Barometer Capital

Barometer Readings Webcast – August 8th 2023

Barometer Readings Webcast – August 8

Macroeconomic Overview

  • (1:40) We continue to be in a structural bull market that started in 2013.
  • The market goes through periods of corrections which is followed by a long rally.
    • (2:00) The correction in 1991 lasted about 18 months. The market then rallied from 1991 to mid-1994.
    • (34:58) We should expect 3-5% of corrections over the course of the year. Data supports markets finishing higher than where we are today.
  • (2:43) During corrections, we want to identify:
    • What has held up the longest
    • What turned up early
    • What gained strength
    • What will lead in the following cycle
  • (3:00) Early cycle sectors are currently leading the market and investors are preparing for the next leg of the bull market.
  • (4:54) Since May, there has been accelerated growth in the industrial sector. On a relative basis, DOW is outperforming S&P.
  • (5:14) Global equity continues to outperform US equity.

Fixed-Income Overview

  • (5:55) 10-year yields have been declining over the past 40 years. We are seeing lower lows and lower highs.
    • Generational low in 2020 but rates have been on the rise since then.
    • There are several periods in history where yields are considerably higher.
  • (6:40) Rates have been increasing over the last 4 months which has put pressure on interest rate sensitive securities.
  • (6:53) Why might rates increase?
    • The credit quality of an issuer is being questioned
    • Significant amount of new bond issuances in the market
    • The economy is more resilient than people expected
    • If inflation is expected to remain higher
    • Fewer global buyers of US bonds
  • (7:29) Private long-term investors see the increase in rates as a way to achieve a higher yield.
  • (7:45) Hedge funds, on the other hand, are shorting the bond market.
  • (7:55) Similarly, Barometer has shorted the US bond market. Why?
    • (8:11) The economy is stronger than what most pessimistic economists have expected.
    • (8:40) The Fed says markets should not expect rates to come down in the near future.
    • (9:00) The market believes that sticky inflation (looking out 5-10 years) is finding its way into bond prices.
    • (9:35) Over the next few years, the expectation is that US government debt will find its way into the 40-45% range (same level as WW2).
    • (10:58) There is not enough interest that can be paid to eliminate the risk of rising debt in the US government or inflation and taxes eating away at returns.
  • (12:48) Stocks continue to outperform bonds.

Sector Performance

  • (13:13) A lot of money has come out of commodities.
    • After the commodity market corrected from 2008 – 2020 prices started to rally.
    • (14:20) When commodities return after a long period of underperformance, they have a tendency to outperform stocks for a long period of time. We expect this is just the beginning of a long period of outperformance.
    • (14:45) Crude oil has recently reversed and is moving higher but investors are only positioned in the 5th percentile.
  • (16:16) Global OECD petroleum inventories are at multi-year lows. Analysts believe inventories can go lower.
  • (23:04) Highly sensitive sectors have been performing well. This includes builders, steel, insurance, investment banks, machinery, auto, oil, aerospace, transportation, business services, and chemicals.
  • (23:37) Defensive sectors have not shown improvement. This includes telecoms, drugs, biotech, utilities, and gas utilities.
  • (24:00) Average sector pulled back 3% over the course of the last week but there has not been significant damage.
  • (24:15) Technology Sector
    • This sector led returns in the SPY until May.
    • (24:35) Our concern is that if rates continue to go higher, stocks with high multiples will have to discount future earnings at a higher rate meaning investors pay a lower multiple for these companies.
    • (25:05) XLK ETF moved from $181 to $169 over the past 10 days which broke the 50 day MA and relative strength has moved to its lowest level since April.
  • (25:54) Financial Sector
    • Financials have been outperforming, especially insurance.
    • (26:20) Fairfax Financial Holdings has done a great job with investments. Shares have done better than 93% of the companies in the SPY over the last 52 weeks.
  • (26:47) Energy Sector
    • Cash flow is growing, debt is being paid down, capital is being returned to shareholders by way of share buybacks, and dividends are increasing.
  • (29:17) Materials started to outperform in May.
  • (30:14) Industrials have been growing versus the market since May. Fairly steady improvement since March 2021.
  • (31:14) Homebuilders ETF is trading better than 93% of stocks in the SPY.
  • (31:41) The healthcare sector has been underweight for Barometer.
    • Large position in Eli Lilly. This pharmaceutical company sells the highly-demanded weight-loss drug and has beat expectations by a high margin.

Barometer Portfolio Positioning (33:40)

  • Underweight position in technology – Barometer is not adding in this area
  • Significant overweight in financials with a tilt towards insurance (eg. Fairfax, Great West)
  • Industrials is an overweight
  • Energy is at a large overweight (just over 2x SPY weight)
  • Healthcare is an underweight
    • Targeted weight in companies with strong products
  • Materials is a significant overweight
  • Significant underweight in sectors that do poorly when rates are higher (eg. communication, real estate, utilities, staples)

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