As of last week, the total return of the S&P 500 was even with 3-month Treasury bill returns since the valuation peak of January 2022, more than two years ago.
-John P Hussman, Ph.D.
Stocks pulled back in April with the S&P 500 falling about 6% from its intra-day high on March 28th to its low on April 19th, before bouncing a bit into the end of the month. The drop wasn’t quite enough to enter a formally recognized “correction” of 10%.
The S&P 500 finished the month down 4.2% but remained up 5.6% in 2024. The Equal Weight version of the index was down 5% in April and was only up 2.1% for the year as of the end of the month.
The Top 10, the Magnificent (Mag) 7, and the Fabulous (Fab) 4 are all still beating the broad indexes - although the Fab 4 was down the most (-6.6%) in April, thanks largely to Meta Platforms selling off after exceeding earnings expectations… which of course, makes little sense; much like what you’ll read below about how Tesla’s stock reacted to a brutally bad earnings report. A sign of the times. And a reminder that the market remains heavily concentrated in the biggest names.
We may still see the S&P 500 enter correction territory before we see a new high, which in my estimation would be a healthy development. But we’ll just have to wait and see.
I am still fundamentally bearish and would not be the least bit surprised to see stocks fall even further than 10%, reaching the 20% threshold for a new “bear market.”
There is nothing special about a 10% or 20% drop from highs – these are just conventions that market participants have adopted. Corrections happen. Bear markets happen. They are nothing to be afraid of, rather they are opportunities to seize. The big challenge is recognizing them in real time because they are only formally defined after they have occurred. You just never know when the first 5% drop will turn into a 10% correction, 20% bear market, or worse. This is why I so often remind you that at Elevate we don’t predict, we prepare.
We prepare for a wide range of outcomes so that we don’t get caught flat footed. We use rules-based exit strategies to get us out of positions (even in great companies that will be around forever) when they start to behave abnormally. We use objective statistical analysis, and not “gut” feeling, to identify abnormal behavior. And then we turn around and use rules-based entry signals to get back in the game when the situation has passed.
Seems pretty simple right? Why doesn’t everyone do it this way, you ask?
Well, it’s a lot of work, for one. Most advisors would rather manage your expectations than your portfolio.
Another issue is there is a risk of being wrong. For example, sometimes we exit a position on the basis of a rule being triggered and it turns out to be the low point for the stock. As soon as we sell the stock bounces and if we want to get back in, we have to pay more than what we sold it for. It happens.
This is the risk we have chosen to take in place of taking the risk that a stock (or the whole market) will drop far more and along with it, our portfolio value. I think our way is the better approach, and if I didn’t, we wouldn’t do it.
We could always just buy “the market” using a bunch of low-cost ETFs and let it ride, like everyone else. In fact, we do offer that style, but it isn’t a big part of our business. I think we actually do that better than our competitors, too. And we do it for a lower cost than they do. I just don’t think it is the best way to invest. Call me crazy.
Anyway, back to the markets…
Stocks don’t have to fall into correction territory from here. They could always resume their rally after the brief “pullback,” if you want to call it that. In my view, there isn’t much (if any) strong economic reason for that to happen, but that hasn’t stopped stocks from grinding higher since the last correction that ended in October last year, or since the lows of the bear market in October 2022 for that matter.
The stock market has largely rallied from those lows despite the economic backdrop, not because of it.
Last month, I showed you that while government officials and financial media keep talking about inflation falling, inflation is actually not falling. In fact, it is probably accelerating. I’ll show more evidence of this in a moment.
As regular readers know, when the financial media and their guests talk about inflation falling, they are really talking about “disinflation,” which doesn’t even mean that prices are falling. It means prices are rising by less than they did at some point in the past. And of course, this all depends on which point in the past you want to use.
For example, prices are rising by a over 3% per year right now (depending on the measure of prices used). That is a lower rate of increase than during 1980. But what does that matter?
The current rate of inflation is also less than the 9% rate we saw in June 2022, which is great, but again, what does that matter?
As I have been writing in this commentary for months, disinflation has stalled. We got more evidence of that fact on April 10th, two days after my last commentary was published. The report showed that prices in March 2024 rose by 3.5% from a year earlier. The last time “inflation was falling” according to this data was June 2023 – almost a year ago.
Again, disinflation (the correct way to say it) has stalled.
It seems like the Federal Reserve (Fed) has finally noticed.
The Fed’s Board of Governors meets every 6 weeks to discuss the economy and monetary policy and sets the price of money by adjusting short-term interest rates. When rates are higher it costs more to borrow money and is supposed to slow down the economy while keeping a lid on price increases. When rates are lower, money is relatively cheaper which stimulates the economy and drives prices higher.
These actions generally impact the job market and employment rates, too. Higher interest rates and a slower economy leads to fewer jobs and higher unemployment rates, while lower interest rates lead to more jobs and a lower unemployment rate, all else equal. Unfortunately, all else is rarely, if ever, equal.
The Fed’s job is two-fold: to maintain price stability and maximum employment.
These two mandates are in constant tension with one another. Going too far with interest rates in either direction means one of the mandates will not be achieved. They are constantly trying to thread the needle… it’s really no wonder they fail so often.
In my opinion, it’s a silly proposition to think that any person, or group of people could ever consistently get this right. The market itself would be at least as good at setting the appropriate interest rate without any human intervention. Sure, there would be booms and busts but how is that any different from now? It just seems like a lot of wasted effort to have something like 800 Ph.D. economists working at the Fed and still failing to prevent the business cycle from running its natural course. Those people could be doing something more useful.
At any rate, the Fed made a few changes to their post-meeting press release/statement. One of which was the addition of a new sentence which says:
In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.
No kidding! I’ve been writing about this for months!
The other major development relates to the Fed’s balance sheet. Without getting too far into the weeds here, the Fed owns a bunch of bonds. They bought bonds during various times since the Great Financial Crisis in 2008-09 to keep interest rates artificially low and stimulate the economy. The insanely high rates of inflation we have seen in recent years is the direct result of this “zero interest rate policy” or ZIRP. They were allowing $60 billion per month of these bonds to mature which had the effect of removing some of that artificial stimulus. Starting in June, they are only going to allow $25 billion per month to mature and “roll off” their balance sheet. This basically means that they are taking their foot off the brake as it relates to slowing the economy, which, all else equal, will help to reaccelerate inflation.
Friends… this makes no sense, and they have no clue what they are doing. They are seemingly trying the economic version of the sales tactic of “throwing things at the wall to see what sticks.” And you and I get to be part of the grand experiment. Make no mistake – there is no precedent for any of this. It’s 100% trial and error. My bet is we’ll continue to learn things the hard way – through error.
Take for example a comment Chairman of the Fed, Jerome Powell made in response to a question during his post-meeting press conference. Here is the exchange:
Question: [The recently reported] GDP [growth rate] has led some to start mentioning the term “stagflation” with respect to the U.S. economy. Do you or anyone else on the FOMC think this is now a risk?
Powell Answer: I don't see the “stag” or the “flation,” actually.
To be fair, he said more than that but that was his punchline. Which, I’ll admit is humorous. You can read the whole transcript here.
However, this is the same guy that didn’t see inflation being a problem in 2021 just before it spiked to a 40-year high. Back then he (famously) said inflation would be “transitory.”
Here we are 3 years later still dealing with inflation rates that are nearly double the Fed’s 2% target and that is using calculation methods that are not the same as they were back in the “stagflationary” 1970’s.
According to economist John Williams who runs the great shadowstats.com, using 1980 methodology for calculating inflation, it was closer to 17% in June 2022 when it was being reported as 9%, and is probably still around 11% today – not 3.5%.
Anyone who has left their home in the past year knows this intuitively.
Now, this doesn’t mean (to me) that government statistics cannot be trusted or useful. But it is illustrative of why I like to focus on the rate of change in the numbers, not in the numbers themselves. Notice how the two lines in the chart above move in seemingly perfect unison. And, if the data we were getting was totally fraudulent, there is no way we would have ever seen a 9% inflation rate. They would have just changed it and we’d see a very flat line around 2% over time.
That said, I have a lot of respect for Bill Bonner who has been writing about financial topics for probably longer than I have been alive, and he recently raised an interesting question about GDP growth rates:
Another curiosity of the GDP growth story is the role of fiscal deficits. If the government spends another billion dollars – even if it is frittered away on weapons – the amount is included as a plus in GDP. So, the more the feds spend, the higher GDP goes... at least in the short run.
Deficits are especially important. If the government takes in $100 in tax revenues, and spends it, it removes that money from the consumer economy. No net increase to GDP.
But if it borrows the money, the extra spending it comes as if "out of nowhere," and is added to the total. There is no offsetting drawdown in the consumer economy, so GDP goes up.
Last year, federal deficits were 6% of GDP. That was money that the feds spent, but didn't raise from taxes. It must have gone somewhere. So, here's a simple question:
How could the feds pump an additional 6% (of GDP) into the economy, with almost $3 trillion added to the national debt, but only get an increase of 3.4% (annualized from the fourth quarter) in GDP?
What happened to the other 2.6%? Where's the missing $1.2 trillion? Where did the money go?
Does this mean that the real – non-government – economy is actually shrinking at such an alarming rate that it wipes out much of the feds' new-money inputs?
Yes, Mr. Bonner, I think that is exactly what it means!
Meanwhile growth does appear to be slowing across the economy. GDP growth was reported lower than expected on April 25th, at 1.6% vs. expectations of 2.4%. That is down from 3.4% in the fourth quarter of 2023 and 5% in the third quarter of 2023.
Stagflation is defined as low economic growth accompanied by high inflation. Not being able to see the “stag” or the “flation,” means you aren’t looking. And don’t get me started on the national debt to GDP ratio today compared to what it was in the stagflationary 70’s…
Look no further than some of the sales and earnings reports of large consumer-focused stocks recently like Starbucks and McDonalds who are seeing declines in annual “same store sales” for the first time since the pandemic shutdown.
We aren’t quite there (to stagflation) yet and the dip in growth could be short-lived. Nobody knows, including me. But saying you can’t see it even as a potential outcome seems irresponsible, or disingenuous.
As always there is more to write about than I have time or capacity to do. Before I move on to some changes coming for clients, I just wanted to note that by the end of April, Tesla had officially clawed its way back into the Top 10 companies in the world by market capitalization or value. This on the heels of a pretty awful earnings report which is worth exploring because it is a sign of the environment in which we are investing where fundamental valuations don’t matter - until they do.
Tesla’s revenue and earnings per share for the first quarter both missed expectations but the stock bounced after the release because the company said it would accelerate plans to develop and sell more affordable vehicles.
Interestingly, Reuters reported recently that Tesla had scrapped plans for a more affordable vehicle in favor of developing a “robotaxi.” Elon, via Twitter, said Reuters was lying… I felt at the time that Elon probably fed that information to a reporter to see how the market would react to the news. Given the earnings report and plans to accelerate production of this affordable vehicle, I am even more confident that the media was used to float a “trial balloon” to see what they should promote on the upcoming call. Sure, my tin foil hat could be impacting my perception on this one, but my theory is at least plausible. Elon isn’t an idiot but anyone who trusts his timelines as being reliable needs to have their head examined – tin foil or not. And given that they can’t seem to make a truck without the pedals falling off, I am not sure I’d want to be the first passenger in their robotaxi.
As for the earnings and the market reaction, it is just a great microcosm of the entire market environment. Tesla’s Free Cash Flow (FCF) was negative $2.5 billion for the quarter – the first drop in FCF since first quarter of 2020 (when panicked politicians and world leaders shut the global economy down). At Elevate, we like to call FCF the number that doesn’t lie. It is the amount of cash left over after a business pays all its bills, taxes, and then invests in the business. This is the metric that should drive share price because a common share of stock is a “residual claim” on the company’s earnings. The common stockholder doesn’t get paid until everyone else (employees, vendors, lenders, the tax man, etc.) get paid.
Another number I focus on is the rate of change in revenue/sales, because it also doesn’t lie. It is very difficult (but not impossible) to use Generally Accepted Accounting Principles (GAAP) to make the top line (revenue) of an income statement say something that isn’t true. You either sell products and services, or you don’t. The rate of change from one quarter to the next and one year to the next tells me much of what I need to know about the health of a business. I pretty much never invest in a business that has more than one year of declining sales in the past 5 years, and I prefer zero years of declining sales. That said, there are situations that arise where I don’t want to sell a great business for one bad year, and there are yet other situations where, as mentioned a minute ago, politicians and leaders fearfully shut down the economy for an extended period. So, as with any other rule, there can be exceptions.
Tesla’s revenue in the first quarter of 2024 fell by $4 billion dollars from the prior quarter and fell $2 billion from the first quarter of 2023, a year ago.
So, the two numbers that tell no lies both told us the business is declining, but the investor presentation was full of pretty “hockey stick” charts about AI and GPUs and miles driven with “full” self-driving….
So, naturally, the stock jumped 12% in the overnight trading session. And then it added more gains rising as much as 43% from its pre-earnings low around $139/share to almost $199/share.
Additionally, inventory continues to build (as I pointed out back in September 2023). Tesla is overproducing, probably to reduce costs, because they are having to discount the prices again and again and again to sell cars, thanks at least in part to a ton of new competition in the electric vehicle space.
All of the above means that margins will likely continue to deteriorate. And as margins compress, the multiple (of sales and earnings) should also fall, leading to lower and lower share prices the more cars they produce and deliver.
Usually when Tesla plans to develop a new product, like a new low-cost vehicle for example, they do a big reveal marketing event--- this new low-cost vehicle they won’t tell you anything about. They won’t answer questions about it on the call. No show. No hype. Nada… Saying you have a plan is not the same as actually having a plan.
They are going to give up their margins, and with it, their premium 70x earnings multiple. Most car companies trade at 5- or 6-times earnings. This implies a lot of remaining downside for Tesla’s stock price.
And now it turns out that US prosecutors are examining whether Tesla committed securities or wire fraud in relation to claims about its “self-driving” capabilities. At least the stock actually fell on this news. The “f-word” (fraud) is not usually tossed around lightly.
Shares have fallen back to around $173, as of mid-day May 9th.
I started with a brief quote from the great John Hussman, Ph.D. and I want to come back to that and provide additional context. There is some technical language in it but I think you’ll get the idea. Bold emphasis added is mine. Here is the full quote:
As of last week, the total return of the S&P 500 was even with 3-month Treasury bill returns since the valuation peak of January 2022, more than two years ago. In our view, investors continue to “grasp at the suds of yesterday’s bubble,” ignoring extreme valuations, lopsided bullish sentiment, emerging pressure on profit margins, economic conditions at the border of recession (though the evidence is not yet decisive) and most important for near-term outcomes, unfavorable market internals.
An improvement in the uniformity of market internals would not improve our expectations for long-term returns, nor would it reduce the risk of severe market losses over the completion of this cycle. Still, improved internals would encourage a more neutral or even constructive near-term outlook (albeit with position limits and safety nets). For now, rich valuations, unfavorable market internals, and other elements of our discipline hold us to a defensive outlook.
Regardless of how much we might comment on underlying market conditions, particularly valuations, remember the condition of market internals drives much of our investment outlook at each point in time – particularly with the adaptations we adopted in 2021. Valuations are like potential energy, and it’s important to know when you’re sitting on a powder keg. But investor psychology, which we infer from market internals, is the main catalyst that suppresses or releases that potential energy.
The chart below shows our most reliable valuation measure, based on its correlation with actual subsequent S&P 500 total returns across a century of market cycles: the ratio of nonfinancial market capitalization to corporate gross value-added, including estimated foreign revenues.
Notice that the current extreme is just shy of those observed in August 1929 and January 2022. The current level is about three times the historical norm.
You can read the full Hussman Market Comment here.
Ultimately, my outlook is unchanged and not all that dissimilar from Dr. Hussman’s. While the market rallies further into bubble territory, we are forced to participate or watch from the sidelines. The most reasonable thing to do is stay long and follow our trailing stops so that we get out before the next big drop inevitably arrives.
As the markets were declining in April we saw some of our trailing stop rules trigger so we closed and reduced some positions. On the other hand, we also found some opportunities to increase some of our allocations to existing positions like Microsoft and Amazon, among others, as they dipped but remained in long-term uptrends.
Our core Elevate Capital Strategy performed well while the Low-Volatility version was down a bit more than I’d normally expect, relative to the S&P 500 and other indexes in April. Please login to your Performance Portal to see how your portfolio held up during April’s decline.
Speaking of the Performance Portal, it will be moving to a new location soon. We are currently testing the new technology and rolling it out on a limited basis. By July 1st, everyone will be moved over to the new portal, and we’ll lose access to the current portal. The new portal will have at most two years of history from Charles Schwab. Anything from before that, or from a different custodian like Interactive Brokers or TD Ameritrade will no longer be available.
The new portal will be our primary way of sharing secure documents with you, including your statements and tax forms from Charles Schwab, which will be automatically posted to your portal’s “secure vault” as soon as they become available. You’ll be able to upload documents to your vault as well and you can then share those with us. This is the most secure way to share sensitive information with us. No more need for complicated secure emails.
The new portal will also be our preferred way to get updates on your current willingness and ability to take risk in your investment portfolio(s). When an update is necessary, we’ll post a new (and short) questionnaire there that you will complete upon logging in.
If you would like early access to the new portal, please let us know here.
Until next time, I thank God for each of you, and I thank each of you for reading this commentary.
Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio performed vs. the markets last month.
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisors
Legal Information and Disclosures
This commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Elevate Capital Advisors, LLC (“Elevate”) has no duty or obligation to update the information contained herein. This information is being made available for educational purposes only. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elevate believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elevate. Further, wherever there exists the potential for profit there is also the risk of loss.