Athos Capital Advisors – Monthly Newsletter
The Fed is Getting What it Wants
- The Fed is getting what it wants
- Inflation is going down
- Unemployment is going up
- Interest rates appear to have peaked
- This is good for most financial assets
- With two major tailwinds to the stock and bond markets
- A huge build up in money market assets – flows will likely reverse when rates come down
- Outside of the Magnificent 7 it has been a two year bear market
- 50% of stocks below October 2022 low
- Small caps have been down for 2 years
The Federal Reserve is getting what it wants. Jerome Powell said as much at a speech last week at a symposium in Atlanta. Inflation has slowed – prices continue to go up, they’re just going up at a slower pace – and the labor market has begun to loosen. The Fed has a “dual mandate” – price stability and maximum employment – and to engineer this they control the money supply and interest rates. Both components of The Fed’s dual mandate have been in significant disequilibrium ever since the COVID pandemic swept across the world in early 2020. After three years and taking interest rates from 0% to 5.5%, both inflation and the labor market (most importantly inflation) have moved much closer to the targets set by Jerome Powell and The Fed. This means The Fed may be done raising interest rates and might even begin to cut rates in 2024, providing a more stable outlook and boost to financial assets.
Equally important to the likely peaking of interest rates is the fact that markets now more accurately reflect the probable trajectory of interest rates. This hasn’t been true for two years and creates a much more favorable backdrop for financial markets.
Inflation Continues to Decline
Inflation has continued to decelerate, and the labor market has also weakened considerably. As long as the rate of inflation continues to come down and remains low, the Fed will likely conclude its cycle of raising interest rates.
The Labor Market is Loosening
The labor market also continues to show signs of loosening, down from the extremely tight levels seen in 2021-2022. Unemployment has begun to nudge higher and the number of job openings has continued to trend lower. The ratio of job openings to unemployed workers has fallen from a peak of 2 openings per worker in 2022 to almost 1.25 job openings per worker currently. A loosening labor market is considered a key factor in the fight against inflation; however, the Fed has been clear that it doesn’t intend to cause a significant rise in unemployment. As the labor market continues to weaken The Fed will have renewed pressure to cut interest rates and move policy to a less restrictive level.
Interest Rates May Have Peaked
News of cooling inflation and a looser labor market has allowed financial markets to adjust rapidly. The stock and bond market rallies in November occurred after a crescendo was reached on the 10-year Treasury yield, and as yields began to fall, stocks rallied. Interest rate futures markets now predict that The Fed is done raising interest rates, and a year from now, they will have cut interest rates by 100 basis points. We have experienced this tug-of-war between the Fed and the bond market several times in the past two years. Each time, the market lost as it fought against a Fed that was clear it would continue to raise interest rates and keep them elevated. While the market has swiftly priced in several rate cuts for next year, it is no longer egregiously out of sync with the likely trajectory of interest rates.
Tailwinds – Money Market Assets Eclipse $5.7 trillion
Investors have flocked to money market funds as interest rates have risen. This influx should create a significant tailwind for both stock and bond markets as capital begins to flow back into riskier assets in search of higher returns. We anticipate that this shift may have already begun as the market looks ahead and foresees a leveling off in interest rates – and consequently, the yield on money market funds – and even eventual rate cuts, which will further lower the yield on money market funds.
A Bifurcated Stock Market – Value Underneath
The stock market remains buoyed by a handful of mega-cap tech stocks, often referred to as “the Magnificent Seven”. While this dynamic is typically the case, 2023 has witnessed an even more pronounced trend than usual. The rest of the stock market has remained relatively flat this year, essentially experiencing a two-year bear market. In our view, this presents a positive tailwind for the stock market because valuations are much more attractive in the S&P 493, providing these stocks with significant room for a rebound. This, in turn, can contribute to greater breadth in the overall stock market.
Stock Market Returns Have Been Highly Concentrated
The chart above provides another perspective on the divided nature of the stock market this year. The number of stocks outperforming the S&P 500 is currently at a 30-year low. This underscores the importance of either having exposure to these top-performing stocks or owning the indices. Furthermore, approximately 50% of all Russell 3000 constituents recently traded below their October 2022 lows, further emphasizing the weakness beneath the surface, especially in comparison to the handful of stocks driving the market’s upward movement.
Interval Funds Continue to Outperform
Athos Capital clients are continuing to benefit from the robust performance of three floating rate private credit investments. These investments continue to generate consistent returns in a volatile environment, offering low volatility and high income. Both Cliffwater funds have gained over 11% year-to-date.
Outlook and Positioning
- It remains important to stay balanced across portfolios, sticking to long term asset allocation targets, and with a continued emphasis on best-in-class interval funds, high quality equities, select energy investments, and short duration fixed income
- Athos Capital’s Interval Fund lineup continues to generate high rates of income and low volatility with expected returns in the 11% range
- Traditional fixed income remains challenged – investors should continue to stay at the short end of the yield curve where risk is lowest and yields are the highest
- Continue to focus on high quality, large cap equities with recurring cash flows and strong balance sheets
As always, I look forward to hearing from you.
Henry A. Miketa
President & Founder