The economic data was positive overall this week and the markets seem to have taken the Fed rate hike in stride. Last week's market saw tech stocks take a backseat to industrials. But the recent fascination with AI returned this week and pushed markets higher. Is the market over-valued? Is this reminiscent of 1999?
The inspiration for this week's musings is the 1983 movie "Max Dugan Returns". This movie was not a box office success, earning only $17 million. I couldn't find an official budget for the film, but given that there were only a couple of high profile actors and no CGI or special effects to speak of in the film, I'm guessing the budget wasn't very high. Here's some trivia to enjoy about the film:
This film was Matthew Broderick's first film, although "War Games" was being filmed at the same time and was also released in 1983, albeit 3 months later. During filming of "Max Dugan," Broderick's real father, actor James Broderick passed away and on-film co-star Jason Robards helped Matthew through the loss.
Former professional baseball player and coach Charley Lau appears as himself and helps Broderick's character learn how to bat.
This film was one of many for famous playwright and screen writer Neil Simon. Actress Marsha Mason, who plays the lead role in the film was married to Simon at the time, but this was their last collaboration as they divorced just before the film was released. Broderick was also a regular to Simon's films, as he also starred in the film version of Simon's play, "Biloxi Blues."
This movie is one of three where Donald Sutherland and his son Kiefer Sutherland appear together. It was Kiefer's first role and he only has a bit part at the beginning of the film.
Here's what we've seen so far this week...
Sometimes, You Just Gotta Take What's Given. Markets are poised for another win this week despite cooling off on Thursday. Investors seem to think that the Fed is finished with rate hikes as current Fed Futures show an 80% probability of no rate hike in September.
The Fed has long proposed the idea that they need to continue to fight sticky inflation. For those who are not proponents of the CPI, but rather adhere to the Fed's favorite inflation barometer - PCE Prices - you're out of luck there, as well. The June PCE Price Index was released this morning and not only has the index been but in half over the past 12 months, but the current reading (3.0%) is below the long-term historical average (3.3%). This is one reason the markets seem to think the Fed is finished raising rates.
Gas prices are higher this month, which could add more to the bottom line when it comes to inflation for July. Along with the increase in gas prices, markets got a little spooked yesterday when the Bank of Japan hinted at a "more flexible approach" to yield management as inflation in Japan has been stickier than in the U.S. In addition, regulators announced yesterday that they might increase capital requirements for the largest banks (between 16-20%) in order to protect against future banking issues. Smaller banks with $100-250 million in assets would only see an average increase of 5% in capital requirements. This also spooked markets as banks would have less capital to loan, which would threaten future economic growth.
Fortunately, the Fed doesn't fall into that camp as they are no longer forecasting a recession this year. The market tends to agree. It reminds me of the inspiration to this weeks musing from to "Max Dugan Returns." The main character, Max Dugan (played by Jason Robards), seeks to make a mends with his daughter by giving her money to make up for the lost years of not spending much time with her as her father. His daughter, Nora (played by March Mason), refuses the money and any subsequent gifts. In the end, she relents to at least some of the gifts as she is in a bit of a financial pickle. Just like Nora and the markets, sometimes, you just gotta take what you're given.
Can You Make Money In This Environment? Max Dugan's grandson Michael (played by a young Matthew Broderick) asks him, "Can you make money from philosophy?" To which Max replies, "Yeah, if you have the right one."
When markets seem to be stubbornly moving higher, it's important to remember the impact of missing some of the best days in the market. If an investor were to have missed just the 10 best days over the last 20years, the difference in return is nearly cut in half. Trying to time the market is extremely difficult and not well-suited for adhering to long-term financial plans.
If we just look at the positive calendar years for the S&P 500 Index versus the negative years, since 1970, the market is positive nearly 80% of the time. Staying invested serves investors best, even if invested during down years. If negative and positive calendar years were a 50:50 toss-up, maybe one could understand trying to time the market to avoid the negative years. But, at only a 20% occurrence, trying to time negative markets isn't the best philosophy.
That's not the current reasoning of infamous money manager John Hussman, as he's calling for a market crash. Hussman gained notoriety for correctly predicting the 2000 and 2008 stock market crashes. What's the problem with that, you ask? Following the 2008 Financial Crisis, Hussman remained a "permabear" and kept his mutual funds at an extremely conservative allocation. His more notable fund - Hussman Strategic Growth - maintained a high cash/bond allocation post-2008 and it cost him dearly. Currently, the fund holds more than 30% in cash and is short the market. The fund is down nearly 10% this year, while the S&P 500 Index is up more than 19% - which would explain why the firm has lost 76% of its assets over the last 10 years.
Is it possible markets are overvalued? Is AI due to implode? First, there is a reason for the excitement around AI. If we look at the graphic, it took the internet 7 years to reach 100 million uses after its launch in the early '90s. Facebook, took over 4 years to reach 100 million users. TikTok reached 100 million users in 9 months. Most recently, ChatGPT took only 2 months to reach 100 million users and @Threads, the Meta-owned AI platform, reached the same mark in only 5 days! It's not too difficult to see the capabilities of AI and the potential to change the way we interact and conduct business. However, just like the internet, AI is in its infancy and a consolidation is likely ahead. In conjunction with that thought - can we say that the market is over-valued? Markets do not react with reasoning alone and tend to follow irrational thought patterns.
Why? Well, because markets are made up of investors (human beings) who are often irrational. We would argue against full valuation of the market at the moment. In terms of Forward P/E, the S&P 500 is trading at a 12% discount to the previous high in December of 2021. In terms of Profit Margins, the S&P 500 is trading at a 16% discount to the previous high in December of 2021. Lastly, the fundamentals point to companies continuing to profit. Personal Spending increased in June and May's number was revised higher. The first reading of 2nd quarter GDP came in hotter than expected (+2.4%) versus Q1 (+2.0%). The latest estimate from the Fed's GDPNow is calling for +3.5% GDP in Q3, with a 30% increase in Personal Consumptions, quarter-over-quarter. For now, we need to accept what the market is giving and stay invested. There will come a time to be defensive, but we believe that time is not now.
Remember the sage words of Max Dugan when it comes to investing...
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