Market Commentary:
Summary of our views is as follows:
∙ The price of money is a significant driver of asset prices and economic activity. This has been the largest, fastest increase in rates ever in the US. We believe the full impacts are not yet known and may not be for a while.
∙ While inflation is clearly declining, we doubt it will return to the very low levels targeted by the Federal Reserve anytime soon. The inputs that kept inflation so low for so long (cheap labor; cheap goods; cheap energy as an input to manufacturing) have all changed. What will the Fed’s response be if inflation only declines to perhaps 3% to 4%?
∙ The distribution of potential outcomes in public and private markets is wide, and much wider than it has been in decades. We caution using a lens from the 2000 – 2021 period as a mechanism to evaluate investments today.
∙ From 1968‐82 the equity market experienced multiple violent rallies and subsequent selloffs, and 70% of purchasing power was lost to inflation. We could see a mini period that is similar ‐> rangebound choppy markets and steady erosion of purchasing power.
∙ The mark‐to‐market of private investments has the potential to be an additional drag. Many will show losses, which may result in less demand, and possibly a desire to pair back exposure. This brings elevated risk to public and private equities.
∙ The risk of a credit crunch in the second half of 2023 is increasing. Investors are no longer willing to accept zero interest from bank deposits and have been reallocating capital into money market funds or other short duration investments. Regional banks have historically been a major provider of CRE, C&I and personal loans. Regional bank business uncertainty could result in tighter lending standards or even an unwillingness to extend credit.
∙ Demand for downside protection in the US equity markets remains anemic. Put option skew remains low, while market liquidity has been on a general downtrend. Don’t underestimate the potential for either a grind lower or a gap lower in equity indices at some point in the remainder of 2023.
The investor wall of worry appears to be transitioning from high inflation to tightening credit conditions. Mitigating the impacts of high inflation was the #1 topic we were asked about for a year, and that has swiftly faded since the regional banking crisis emerged in March.
This perhaps explains some of the recent bifurcation of mega cap stocks performing exceptionally well, and mid cap and small cap stocks performing abysmally, as larger companies tend to have more and better funding alternatives.
While the S&P 500 continues to be stuck in a range for the past 12 months, there are a few indicators that appear to be waxing positive.
∙ Technical indicators on the S&P 500 are starting to show slight signs of improvement. While we are not a proponent of simple moving averages (SMAs), many market participants do embrace them, and both the 50 day and the 100 day have turned higher and are showing some early signs of an upward trend.
∙ We are also starting to see better follow‐through behavior from individual stocks in positive trends that are breaking out to the upside, after what has been a long torturous period of weak behavior. ∙ The VIX continues to grind lower, and the MOVE index (interest rate volatility) also appears to have settled down.
These are nothing more than observations at this point. It will be interesting to see if speculative investor participation increases in earnest if these positive trends accelerate, as elevated short‐term interest rates of 4.5% or more provide some stiff competition for capital.
Source: TradingView
Source: TradingView
0 DTE Options:
One of our preferred investment managers, The Ambrus Group, recently published an insightful paper that dispelled many of the false narratives about zero day to expiration options. They discuss the diverse user base, how these options are being utilized in portfolios, and the potential impacts for the broader markets. We strongly recommend downloading and reading the paper.
https://www.ambrusgroup.com/research
Commercial Real Estate – The Sundial Take:
How vulnerable is commercial real estate? Most everyone we speak to is expecting a universal decline in prices, an increase in defaults, and significant investor pain. Our take is more nuanced – some property types may be quite vulnerable, while others may be quite insulated and perform handsomely. While a tightening of credit conditions is expected, there are already many “solution capital” funds looking to gain exposure in high quality properties that are in need of a capital infusion in conjunction with a debt refinancing. Underlying fundamentals still look pretty good to us – vacancies are low in multi‐family and extremely low in industrial properties. Additionally, today’s loan‐to‐values are now as low as they were in the depths of the great financial crisis. Property owners tend not to pass the keys to banks when there is a lot of equity still in the deal.
It isn’t obvious to us that there has to be significant downside to all types of CRE, and particularly in our preferred types of storage, industrial, and multifamily, in growing, landlord friendly markets. We do expect and have prepared for modest downside, or sideways valuations much like we anticipate in equity markets for a while.
The obvious risk to our view is if the recent trend of deposits leaving banks continues to a point where those institutions completely cut off lending, followed by the piles of solution capital waiting in the wings deciding to re‐ allocate elsewhere. Right now, we hear more stories of solution capital looking for deals and either not finding them or having to compete heavily for them. Perhaps the tidal wave of a CRE capital shortfall is coming, but it isn’t yet visible from the shore we stand on.
Here are a few CRE related graphs worth reviewing:
We expect the “Private/Other” (light blue slice) to grow steadily in 2023 as Regional Bank lending declines.
Source: 2. MSCI Real Capital Analytics, as of December 31, 2022
Blackstone hosted a conference call for their BREIT product in April. The statistics they shared didn’t sound catastrophic:
Industrial properties vacancy is less than 2%. Rents are strong and growing. Property cashflow growth was 9% in Q1 2023.
Lending against commercial real estate is only about 60% LTV. The expectation that banks or even property owners are going to take a massive hit is pretty low at this point.
Office space is really the only property type with issues. All other types look quite strong, with rent growth and very high occupancy.
Construction lending availability is less, which is good for existing property owners.
What isn’t being talked about enough in our opinion is the growing risk to small private companies that depend on borrowing from regional banks. Small and regional banks specialize in funding local industries. These are the banks that lend to businesses with less than 100 employees, which is much of the US. Where will this capital come from? Investors we speak to appear to be souring on Private Equity. If that trend accelerates, companies with limited funding options may be in for some significant pain.
Monthly Podcast Recommendation:
RealVision: Unpacking Modern Monetary Theory
https://www.realvision.com/o8cdow984nt
We strongly recommend listening to this interview with Warren Mosler. It covers some very interesting and also controversial concepts such as:
∙ Politicians are much better off with high unemployment than high inflation. 10% unemployment = 90% of the voters still have jobs. Inflation makes every voter angry.
∙ Raising rates is actually stimulative for the current economy.
Warren is a former colleague and arguably one of the smartest macro minds we have ever come across.
STRATEGY COMMENTARY:
As a reminder, our Sundial Dynamic All‐Weather Portfolios attempt to achieve positive returns regardless of the macroeconomic regime, such as positive or negative growth, or an inflationary or deflationary environment.
This is achieved through a few key principles:
∙ Utilize multiple asset classes and strategies, beyond traditional equity and fixed income markets ∙ Utilize both active (tactical) and passive (buy and hold) strategies
∙ Recognize that some investments are stability seeking (short volatility bias) and others are instability or dislocation seeking (long volatility bias) and it is critical that a portfolio contains both.
The desired result is a portfolio of non‐correlated revenue streams, that exhibits attractive asymmetry through tactical allocations and return stacking, truncates the downside in adverse markets, and is fully offensive in constructive markets.
Tactical Equity Strategies:
Allocation: High end of the target range
Comment: Our tactical equity strategies have been increasing exposures over the past month which we take as a positive sign. Also worth noting is that these strategies have been behaving independently vs. the S&P 500, and we very much like this non‐correlation in portfolios. We continue to believe this is an environment for individual stock picking, and not simply investing in equity indices.
Passive Equity Strategies:
Allocation: Low end of the target range
Comment: Our passive equity longs remain at the low end of our targeted range. These positions are mostly in ETFs and other diversified exposures. We see little reason to tinker with the positions until the macro and central bank outlook is more clear. On any significant pullback we would expect to add to existing positions, but with markets close to the top end of the trading range of the past year, we prefer to simply sit tight for now. We are becoming more optimistic on international equity exposure as well.
Yield Generating Strategies:
Allocation: High end of the target range.
Comment: A full allocation reflects our defensive stance. We continue to utilize mostly alternative yield generating investments and our Government and corporate bond exposures are limited to short maturities where
yields of around 5% are quite attractive. Ironically, a regional banking induced credit crunch brings more opportunities to collect high yields lending to companies and against properties with significant collateral for security.
Trend Following and Inflation Benefitting Strategies:
Allocation: High end of the target range
Comment: Our trend following focused investments have stabilized, or in some cases almost fully recovered after experiencing a drawdown in March. We believe the uncertain macro environment continues to be constructive for “dislocation seeking” trend following strategies. Now more than ever, we embrace this uncorrelated stream of returns, particularly as these strategies could capture some very painful trends of lower stocks, higher or lower rates, and increased implied and realized volatility if we do go into a recession and/or a sustained credit crunch.
Long Volatility / Long Convexity Strategies:
Allocation: High end of the range
Comment: We continue to maintain maximum exposure to these strategies, and when we take on a new portfolio, this is also one of the first positions we initiate. The cost of tail protection (skew) remains quite low, the potential for a left fat tail is real, and we are strong proponents of this exposure in all portfolios.
CHARTS & TABLES:
Market Breadth still looking pretty weak
Source: https://twitter.com/LizYoungStrat/status/1654509470720950273
Corporate and High Yield Maturities Have Been in Decline
Source: https://twitter.com/LizYoungStrat/status/1649086005931024384
Small Caps vs. S&P 500 – Back down to the lows in terms of relative performance
Source: TradingView
Gold Looks like it wants to break out to the upside
Source: TradingView
The KRE Regional Bank ETF looking sickly
Source: TradingView
Source: https://twitter.com/NickTimiraos/status/1655676638581891092?t=0BaM00kNJwHQlf5hjVg8CQ&s=09
Source: https://twitter.com/biancoresearch/status/1650168196098293760?t=r71cu69Dyo‐aT4z5gmZdDA&s=09
Source: https://twitter.com/WarrenPies/status/1654146037240537091?t=qtUs87rKWmXrTWnD7‐LrvA&s=09
Trucking rates have been in steady decline
Source: https://twitter.com/TannerDeHartFW/status/1645419622315720704
Disclaimers
This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities nor does it constitute tax advice. This information is for informational purposes only and is confidential and may not be reproduced or transferred without the written consent of Sundial. Past performance is not indicative of future results. Statements and opinions in this publication are based on sources of information believed to be accurate and reliable, but we make no representations or guarantees as to the accuracy or completeness thereof. These materials are subject to a more complete description and do not contain all of the information necessary to make any investment decision, including, but not limited to, the risks, fees, and investment strategies of an investment.
This correspondence may include forward‐looking statements. Forward‐looking statements are necessarily based upon speculation, expectations, estimates and assumptions that are inherently unreliable and subject to significant business, economic and competitive uncertainties, and contingencies. Forward‐looking statements are not a promise or guarantee of future events.
Benchmarks and indices are presented herein for illustrative and comparative purposes only. Such benchmarks and indices are not available for direct investment, may be unmanaged, assume reinvestment of income, do not reflect the impact of any trading commissions and costs, management or performance fees, and have limitations when used for comparison or other purposes because they, among other things, may have different strategies, volatility, credit, or other material characteristics (such as limitations on the number and types of securities or instruments) than the Firm. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark index. We make no representations that any benchmark or index is an appropriate measure for comparison. The S&P 500® Index is a stock market index from S&P Dow Jones Indices. It is a market capitalization weighted index of 500 of the largest U.S. companies, designed to measure broad U.S. equity performance.
Asset allocation and diversification will not necessarily improve an investor’s returns and cannot eliminate the risk of investment losses. There are no assurances that an investor’s return will match or exceed any specific benchmark.
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