These are difficult times for investors. While one-sided bearishness and much lower valuations are tempting, you should only buy equities today if you are prepared to ride through even more stormy seas. The prices you pay today could easily fall 20%+ during the summer and the rest of 2022. You have likely already spring cleaned your portfolio of the stocks that were overvalued and where you saw downside earnings risk. Hopefully, your core portfolio is one that you feel good about riding through a mild recession: Defensible top lines, sustainable margins and the ability to generate cash flow. A mild recession will take many companies into the rocks, and you want to own a portfolio of companies that can survive the storm and emerge stronger when inflation and the Fed eases. Our days are now getting shorter. Winter is coming. Be ready.


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The S&P 500 makes a much lower low...

Sp500

StockCharts


And credit yields set a much higher high...

This is not a time to be standing on the stock market's railroad track.

credit yields

Bloomberg 


$10 trillion in equity value evaporated in the last week...

And $25+ trillion since November.

equityvalue

@Schuldensuehner


Equity valuations in a free fall as investors shift their thinking from "what if" to "how severe" a recession...

It was “the worst stretch of selling in the history of the S&P 500,” according to Sundial Capital Research’s Jason Goepfert, who noted that there were five days since June 8 when more than 90% of the index’s stocks finished lower. The question now is how much more can go wrong.

Plenty. The week’s drop, which sent the S&P 500 into a bear market, was caused by rising bond yields, some weak economic data, and, of course, the Federal Reserve, which raised interest rates by three-quarters of a point for the first time since 1994.

And there’s more where that came from. The Fed, battling inflation unlike any it has seen in the past 40 years, could raise interest rates higher than currently expected—there’s an 89% chance of another three-quarter-point increase in July, although the chances of that happening in September are much lower—while signs of an economic slowdown emerged this past week as housing starts fell 14% month over month in May and retail sales dipped 0.3%.

 “The Fed needs to bring inflation down, and the growth rate of the economy will be a victim,” says Dave Donabedian, chief investment officer at CIBC Private Wealth US.

Barrons


Congratulations for living through one of the speediest declines of all time ...

bearmarket

BofA Global


The Atlanta Fed has moved its Q2 forecast to +0.0%..


Q2forecast

Atlanta Fed


And given the ongoing economic disappointments, it is probably only a matter of days before the Q2 GDP forecasts move into the red ...

Q2 GDP

 

Daily Shot


Just a little heads up from the Philly Fed to the ISM Manufacturing watchers...

@SusanneSpectr: Ouch. 2023 does not look like it will be a good year.

SusanneSpectr

Goldman dials up the odds and potential timing of a U.S. recession...

Goldman Sachs Group Inc. economists cut their US growth forecasts and warned that the risk of recession is rising. 

The Goldman team now sees a 30% probability of entering a recession over the next year, up from 15% previously, and a 25% conditional probability of entering a recession in the second year if one is avoided in the first, they wrote in a Monday research note. That implies a 48% cumulative probability in the next two years versus 35% previously.

 “We now see recession risk as higher and more front-load,” economists led by Jan Hatzius wrote in the note. “The main reasons are that our baseline growth path is now lower and that we are increasingly concerned that the Fed will feel compelled to respond forcefully to high headline inflation and consumer inflation expectations if energy prices rise further, even if activity slows sharply.”... 

“What might a recession look like? With no major imbalances to unwind, a recession caused by moderate overtightening would most likely be shallow, though even shallower recessions have seen the unemployment rate rise by about 2½percentage points on average,” the Goldman economists wrote. “One additional concern this time is that the fiscal and monetary policy response might be more limited than usual.”

Bloomberg


Ditto for BofA...

@MylesUdland: BofA cuts its US growth forecast, sees a 40% chance of recession next year. "In the spring of 2021, we argued that the biggest risk to the US economy was a boom-bust scenario... Over time, the boom-bust scenario has become our baseline forecast."

MylesUdland

The S&P 500 is fully discounting a recession right now...

Unsurprisingly, stocks typically don’t do well during recessions. The S&P 500 has fallen a median of 24% during recessions going back to 1946, according to research from Deutsche Bank.

 “If we don’t get a recession, we are getting close to extreme territory,” Deutsche Bank strategist Jim Reid wrote in a note. 

The silver lining for investors is that, when the Fed begins to shift toward easing monetary policy, markets have historically responded positively and quickly—especially if the primary cause of their slide was related to central-bank policy, according to Goldman Sachs’s analysis. 

What no one is sure of is when exactly the Fed will shift gears, and how much more pressure the economy might come under in the meantime.

WSJ

wsj

It has been a while since the BofA/ML Bull & Bear indicator has hit zero. ...

And don't forget that a zero reading is actually a bullish indicator.
BullBear

BofA Global


Tidbits from the Fed Chair Powell last week tell you what the #1 priority of the FOMC is right now...

“Over the coming months, we will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2%. We anticipate that ongoing rate increases will be appropriate -- You know, frankly, we saw last year inflation came down over the course of the summer, and then turned right around and went back up. So I think we’re going to be careful about declaring victory.”

“I will say, the worst mistake we could make would be to fail, which it’s not an option. You know, we have to restore price stability. We really do, because everything—it’s the bedrock of the economy. If you don’t have price stability, the economy is really not going to work the way it’s supposed to.”

“Frankly, I think this year has been a demonstration of how well it can work. You know, with us having really just done very little in the way of raising interest rates, financial conditions have tightened quite significantly through the expectations channel as we’ve made it clear what our plans are. So I think that’s been a very healthy thing to be happening.“

The Transcript


While stocks have taken up most of the conversation, it is actually bonds and credit that have worried investors the most...

bondsandcredit

BofA Global


Volumes have exploded for the bond and bank credit ETFs, as longs want out (and shorts want in)...

volumes

BofA Global


Rising 30-year mortgage rates and higher home prices have made a new existing monthly mortgage cost 50% more in the last six months...

30yr

(@M_McDonough)


So it is no wonder why home sales activity is slowing rapidly...

But the lack of available inventory is still keeping prices stubbornly high.

The median existing-home sale price in the U.S. shot above $400,000 in May, setting a new record, as the housing market stalled under the weight of higher mortgage-interest rates. 

Sales of previously owned homes slid for a fourth straight month, declining 3.4% in May from the prior month to a seasonally adjusted annual rate of 5.41 million, the weakest rate since June 2020, the National Association of Realtors said Tuesday. May sales fell 8.6% from a year earlier.

 Home-buying demand continues to exceed supply, buoying home prices to new highs. The median existing-home price rose 14.8% in May from a year earlier to $407,600, a record high in data going back to 1999, NAR said. 

“The impact of higher mortgage rates have not been fully reflected in the data,” said Lawrence Yun, NAR’s chief economist. “In the upcoming months, I do anticipate a further decline in home sales.”... 

The average rate on a 30-year fixed-rate mortgage was 5.78% in the week ended Thursday, the highest level since 2008 and up from 2.93% a year earlier, according to housing-finance agency Freddie Mac. 

Mortgage applications to purchase homes have declined in response to rising rates. Two real-estate brokerage companies said last week they would lay off hundreds of employees due to decreased home-buying demand.

WSJ

homesale



Home builders are now in the foxholes with helmets on...

"While our second quarter results demonstrate strength and excellent performance throughout the quarter, the weight of a rapid doubling of interest rates over six months, together with accelerated price appreciation, began to drive buyers in many markets to pause and reconsider. We began to see these effects after quarter end."

"The Fed's stated determination to curtail inflation through interest rate increases and quantitative tightening have begun to have the desired effect of slowing sales in some markets and stalling price increases across the country. While we believe that there remains a significant shortage of dwellings, and especially workforce housing, in the United States, the relationship between price and interest rates is going through a rebalance."

Lennar Corp 


And the rest of the housing industry is preparing for a dramatic slowdown in volumes even as sellers are quick to cut prices...

"With May demand 17% below expectations, we don’t have enough work for our agents and support staff, and fewer sales leave us with less money for headquarters projects -- But mortgage rates increased faster than at any point in history. We could be facing years, not months, of fewer home sales" - Redfin (RDFN) CEO Glenn Kelman

The Transcript

transcript



Homebuilding stocks have few fans remaining ...

@bespokeinvest: Roughly 2/3 of homebuilders are down 40%+ YTD.  Many of them fell 15%+ last week alone and are 15-20% below their 50-DMAs. These are massive declines. (Jun 20)   homebuilderdown


And the stocks are now trading below their pre-COVID prices...

In other words, the big 'work from home' shift was a total bust for long term investors in the stocks.

longterminvestors

(@bespokeinvest)



Checking in on the tech mega caps also shows little love from investors...

@bespokeinvest: Every mega-cap Tech stock is down at least 25% YTD as we approach the halfway point of 2022. (Jun 20).

megacap

Let's see if the Nasdaq can hold onto its 200-week moving average now which looks to be a big level for investors...

Nasdaq

BofA Global 


As we noted, a bear market claws its way through everything and last week it was the energy sector's turn to be mauled...

@LizAnnSonders: That was quick: S&P 500 Energy sector has entered its own bear market, its worst drawdown since December 2021

energysector

Utilities were also hit hard this month because of the bear and rising rates. But this is an interesting long-term chart. Could it all be interest rate related?

@hmeisler: I've probably shown this chart a dozen times over the year. Long term Utes.

hmeisler

The 60/40 portfolio returns continue to challenge their worst windows...

@bespokeinvest: This has been the 2nd worst period for traditional “60/40” portfolios (60% stocks, 40% bonds) since the 1970s. Only the worst stretches of the Financial Crisis were worse. (Jun 18)6040


Someday, lower prices will attract buyers. The sample size continues to shrink but maybe we are getting closer...

@RyanDetrick: The S&P 500 was down 5.8% last week, for the second consecutive 5% weekly drop.

That's the bad news.

The good news is a year after such events the returns have been solid. Up 28.3% on average and higher 6 of 7 times (only 1987 crash was lower a year later).


1987


More importantly to buyers is that the P/E multiple gets cheaper by the week...

 @FactSet: The forward 12-month P/E ratio for $SPX of 15.3 is below the 5-year average (18.6) and below the 10-year average (16.9).

factsetS&P 500


And while the big caps trade toward 15x, the small caps are trading at 10x. Now do we believe in that 'E'? ...

@1MainCapital: Forward positive P/E on Russell 2k is sub 10x.

maincapital


If you have real estate exposure, you will want to dig into this new paper...

Office real estate assets with excess debt leverage could have challenges with interest rates rising and the current lending environment difficult.

Work From Home and the Office Real Estate Apocalypse

Date Written: May 31, 2022

Abstract

We study the impact of remote work on the commercial office sector. We document large shifts in lease revenues, office occupancy, lease renewal rates, lease durations, and market rents as firms shifted to remote work in the wake of the Covid-19 pandemic. We show that the pandemic has had large effects on both current and expected future cash flows for office buildings. Remote work also changes the risk premium on office real estate. We revalue the stock of New York City commercial office buildings taking into account pandemic-induced cash flow and discount rate effects. We find a 32% decline in office values in 2020 and 28% in the longer-run, the latter representing a $500 billion value destruction. Higher quality office buildings were somewhat buffered against these trends due to a flight to quality, while lower quality office buildings see much more dramatic swings. These valuation changes have repercussions for local public finances and financial sector stability.

SSRN


What if this was just a training run before the beaver and his posse hop a floating log into Vancouver...

Single beaver caused mass internet, cell service outages in Northern B.C.

PRINCE RUPERT, B.C. - Officials have now identified a beaver as the cause of a June 7 outage which left many residents of northwestern B.C. without internet, landline and cellular service for more than eight hours.

The beaver gnawed its way through an aspen tree which then fell on both BC Hydro lines and a Telus fibre-optic cable line strung along BC Hydro poles between Topley and Houston.

The resulting power outage affected just 21 customers but the fibre optics damage affected Telus customers in Burns Lake, Granisle, Haida Gwaii, the Hazeltons, Kitimat, Prince George, Prince Rupert, Smithers, Terrace, Thornhill, Houston, Topley, Telkwa, Fraser Lake and Vanderhoof...

BC Hydro official Bob Gammer said crews identified a beaver as the culprit because of chew marks at the bottom of the downed tree.

The lines are located in a swampy area and with the high water levels, there was some difficulty accessing the site, he added.

“It's unusual, but it does happen every once in a while,” Gammer said. “So I wouldn't be a rich man if I had a nickel for every beaver outage, but they do happen.”

BCTV News


Book a Southwest flight to Austin immediately...

We’ve received a decree from the mayor, folks: The beach is staying open, no matter what’s in the water. Only, we know what’s in the water. It’s Jaws.

The Alamo Drafthouse’s Rolling Roadshow has been running Jaws On The Water, its most celebrated event, long enough for CNN to declare there’s no scarier way to watch Steven Spielberg’s first true masterpiece. At Lake Travis’ beautiful Volente Beach Resort, audiences gather to compare scars, chum their stomachs with food and beverages, and scream in terror and delight at one of the greatest movies of all time, in the greatest possible viewing environment imaginable.

Jaws is scary enough on its own - but imagine watching it while bobbing on open water in an inner tube, your feet dangling into reach of untold marine terrors. That’s the Jaws On The Water experience: a true must-do for any fans of film, fun, or fish. And though Lake Travis may well be away from the ocean, we can’t guarantee that it’s shark-free (or rather, that it’s free of scuba divers trained to make the experience as four-dimensional as possible).

Birth Movies Death 

jaws

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DISCLOSURES

The author has current equity ownership in:none.

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, Hamilton Lane is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of Hamilton Lane.

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