Economic headwinds, elevated market valuations, and tight credit conditions have us on alert again for a slowing economy, or, at the very least, a repricing lower of the overall equity market.  In this light, we have adjusted our portfolio to a more defensive posture with the below summary of recent actions:

Summary of changes

• Deployed a recession protection theme.
• Reduced weight to our AI theme
• Maintained weights to our De-Globalization and Cash Flow Aristocrats theme.
• Maintained an elevated cash level.

                 Entering 2023, we were of the opinion that tighter monetary policy would eventually filter into demand (and thus the labor markets) to slow economic growth enough to present a recessionary environment.  What we did not count on was a reversal of tighter policies like we witnessed in March following the collapse and subsequent bailout of Silicon Valley Bank.  We believe the reduction in the Treasury General Account injected liquidity into the system and added to the subsequent buoyed consumer spending and a resilient labor market to help propel equity prices higher, forcing our hand into a barbell approach whereby we added our Artificial Intelligence theme and moved out of our more defensive positions.        

                 However, we now find ourselves at a crossroad, with the still elevated market valuations combining with tighter fiscal and monetary policies, upcoming economic headwinds, and an uncooperative treasury market.   To be sure, we find ourselves of the opinion that artificial intelligence will continue to have an impact on productivity in the long run and thus, should remain a part of the portfolio.  But with the liquidity impact of the Bank Term Funding Program waning, consumers savings accounts dwindling, fiscal support on the decline, and energy prices elevated, can the consumer continue to spend at the pace witnessed during the first 3 quarters of the year?  We believe that ultimately the fiscal bill will come due and the impact of such, will have a negative impact on economic data and equity prices.  This transition has us adjusting the portfolio by reducing (though not eliminating) our AI weights and adding a Recession Protection theme. In this mindset, we favor shorter duration equities, or those well-established companies which produce high levels of current cash flow, during this period in which we believe inflation and by extension, long-term interest rates, may remain elevated. 

Economic Headwinds

• Tight monetary policy historically leads to weaker demand.
• Consumer savings ebbing post COVID relief.
• COVID aid programs down $48bn in the third quarter
• Higher energy prices eating up more of consumer’s wallet.
• Student loan payments resuming
• West coast individuals paying delayed taxes from April.
• Consumer confidence measures moving lower.
• Banks tightening lending standards which historically hits manufacturing.,
• The UAW strike (along with other strikes) impacting labor and supply.
• Panama Canal disruptions impacting supply chains.
• Global economies faltering:
  1. Europe has been mixed (and continues to see pressure from regional geopolitical issues).
  2. China, in contrast, has been weaker than expected this year.
• Government Shutdown on hold but not resolved.
• Labor market imbalance keeps the central bank restrictive.

Source: Energy Information Administration (EIA) and Strategas Securities as of October 2, 2023

Elevated Market Valuations

• Earnings expectation revisions on the street for 2024 have moved lower but are still showing an 11% increase.
• The current level of inflation historically suggests an index level much lower than the current price.
• The lagged impact of tight monetary policy would suggest a notable drop in net income from the current level.
• Operating Margins this negative has coincided with recessions in the last 4 recessions.
• Valuation measures are all near their historical highs.

Source: FactSet and Strategas Securities as of October 2, 2023

All Historical Valuations near all-time highs

Source: FactSet and Strategas Securities as of October 2, 2023

P/E = price-to-earnings  ratio relates a company's share price to its earnings per share; Enterprise value-to-sales (EV/Sales) = a company's total value (in enterprise value terms) divided by its total sales revenue; Earnings per share (EPS) = a company's net profit divided by the number of common shares it has outstanding; Enterprise value-to- earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) = a company's total value (in enterprise value terms) divided by its earnings before interest, taxes, depreciation, and amortization; Shiller/Cape= is calculated by dividing a company’s stock price by the average of the company’s earnings for the last ten years, adjusted for inflation. The CAPE ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle; Price/Book = A company’s market price per share divided by its Book Value per share; P/Free Cash Flow = A company’s market value divided by its cash flow from operations; TTM P/E = Trailing Twelve Months Price to Earnings Ratio; NTM P/E =Next Twelve Months Price to Earnings Ratio; P/Free Cash Flow = A company’s market value divided by its cash flow from operations; CPI = the Consumer Price Index which measures the overall change in consumer prices based on a representative basket of goods and services over time; CY = calendar year

Tight Credit Conditions

• Monetary Policy acts with a lag.
• Interest Rate levels surging higher.
• Rare bear steepening is an “end of business cycle dynamic” indicator.
• Recognition on the part of holders of Treasury securities that the Federal Reserve is likely to keep short-term interest rates higher for longer than previously anticipated.
• Fiscal spending could feel squeeze from higher rates and maturing debt.
• Net interest costs, % of tax revenue now at 14.2% - its highest level since the late 90’s.
• Banks continue to tighten lending standards.

Source: Bloomberg LLC and Strategas Securities, as of October 2, 2023

Bear Steepener Example

Source: Bloomberg LLC and Strategas Securities, as of September 25, 2023

    To be sure, those items listed above are what we believe will ultimately become headwinds to the US economy and thus the investment landscape. And while there is no guarantee that, should these all come to fruition, the end result is a recession, we are of the mindset to position the portfolio in advance of this possibility.  We therefore have adjusted the portfolio in accordance with the belief that these items will present enough of a challenge to current conditions for us to become more cautious within the equity markets and within the Strategas Macro Thematic Opportunity ETF (ticker: SAMT). For more details on the fund please do not hesitate to reach out or visit SAMT.

For more information on our specific Exchange Traded Products, please visit our website: www.strategasetfs.com/. For additional information on Strategas Asset Management, how to access our research or our other investment solutions please visit our website: https://www.strategasasset.com/.