The First Quarter

Observations, April 1, 2024:


In March, bond and equity markets followed different paths, as they have in prior months.  Despite a dovish FOMC press conference on March 20th, fixed investors remained cautious, with yields higher year to date and negative returns of -78 bps. On the other hand, equity investors continued to invest in AI stocks, with NVIDIA Corp (NVDA) up 16.34% in March alone. Jerome Powell indicated that the FOMC still believes that financial conditions are weighing on economic activity. Given record high stock prices, tight credit spreads and rising home prices, to the contrary we see easy financial conditions, with employment growth, increased high yield issuance and low jobless claims. With the S&P 500 up 33% and home prices up 6% from a year ago, Evercore ISI notes that consumer net worth is up 9% year over year.  The unintended consequences of being data dependent and providing forward guidance is that data can change from month to month, while markets will rapidly adjust to a forecast before it does or doesn’t happen. Equity investors believe that the FOMC desperately wants to cut rates.  Fed Governor Christopher Waller’s comments Wednesday evening make us suspect that if inflation reaccelerates, equity markets will again be disappointed by fewer rate cuts.


We are at a moment of speculative excess, with the S&P 500 trading at 21.84x 2025 earnings, at the highest level since 2019, with a 1.38% dividend yield. Many US investors are focused on assets such as Bitcoin or zero-day option trading, which have no income stream.  Yet other areas such as energy remain attractive. Despite outperforming the S&P 500 in March, the largest E&P ETF has assets that are 26% lower than when energy was hot at the end of 2022.  With energy valuations still 2x the historic discount vs the S&P, strong FCF yields and positive earnings revisions, the risk/reward is favorable. Luckily, shipping also fits the bill.   You can buy an expensive tanker company at 7.8x 2025E p/e and a 12.83% dividend yield or an expensive product tanker owner at 10.4x 2025E p/e and a 22.5% dividend yield.  There are still bargains, one just needs to look harder.


We have written extensively on the impacts of poorly thought-out US decarbonization policies and their impacts. In Europe, the consequences from policies promoting EVs have resulted in the hollowing out of their industrial base and unemployment. The automobile sector including their suppliers employs 3.0 million Europeans, and 7% of all Germans. While Europe had a competitive moat in the production of internal combustion engines, electric motors are a commodity.  China for many reasons excels at manufacturing EVs. Across the continent, new registrations of Chinese-brand consumer vehicles have more than doubled between 2022 to 2023 and make up 9% of the pure-battery market in western Europe. Tariffs are unlikely, given the large presence of German automotive manufacturing in China that would face retaliation. Further EU legislation includes implementation of the Carbon Border Adjustment Mechanism, an EU tool to put a fair price on the carbon emitted during the production of carbon intensive goods that are entering the EU, and to encourage cleaner industrial production in non-EU countries.  It will likely make EU produced industrial and agricultural goods globally uncompetitive as well as increasing inflation and causing living standards to decline. Political unrest is occurring as farmers rebel throughout Europe. If Labor sweeps the Conservatives away in the UK as forecast and raises taxes even further on the affluent, we expect waves of wealthy UK retirees to move to Florida.  There are those in the US who speak of the need for government industrial policies. It is hard for us to see that US outcomes would be much better in that case, given that much of US growth in the second half of the 20th century came from competition, entrepreneurship and letting markets work.