Play Ball?

It’s that time of year – the days are getting longer, temperatures are (finally!) going up, the grass is getting green and of course baseball is back. It was the Colorado Rockies’ home opening weekend which always creates an exciting buzz around Denver. It got me thinking about baseball-related investing analogies. One of my favorites is from the great Warren Buffett which fortunately applies not just to stocks, but really to putting capital at risk in any asset:

“What’s nice about investing is you don’t have to swing at every pitch.”

- Warren Buffett

What an appropriate quote for this moment in time! Our team has written extensively over the past -six months about the value of patience, exploring the impact of inflation, pointing out how the investing regime is changing with Fed Policy and focusing on the preservation of capital. From time to time it’s worthwhile to take a step back and observe the entire flow of the game before taking a swing at the next pitch.

The best hitters know the count

If you’re like me, it is easy to get caught up in the day-to-day tidal flow of market information and short-term market trends. Yes, the stock market has rallied since the bottom in 4Q of 2022 showing impressive resilience. The Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and Treasury Department all have shown decisiveness and creativity handling the recent banking crisis centered on Silicon Valley Bank with a combination of unique policy decisions (guaranteeing all depositors above FDIC limits) and creating the new Bank Term Funding Program (BTFP), allowing banks to fund underwater security holdings at par. Yet does recent positive stock market momentum suggest we are setting up for a new (and investable) bull market?

Let’s take a step back and take a snapshot of the big picture; what are the defining characteristics of the current market for the longer-term stock investor?

1. The Federal Reserve remains in tightening mode to fight inflation and based on the most recent commentary from Chairman Powell they intend to keep rates higher for longer. In addition we have just started to see the lagged impact of higher rates from the initial rate hikes in March of 2022.
2. The nature of inflation is changing from stimulus-driven demand and broken supply chains to something far more nuanced. Global trade is being replaced by regional trade, goods inflation is being replaced by wage inflation, and we are at the front end of a generational energy transition as we de-carbonize our energy sources.
3. Asset price volatility is high across equities, bonds and real assets. We see this everywhere but by far the most indicative asset class is US Government Bonds and Bills, the largest and most liquid security market in the world. Asset prices for US Government debt should be stable given the size and liquidity of this market – however since mid-March we’ve seen historically large price swings.
4. The banking system is more fragile than we thought, and once a banking crisis starts it is not clear where it ends. Are Silicon Valley Bank, Signature Bank and Credit Suisse one-off situations caused by bad management decisions and poor risk controls, or are they the pebbles that start an avalanche?
5. The economy as defined by jobs and revenue growth remains resilient. Unemployment is low, jobs are being created and corporate revenue growth buoyed by price increases is consistently at or above expectations. Yet underneath we are seeing declining margins and earnings per share expectations.

Stepping up to the plate

So knowing all of this, what is an investor stepping up to the plate to do? Is now a good time to take a swing at equities? Or is now a good time to watch a few pitches and see how this game unfolds? As long as we’re in the mood for baseball, it’s time for another baseball quote!

“You can observe a lot by just watching.”

- Yogi Berra

And with short term rates providing nearly a 5% risk free return, investors can generate a relatively interesting return while making decisions on whether to swing at the next opportunity. We took a look at the earnings yield on equities relative to the Federal Fund Rate over time in the chart below. While no single chart should guide an investment decision, investors should think about potential returns relative to the risk they are taking before deciding to ‘take a swing’ at equities – especially where the game is at today.

Important Disclosures & Definitions

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

One may not invest directly in an index.

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