June 2024 Markets Update: We Appear to be Getting Further Confirmation Monetary Policy Lag Arrived, as Precious Metals Continue to Shine

Global Asset Performance Overview Heat Map

US Equities finished a modest month with a rough week. All major areas of the US bond market appear to be continuing their bear market. The takeaway seemingly remains precious metals. Silver outperformed all assets weekly & monthly, plus silver, gold, & miners lead all areas of global financial markets on a 3-month basis.

State of the US Equity Market: Extremely Narrow Market Leadership, Excessively Optimistic Valuations, & Signs of Fading Momentum in the Rally are Concerning Alone

If you’re looking at the US equity market with a bullish bias, or even as an impartial market participant specifically interested in the short-term story, you’d probably be thinking everything is fine. There’s no reason to pause for concern being too overweight on US large-caps, but specifically on speculative, overpriced, and fundamentally highly cyclical mega-cap tech. We’ve reiterated why we were the most overweight in Communications in S&P 500 segments heading into 2024 enough times by now and detailed why we liked Utilities in our last two newsletters, but we remain quite bearish on speculative large-cap tech even in the near-term. The near and mid-term risk reward isn’t there for us, simply because we feel there are better options available. We feel that way if you’re someone who has to be in only the US equity market, but we mostly feel that way for multi-asset investors. We remain bearish in the long-term on US large-caps and continue to expect the largest drawdowns to ultimately be observed by speculative large-cap tech stocks.

NVIDIA

Even though NVIDIA has certainly been a shining star for the US equity market since late 2022, it’s worth noting we’ve seen this kind of excessive enthusiasm end badly before. Have we ever seen any publicly traded equity sustain this kind of price growth, while staying at a somewhat reasonable valuation – in terms of earnings multiples? I can only remember cases where it ultimately ends in deep disappointment (ex’s: Cisco, Lucent, Nortel, etc.). When it comes to a giant success like Apple, keep in mind how long it took someone like a Berkshire Hathaway to believe in it. A couple decades and that came from consistent success with the business approach and the bottom-line fundamentals. After that it really took off becoming the world’s largest publicly traded company for a good chunk of time, before Microsoft reclaimed that spot. ?Concisely, for this kind of price growth, NVIDIA should have to deliver on far more than just a few quarters of extremely impressive earnings growth. It has to be sustained and long-term. With top clients like Amazon, Meta, & others building out their own GPU data centers, my feeling is it’ll be extremely challenging for NVIDIA to maintain the kind of growth they’ve recently generated.

There is also history to support what happens specifically to market participants when semiconductor stocks start really aggressively outperforming S&P 500 large-caps. We saw the exact same phenomenon preceding the tech bust. But if you really breakdown the logic as to why that would happen, semiconductor stocks – including NVIDIA – are known to have cyclical fundamentals. Hence such a rapid rise in semi’s relative to broader US large-caps is concerning because it demonstrate the mindset of a market not rooted in fundamentals or even thinking much about them. That’s eerily similar to the market environment today. When the equity ?market is trading on interest rates, it can ‘hang up in the air’ for a bit, so to speak. Meaning stock market prices and valuations can become disconnected from reasonable earnings expectations and/or the economic reality. In either case, the equity market inevitably fixes the valuation imbalance by reconnecting to earnings and fair market prices. That’s how equity market cycles have always gone; the market ultimately finds it’s footing on earnings.

If a dramatically overpriced US equity market hiding behind a handful of monopolistic tech mega-caps was to encounter serious economic or credit market disappointment, the early 2000’s tech bust analogy wouldn’t seem too farfetched at all. What happened during the tech bust? The US equity market got far too excited about the internet and forgot that everything has a price, plus participants were clearly paying no mind to the macro backdrop. Very similar climate to the one we’re in today. Then when credit market disappointment occurred, it led to such a rapid selloff of tech stocks that it caused a mild US recession. We’re not looking at that kind of macro backdrop today. In my view, it’s significantly more dangerous.

History and Economic Rationale Defeat the Commonly Misconstrued Argument that there is Somehow More Safety in a Greatly Concentrated US Equity Market

The market cap concentration of the top 10 mega-caps relative to the total US stock market is comparable only to the peak reached directly preceding the Great Depression and the early 2000’s tech bust. Are we really expecting that ratio to continue going upwards in favor of monopolistic tech mega-caps? I don’t think so, as the wheels have already begun to fall off a few names in 2024. ?

Looking at the charts below highlighting fundamentals and projections for 2024, it makes sense as to why the “Magnificent 7” have been leading the entire US equity market for over a year and a half now. They’re consistently the only US large-caps that produce positive YoY growth in earnings and revenues. Look what just happened to Salesforce this week; big miss and they paid the price. Intel is down -40% YTD despite being amongst the best-known semiconductor stocks. There might be comfort in non-cyclical mega-cap growth, but there’s no safety to be had with such thin market breadth. ?

If anything it should be obvious that there’s inherently more market risk, given this performance is driven by fundamentals. Even on that point, it’s worth noting the “Enormous Eight” are quite clearly overpriced & very expensive relative to the rest of the market. More broadly the US equity market is the most expensive of any peers – in advanced or developing economies – relative to their respective country annual GDP. All things that tell me there’s elevated market risk, we’re likely at the very late stages of an equity market cycle, and we should not anticipate this shrinking rally to miraculously broaden while the Fed holds monetary policy restrictive.

With all that said, this is where we stand with the S&P 500 segment breakdown. No changes from last month or really the month before. We like the non-cyclical growth fundamentals we continue to see in Communications, in conjunction with getting a piece of the “AI story”. We were right about Utilities and don’t think now is the right time to get out. The only area we’re continuing to wait for the outcome we ultimately expect is Information Technology. Given the dynamic described above with both the point of concentration US large-caps have gotten to, as well as their sheer market cap relative to the entire US economy, it could definitely take some time for that outcome to materialize. However we do remain underweight even in the near to mid-term because the risk reward isn’t close to there for us. We see better options and don’t want to find ourselves in a position where we’re chasing a dream that’s already been made. NVIDIA has paid off for those who saw the AI rally coming in late 2022. Could it go up more? Absolutely. By the same token, valuations are most expensive in large-cap speculative tech and if we were to observe something like a credit event, the selloff process could be devastating. We continue to be comfortable with our selective exposure and the returns produced thus far.

Multi-Asset Investors Have an Advantage in with the Current Macro Backdrop: We Maintain our Bullish Thesis on Precious Metals, Followed by Broader Commodities

If you look outside the US equity market, you’ll note there are areas of the market where multi-asset investors are doing better than those in financial markets alone on a YTD basis. But for those who have been following our research know, as well as for those just tuning in, we believe we’re in the early stages of a long-term commodities sypercycle. The precious metals bull market has already begun and history has taught us they tend to last at least a few years. We see this one as being on the longer-end of historic bullish precious metals cycles and ultimately, we feel it could develop into a broad commodities supercycle.

Gold Has Broken Out, Following the Path of Prior Historic Bullish Precious Metals Cycles in Either Stagflation or Severe Deflationary Macro Backdrops

Gold Began the Breakout by Hitting ATHs in All Major Global Currencies

The Long-Term Bull Thesis is Followed by a “Triple Threat” of Dangerous Macroeconomic Conditions

The US economy has a “triple threat” of economic challenges it won’t be able to overcome without one of two things: a) a major deflationary recession like we observed during the Great Depression or GFC, or b) stagflation – like the kind we saw in the 1970’s. The US Fed hiking cycle is why I believe the first is more likely, but there are also becoming a lot more increasing signs that we could be going into the latter. For those who have a solid understanding of macroeconomics will understand where I’m coming from with this, but if we were to enter a multi-year period of economic stagflation, it would be due to a historically resilient US labor market. At the macro level, we would have to observe an “it’s different this time” outcome in US labor to keep the economy out of severe deflation, which is why I believe that outcome is more likely. But the question investors are interested in isn’t ultimately what the macroeconomic climate of the US currently looks like. It's where to invest their capital. We’re in one of those rare moments where due to the above three “triple threats”, either outcome should result in a secular bullish precious metals cycle and a broader commodities supercycle.

Once Highly Correlated, “Safe Haven” Assets, Now Correlation has Turned into Divergence

Seems self-explanatory, but during the GFC for example, both gold and long-term US Treasury’s outperformed, thereby giving some multi-asset investors relief from the major drawdown observed in US equities. We’re in a secular bear market with long-term US Treasury’s. In addition to well above average inflation and “higher for longer” interest rates – both bearish for fixed income broadly – we have a supply/demand mismatch getting further exacerbated in the US Treasury market. Without a “safe haven” in US Treasury’s, it’s only a matter of time before we see more market participants find value in precious metals & commodities.

The US Government is Running Twin Deficits at the Quickest Pace in US History Post-C19

An Increase in US M2 Money Supply is Inherently Very Bullish for Gold & Precious Metals

The ratio of gold/US M2 peaked in 1980, after the mid to late 1970’s stagflation US recession. Today the level is historically very low. But let’s consider how the current macro backdrop could shape this relationship moving forward. For one, the more money the US Treasury prints, the more inherently inflationary the economic environment becomes. Furthermore, more physical currency in circulation will lead to the USD falling in relative value. That’s not even factoring in that the USD currently has more competition than ever for its reserve currency status. Not to say I think it’ll lose it, but it’s hard to deny there’s never been more serious competition looking to overtake it. That’s important to note in this context, specifically because nearly all major global commodities are priced in USD.

That’s not all. How is the US national debt situation looking, as well as the interest payments on it? Does no one see that as highly inflationary in the longer-term? I personally think the US Fed might be starting to get a little fed up with how ‘resilient’ the labor market is. They are looking for the data to give them the green light to begin cutting, but they’re not getting it. If we keep rates higher for longer at the current 5.50% upper bound Fed Funds rate, by 2Q25 annual interest payments on US national debt will be roughly $1.6T. If the Fed were to cut rates 150bps by the end of 1Q25, the annual interest payment would be approximately $1.15T. We’re talking about almost half a trillion dollars saved annually on interest. On the other hand, if the Fed cuts prematurely we already know what happened in the 1970’s – inflation came roaring back expeditiously and with a vengeance.?Despite the “transitory” inflation gaffe, the US Fed is now stuck between a rock and a hard place.

To reiterate, those are all very serious tailwinds for gold, precious metals, and then broader commodities.

While Gold Led the Precious Metals Breakout, we Expect Other Parts of Precious Metals Markets’ (Silver & Miners) to Outperform and we Maintain our Conviction in a Commodities Supercycle

Stagflation is Certainly a Possibility, but we Maintain our Base Case of Severe Deflation Resulting in Recession from Underestimated the Lagged Impact of Rate Hikes

IF the US Fed cuts in December 2024, it would be 17 months from the last Fed hike to the first Fed cut. Dating back to the late 1960’s and factoring in ALL US Fed hiking cycles individually, this would be more than double the US Fed’s average pause. Looking at the times the US Fed held rates elevated for longer, it looks to be mostly in the recent cycle and all of them ended in a hard landing. In the mid-1970’s and early-1980’s, the US Fed was batting stagflation followed by the ramifications of that as it relates to their interest rate policy. It didn’t take long for the US economy to enter recession. I think a fair conclusion to draw from this chart, historic outcomes, and macroeconomic theory is that generally speaking, the longer the Fed waits to cut, the higher the probability they will be too late. For that reason amongst others, we feel the Fed already overshot their window to cut in hopes of a “soft landing” by months now.

It makes sense why essentially all the regional Fed’s began using the 10YR-3M yield curve spread versus the traditional 10YR-2YR spread. Firstly, they’re issuing a lot of new debt using 3M T-Bills due to demand and their interest rates regime. Secondly, it hasn’t been wrong about recessions in the past dating all the way back to the Great Depression. It never inverted in the mid-1990’s like the 10YR-2YR spread did. Given such a deep max inversion observed in this cycle – almost -300% - it’s very challenging to completely rule out a credit event.?

We Have Compounding Evidence of Monetary Policy Lag Perhaps Beginning to Materially Impact Economic Activity

The Lag at Which Monetary Policy Operates is Always Both LONG & VARIABLE

I really like to share the above chart because for me it perfectly sums up how monetary policy lag ultimately impacts the US equity markets. At least how it has historically. The chart above is effectively illustrating that when yields (i.e. rates) begin to rise aggressively, after a period of lag that varies, we should expect to see downward pressure on inflation and economic growth (deflation). In this case we’re talking about the more aggressive US Fed hiking cycle in history, going out of a ZIRP-era decade by +550 bps in 1.5 years. Interest rates will adversely impact the business cycle more than they have to this point. Without meaningful rate cuts, which would already be too late anyway as cuts also work with a lag, we’ll likely observe too much deflation moving through the pipeline and the US economy will fall into recession. It could be via a credit event or deterioration in the labor market and unfortunately the ETA is as the subtitle indicates: long & variable.?

That’s one final point I wanted to make. Just because some may feel we’re past a certain historic average, or more specifically a recession should have happened by now – that does NOT mean we missed it or it won’t happen. That simply means it’s delayed, as the timing of monetary policy lag is highly unpredictable. Historically its proven to be tried and true time after time, but there appears to be a very high propensity in this cycle to imply we’re in the clear because a recession didn’t materialize yet, even though many feel ‘it should have already’. Nothing could be further from the truth. We’re seeing signs of it already putting downward pressure on US economic growth and the Fed has no intentions of cutting anytime soon. They’ve stuck to “higher for longer” interest rates. Historic outcomes support our base case of recession from the overtightening of monetary policy in the course of the US Fed’s hiking cycle in response to surge inflation.

OVOM Research Closing Thoughts: June’s Multi-Asset Portfolio Allocation Strategy

As some of you who have been following may know, we like to use a systematic multi-asset strategy macro model we created to guide our asset allocation decisions. It leverages the “all-weather framework” in a way, but really just as a baseline that we took several steps further. Our proprietary leading indicators are currently leaning towards deflation in several months, but the immediate next two are stagflation. In any case, our model is telling us that growth is going to be lower than expected and we’ll have to see about inflation.

In either a deflation or stagflation environment, equities tend to broadly underperform and so does a lot of fixed income. Precious metals thrive in both and broader commodities have historically done much better during stagflation than deflation. Our biases notwithstanding, we stick to a mostly systematic process with some room for qualitative assessments and the below pie chart represents our current asset allocation strategy.

Now that we’ve identified the asset classes and how much weight we want to put into each, we look at which areas of the respective market perform best in those macro backdrops. For precious metals & commodities in particular we can’t really do any quantitative modeling to see which of the best areas of the precious metals or commodities market we should buy in each macro backdrop, so we tend to focus a lot at historic outcomes and valuations there. The OVOM All Weather Portfolio Strategy returns aren’t bad at all actually, especially when you consider the secular bear market US fixed income has been in and how that could negatively impact a multi-asset portfolio.

Thank you as always for taking the time to read and participate in my monthly markets newsletter. Hope you enjoyed this week’s update and if you have any questions, feedback, concerns, etc., please don’t hesitate to email me at:

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Best of luck to all market participants this upcoming week, month, & year!

Disclaimer: The information and publications are not meant to be, and do not constitute, financial, investment, trading, or similar advice. The material supplied is not intended to be used in making decisions to buy or sell securities, or financial products of any kind. We highly encourage you to do your own research before investing.

Disclaimer: Returns from ETFs do not match the index they’re meant to track on a 1:1 scale. ETFs contain shares of securities comprising a given market metric an ETF is tracking and the composition of the ETF is often not identical to the index its tracking. For example, SPY (SPDR S&P 500 ETF) tracks the S&P 500. A committee ultimately agrees on the companies from the S&P 500 included in the ETF, using guidelines including liquidity, profitability, & balance.