2023 in Review: Lessons Learned, Unexpected Challenges, and the AI Revolution

Who would've thought that with the bullish performance of equity and fixed income markets in 2023, consumer sentiment would remain at record lows? Join us as we navigate this curious contrast and hear lessons from the marketplace's unpredictability. Brad, our insightful guest, breaks down the bond market and expounds on the art of positioning oneself in a place of advantage. We'll also delve into the fascinating discourse around the Fed Chairman's recent actions, the potential beneficiaries of AI, and the current state of commodities and bonds.

Get ready for an enlightening journey through financial market trends from 2022 to 2024! We're exploring the rising demand for cash as a safe haven asset, the surge of exchange-traded funds (ETFs) impacting the market, and the momentous event of a bond ETF crossing $100 billion for the first time! Stay tuned as we discuss the state of overseas markets, companies making waves, M&A news, cryptocurrency prices, and upcoming events like US bank CEOs protesting regulation. Concluding the episode, we emphasize the need for caution in volatile markets as we talk about tax loss swaps and bond strategy. So, strap in for an episode teeming with insights and revelations that just might change the way you look at the financial world!

** For informational and educational purposes only, not intended as investment advice. Views and opinions are subject to change without notice.

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Transcript

Alan Eppers: 0:00

And now introducing Mr Keith Lanton.

Keith Lanton: 0:04

Good morning. Today is Monday, December 4th, first Monday of 2023, actually of December in 2023. So final month of the year, November was extremely good month for both equity and fixed income markets, and we'll talk about that and what the outlook for the rest of the year looks like, as well as some thoughts going into 2024. Today, what we're going to talk about is the fact that markets have been extremely bullish or positive so far in 2023, albeit it's been somewhat of a narrow participation in equity markets. But what we are experiencing is we're experiencing consumer sentiment at or near record lows, and we'll talk about why that may be and what that may mean for the market in the future. And then we'll talk about the year that was, or still almost was, 2023, market predictions going into this year, why those predictions may not have turned out as expected, as people had predicted, and what the monkey wrenches of 2023 were. And once again, humbling us to the fact that if we knew everything that there was to know going into 2023, would we have invested our money to take advantage of what did take place in 2023? If we knew it was going to come, would we have been able to invest our money opportunistically based on all of that knowledge and I would suggest that, even if you knew what 2023 was going to look like, probably would have been very difficult to make money based on that knowledge and therefore goes back to the thesis that staying invested and maintaining an asset allocation and staying true to your risk profile and your personal investment style is more important than the daily news flow, the weekly news flow, because it is nearly impossible to make sense of market from a day to day or week to week or even month to month or perhaps even year to year basis. Very humbling experience and lots of lessons to be learned about staying invested for the long term.

Keith Lanton: 2:15

And then we'll talk about last week actions or comments by the Fed and the Fed Chairman. And then we'll talk a little bit about what else but AI Baron's cover story, talking about AI and the beneficiaries of AI to obvious beneficiaries in video and Microsoft. We'll talk a little bit about them, as well as a couple of other companies that may be beneficiaries of all the spending that may be taking place over the rest of this decade. And then we'll talk a little bit about commodities gold specifically, and, of course, bonds, which have had a tremendous run. I'll touch on that and then we'll hand things over to Brad to get his thoughts and insights on what's taking place in the bond market. Again, tremendous November in the bond market, once again defying a lot of expectations. Once again lesson that things happen very slowly and then very quickly. Brad was talking about all the opportunities in the bond market and playing out in a very slow, methodical manner and then, like the snap of a finger, things changed very quickly and if you didn't situate yourself right from the get-go and didn't take advantage and thought that you could time when to start getting more active in the bond market, you will once again learn the lesson that it's very difficult to time and very difficult to turn on a dime.

Keith Lanton: 3:35

So, consumer sentiment what's going on? Markets? This year up almost 20% on average. Here in the United States We've got the S&P 500 approaching all-time highs Once again, I believe within 4 to 4.5% of all-time highs.

Keith Lanton: 3:51

Yet the University of Michigan Consumer Sentiment Survey is showing that consumer confidence on this survey is around 70. Consumer confidence on this index was down to about 55 at the end of last year as a measure of consumer sentiment. If you were to go back right before the pandemic, we were looking at University of Michigan, consumer Sentiment about 100. So we went all the way down to 55. We're sitting at 70. If you go back to 2008, 2009, the height of the financial crisis, consumer sentiment was around 60.

Keith Lanton: 4:25

So why have consumers remained so negative recently, despite equity markets picking up, despite the fact that things are, by most measures, dramatically better than they were at the height of the financial crisis, when we were wondering whether or not we were spiraling into a great depression? Yet, by most measures, consumers are very dissatisfied with their current mental state of satisfaction in terms of how they feel about the economy. So give this some depth, or to dive into why consumers are feeling so bad amid a booming job market. Perhaps it could be explained the way. Well, because of inflation. But what do you think about inflation?

Keith Lanton: 5:06

Even with inflation, wage gains have been very rapid as well, and we've experienced many positive wage growth years in the last few years. In fact, not everybody, but many folk have experienced wage gains that are close to, if not, depending on each individual's circumstances, exceeding the inflation rate. There are certainly many of us who are experiencing inflation that exceeds our wage gains, by and large on the whole, on an average. Each of us have our own unique circumstances. Wage gains have been pretty close to the rate of inflation, so you would think that inflation in and of itself isn't necessarily the driving force behind the mentality of why consumers are feeling so negative.

Keith Lanton: 5:49

Goldman Sachs, the chief economist, john Hatzius, offered an explanation on why consumers perhaps may be feeling so dour when times are pretty good, and what he did was he pointed to a business survey, dallas Fed Manufacturing Survey specifically. Now, of course, you know this is a business survey, not a consumer survey, but I think that the results very well may carry over to what's taking place in the consumer's mind. Said, because people are people, so people who run businesses are the same people that are the ones out spending their money although they're a subset, it sort of gives us some insight into the human mind and the human emotion.

Keith Lanton: 6:24

And when these business owners were asked what they think that their business will be over the course of the next year, how optimistic are they that their business is going to improve? And I would say that the results show that more businesses were optimistic about the future than pessimistic, but not by a large amount. So about 42, 43% of respondents said that business will be better than expected over the next year. About 27% said it'll be worse and about 30% said it would be the same. But what's interesting is when you ask the folks who responded that their business would be better over the next year, many of those folks attributed the better business they will experience over the next year to either their specific industry or to unique situation within their business. So 40% of the respondents said that their unique industry is reason that their business is going to be better. Almost 30% of them said hey, it's my company. We're doing something unique here that's going to create the more value. We're doing better because we're doing better. And about a third, or about 30%, said we're doing better because the overall economy is doing better. So about 30% said it's the economy. We're just a boat that's rising along with the tide. And then about 70% said it's either us or our general industry. But for the folks who were saying things are going to be a lot worse over the next year or moderately worse over the next year, well, in that category, about 75% of them said it's general economic conditions, nothing to do with our industry, nothing to do with us. In fact, only 5% of the folks who said their business was going to be worse said their business was going to be worse because of unique circumstances tied to their individual business. And what this does is it gives us some unique insights, perhaps, into human psychology. So when things are going well, it's more likely that we're going to attribute things going well to actions that we've taken, things that we've done well, we're taking credit. When things are going poorly, humans very well may think to themselves oh, this isn't me, this isn't my unique circumstance, this is the overall economy, this is general conditions. I am just a victim of the current circumstances. So what does this have to do with consumer sentiment? What does this have to do with the fact that the folks still aren't feeling very good about the economy, despite rising wages.

Keith Lanton: 8:46

Well, the Goldman Economist draws the conclusion that perhaps the reason that we are still not too happy with our current sentiment in terms of the economy is because we are certainly experiencing inflation and we are experiencing, in many cases, wage gains, but many of us, if not most of us, may feel that those wage gains are things that we earned and it's unfair that we are seeing rising prices, just as we are making all these accomplishments within our careers, within our lives, to earn more money. We aren't earning more money because of circumstances. We aren't raising more money necessarily because of inflation, because the minimum wage has gone up before working in a fast food restaurant. We're earning more money because we're smarter, we're working harder, we're doing better because of unique factors to ourselves and just as that's happening, snatching that victory from us is the fact that inflation is going up and our wages, even though they're going up, are being eroded by the fact that that inflation is going up. So, this inflation that we're feeling, this insidious inflation, that is not our fault, but the rising wages, that is our credit, and this, perhaps, is the reason that we're feeling this way and that we are getting frustrated by the current environment. So take away something to think about, both in our individual circumstances and how we feel about the economy and the environment. And it also may be a factor this inflation that so irks so many of us, maybe due to the fact that it's happened relatively quickly after a long period when we didn't experience any inflation. So, bottom line, we aren't used to it, we're not accustomed to it, we didn't build it into our expectations and Over the last three to four years, we've experienced something that we haven't experienced in a long time. Many of us may never have experienced it, depending on our age, and we remember Because we have a recency bias when prices were low. Remember when airfare that cost us $400 was $300. We remember when that gallon of milk was $2.50 an hour, $3.50, further adding to our anger and our frustration Because it is something that was recent to us. So keep that in mind as you approach 2024. Think about it how it relates to you personally. Think about how that may or may not influence your thoughts going into 2024, both personally as well as when it comes to investing, and perhaps think about how that will affect you both personally and psychologically, so that you can have a better mindset going into 2024.

Keith Lanton: 11:21

Now let's take a look at 2023. An annual tradition is to look back, as we approach December, upon the previous year. That is still currently the year, and here we are with a lot of with a lot of thoughts about how 2000 and the 23 played out, and you may recall that, heading into 2023, the average forecast called to the S&P 500 to decline. That was the first negative prediction since at least 1999. So naturally, the S&P 500 is sitting at about 19% year-to-date gains.

Keith Lanton: 11:53

But an interesting wrinkle is that the root cause of some of the most bearish fantasies was generally Correct. The Federal Reserve was more aggressive than widely expected and yield soared to eye watering heights as a result. However, it was the follow-through from those higher rates that has yet to materialize. The widely heralded recession never came. Corporate profits didn't crater and, as just mentioned before us, consumers are still spending. Now there are a few potential reasons why. One is something we've talked about over the past several calls the US economy is less rate sensitive compared to past cycle, something that chairman Powell, I'll, acknowledge just last month. Second, it turns out that the S&P 500 heaviest hitters the mega cap technology companies don't necessarily have an adversarial Relationship with higher rates. Rather, tech companies that have powered index level gains in the stock market this year are generally better equipped to deal with Interest expenses and refinancing risk than their smaller brethren. Additionally, companies such as Alphabet and Tesla have actually profited from their massive cash hordes in recent years and aggregate the 2023 Wall Street forecasting.

Keith Lanton: 13:05

Experience raises a question that has been asked before and, as I alluded to a few minutes ago, even if you knew what would you have done? Having the proper information and starting point in hand is useful, but markets are under no obligation to behave. So, looking back, 2022 negative year in equity markets, s&p down almost 20 percent. The finding feature of 2022-2022 was the year of cash and cash out performance, a year in which many things went wrong and holding cash was your best alternative. In 2023, demand for cash intensified further and going into 2024, that continues to build.

Keith Lanton: 13:49

Despite the fact that markets have moved up, many of us have held on to our cash or increased our cash Allocation. Assets and money market funds this year have soared to a record high of $5.8 trillion. That's according to the investment company Institute. All told, more than a trillion dollars have been added to money market funds so far in 2023. Lofty yields on the shortest-dating paper means that cash is attractive beyond its traditional role as a safe haven asset. Meanwhile, depositors, rattled by March's events, when we saw some bank failures, and frustrated by banks not passing on higher rates quickly enough, have flocked to money market funds as well.

Keith Lanton: 14:31

One other follow-on from this is that we have seen money moving out of mutual funds that are invested in cash, cash alternatives and bonds. We've seen that money move into exchange-traded funds that are tied to bonds. Last week we did get a milestone A bond exchange-traded fund crossed $100 billion for the first time since ETFs launched over two decades ago. It's in the Vanguard. Total bond market ETF symbol. Bnd pushed above $100 billion for the first time ever, and that fund has gotten inflows this year of about $15.6 billion. This milestone marries two of 2023's biggest trends. The highest yields in years have made fixed income more appealing, while relatively low-cost, tax-efficient ETFs have stolen market share from their more expensive mutual fund brethren. There's likely a large portion of flows coming from mutual funds as a source of this ETF growth.

Keith Lanton: 15:33

All right, about halfway through the call and we will take a look at where we are with financial markets this morning. Right now, s&p futures are down about 22.5 points. That's about half a percent lower around the lowest level of the session. Dow futures down about 123. Nasdaq futures accelerating to downside, now down about 105 points below fair value Futures, indicating this lower open as we are cooling off after some very big game over the past several weeks. On top of that we have Treasury yield inching higher. This morning. Two-year note yield is up four basis points to 4.60. The 10-year is up about 2.5 basis points to 4.25, and we are seeing oil down about 7.10 of 1% or 50 cents a barrel. Crude futures just mentioned down slightly and the only economic data we have this week are factory orders. Today at 10 am.

Keith Lanton: 16:37

Overseas markets. Equity indices in the Asia-Pacific region began the week on a mixed note. We had the Sensex in India up over 2%, the Hancing down 1%, japan down slightly, south Korea up slightly, australia up slightly, major European indices largely near their flat lines. In China we had some news come out of there, little bit of deja vu. Chinese health officials are advising against large gatherings amid ongoing reports of cases of acute respiratory diseases. We're also seeing some US Republican senators urging President Biden to implement a ban on travel to China. We'll see if that gets more momentum as winter progresses.

Keith Lanton: 17:21

Some individual companies in the news today Roche is joining the race for a B-City drugs $2.7 billion deal to buy Harmont Therapeutics. This is a company that makes a weight loss drug in trials that potentially could compete with Novo Nordisk and Eli Lilly. And we have some M&A news. Alaska Airlines, some ALK, which is down a little over 10%, offering to buy Alaska Air for $18 per share. So Hawaiian Airlines is a big beneficiary of that. That stock has declined significantly in the past several months. After the wildfires in Hawaii did their business significantly and some other operational issues, that stock was down to about $4 to $5 a share and it's up about $9 a share this morning on that takeover news to just under 14. Spotify symbol, spot says they're going to reduce the headcount by an additional 17%. This is after some previous announcements of job cuts, saying that they beat up too much during COVID, and even after their recent layoffs they're going to now lay up almost one of every five of their employees.

Keith Lanton: 18:30

Coinbase C-O-I-N rising amid elevated cryptocurrency prices. Cryptocurrency up last week. This morning it's up modestly again. Uber this morning up about 5% to just over $60 per share. It's going to join the S&P 500 effective as of the open on Monday, december 18.

Keith Lanton: 18:48

Lulu Lemon LULU, which is a stock that's been a strong performer throughout the last several months, downgraded this morning to equal weight from overweight at Wells Fargo it's down about 2%, or about nine points. Carvana CVNA upgraded to neutral from underweight at JP Morgan it's up about 2 points or 6%. And General Motors, this morning upgraded to buy from neutral at Mizzuho $41 target. That stocks up about 50 cents to about $32.80 per share. This week US bank CEOs are expected to protest regulation before Congress Reports out of China that Tesla's China made. Electric vehicle sales fell 17.8% in November. That is the biggest drop since December of 2022. In geopolitical news, wall Street Journal reporting a US destroyer and several commercial ships were attacked. In the Red Sea Journal also reporting that Israel has increased its attacks on southern Gaza.

Keith Lanton: 19:48

The Financial Times is talking about a case that is before the Supreme Court that will have a strong impact on wealth taxes and whether or not they can be implemented and whether or not wealth taxes are constitutional. Also, the Supreme Court's hearing a case on Purdue Pharmaceutical specifically the bankruptcy there, protected the Sackler family from further prosecution and protected a portion of their wealth. The Sackler family agreed to pay about $6 billion in a settlement, but reports indicate that they were able to keep several billion dollars. The Supreme Court will decide whether or not that agreement was something that was lawful. This case, according to the New York Times, could have implications for other companies who use the bankruptcy system to shield them from lawsuits. Think about 3M and think about Johnson and Johnson, with big litigation suits currently ongoing against them. Financial Times saying China borrowers are defaulting near record numbers and CNBC reporting that some cryptocurrency executives once again suggesting that Bitcoin could make a run at $100,000 per coin.

Keith Lanton: 20:54

What's going on this week? Talked about the one report that is coming out today at 10 o'clock, october, factory Orders. Tomorrow, bureau of Labor Statistics releases the Job Openings and Labor Turnover Survey, also known as JOLTS. Economists expect 9.35M job openings on the last business day of October, which would be about $200,000 less than September. Currently, there are about 1.5 open positions for every unemployed worker. That's down from a peak of about 2 to 1 in March of 2022. Also Tomorrow, institute of Supply Management releases the Servicing Purchasing Managers Index from November. Looking for that stay roughly unchanged at just under 52.

Keith Lanton: 21:32

Thursday, broadcom releases 4th Quarter Results for 2023. Keep in mind, broadcom just closed its $60 billion-plus acquisition of cloud computing from VMware. We'll see how the cultural integration goes there. Broadcom CEO recently saying that the VMware folks are in for a surprise. They're going to have to be back in the office. Many of those folks work in remotely, so seeing an initial change there of policy on the very first week of integration. Friday, perhaps the largest economic data of the week, something the Fed will probably be keeping a close eye on ahead of their meeting next week Bureau of Labor Statistics releases the job support for November. Consensus Estimates for an increase of $175,000 in non-farm payrolls, $25,000 more than in October. Unemployment rate expected to stay unchanged at 3.9%.

Keith Lanton: 22:27

Barron's talking about the equity market, why the equity markets may be moving higher, saying the Fed isn't the only thing sending the stock market higher. Stocks just had their best month in more than a year. It's easy to credit games to the market's conviction that the Fed is unraising interest rates. But Barron says don't forget about earnings, me. Earnings season is wrapping up this week and it's time to start drawing conclusions, they say. The most obvious one is that the earnings recession may be over. S&p Company's third quarter net income was 4.1% higher than a year ago, after three straight quarters of declines and earnings per share were up 7.1% thanks to stock buybacks. Analyst Consensus now calls for $245 per share in S&P 500 earnings next year, which would be more than 11% growth. Some would suggest that's overly optimistic. Nevertheless, even if you dial those expectations back, we'd still be looking for growth, which is something that we haven't seen in the past several quarters.

Keith Lanton: 23:27

Some key tests lie ahead for the financial markets with respect to interest rates, which has been the primary engine driving market. Perhaps we'll hand it off to our earnings, but after last week in some comments from Fed governors, especially Christopher Waller, who expressed confidence that inflation was receding, markets are now pricing in some interest rate cuts next year. In fact, markets pricing in a 25 basis point cut as soon as March and as many as six quarter point cuts by the end of 2024. So key tests for those assumptions will come next week and when the Fed decides and we hear that commentary and we'll get that data on Friday with the employment report to see how much the employment picture is improving or if it is in fact holding steady or strengthening.

Keith Lanton: 24:17

I mentioned I talk about AI, artificial intelligence. Barron had two articles on AI. The cover story of the Barons was NVIDIA and two smaller AI stocks that look undervalued and could be big winners. They go on to remain bullish on NVIDIA, saying that they are the clear and most obvious beneficiary from AI build out, but there are two less well-known companies that investors should consider. They talk about these companies. They are super micro computer symbol SMCI, and vertive holdings, symbol BRT. These are companies they say could ride NVIDIA's coattails.

Keith Lanton: 24:52

Wall Street surveys of corporate technology buyers show that AI infrastructure and AI projects are the top priority for budget spending over the next three years. They talk about NVIDIA that, despite the fact that they are seeing AI competition from large technology companies including Microsoft, amazon, alphabet, google, intel and AMD, nvidia will probably maintain its market leadership, and they say that's because of a significant but often overlooked reason for NVIDIA's dominance, and that is their software programming ecosystem, known as CUDA. Developers have built and shared AI related tools and software libraries on NVIDIA's proprietary platform for more than a decade. It makes it easier to rapidly build AI applications, which are critical for startups and corporations to beat their competitors. Think of CUDA as the operating system for AI, not unlike the role that Microsoft Windows played in the PC boom during the early 1990s. Unlike Microsoft, though, and more like its longtime rival Apple, nvidia has a full-fac model. It controls the AI experience across hardware, networking and software Retooling technology infrastructure to run different AI chips makes little sense when NVIDIA provides the best overall package and performance with the most features.

Keith Lanton: 26:07

The raising AI demand is increasing demand for AI servers that house all those NVIDIA chips, and that's good news for Super Micro. This company is the leading independent manufacturer of high-end AI servers that fill the server racks inside data centers. More than half of its revenue is tied to AI. Tesla and Meta platforms are among Super Micro customers. According to Barclays, ai isn't just hot. As a metaphorical trend, the data centers running those AI servers generate five times more heat than traditional CPU servers and require 10 times more cooling per square foot. That's where the company Vertiv comes in. Vertiv works to keep those temperatures under control. The company's power and cooling infrastructure equipment to data center account for 75% of Vertiv's revenues.

Keith Lanton: 26:54

Now, to be sure, none of these AI opportunities have gone unnoticed. Shares of NVIDIA, super Micro and Vertiv have more than tripled this year due to the market's excitement over AI-related companies. But, barron says, even so, the stocks aren't trading in particularly aggressive valuations thanks to equally explosive earnings growth. The question now is whether the companies can keep growing over the longer term. The other AI company and the other AI feature article has to do with you guessed it Microsoft Deices. Here is Microsoft got an AI boost. It's far from over. Nvidia may be first on the list of AI beneficiaries, but Microsoft, they say, is a clear number two. With that, I will turn it over to Brad. Give us some more insights into markets, fix the market, having a real strong rally here, brad. Perhaps give us some insights what to expect at your end and heading into 2024. Morning Brad.

Brad Harris: 27:51

Morning, keith. How are you? Good morning everyone. I hope everyone had a great weekend.

Brad Harris: 27:55

The 10-year treasury rallied over 2% this past week, after having rallied 3% the previous two weeks and almost 2% the two weeks prior, for almost a 7% move on the 10-year treasury. The 30-year treasury was up almost 10% in that same time period. Municipals also had a 7-10% move during that period on what municipal market data watches. But if you had been buying 10-20 years out of favor 3% discount bonds, that move this past month could have been closer to 15-20%. Which is why the previous two weeks I had been touting 3% bonds going 8-12 years at these deeply discounted prices After the previous moves.

Brad Harris: 28:42

I just didn't want to say to be careful last week, because sometimes you just can't fight the momentum.

Brad Harris: 28:51

Maybe when you get out of a market you have caught the fallen knife and you've won and you've made 10%, but there may be the next 20% on the table that you're missing and sometimes, when you're just too close to it, you can't appreciate that that does happen.

Brad Harris: 29:08

So instead of prognosticating right here, here's what I would look at in bonds, in taxable accounts, there are a couple of weeks to do tax loss swaps and I'm happy, as many of you know, to work around the clock for the next few weeks to help make these work for you and, if the strategy makes sense, for new money. I still like 8-12-year munis with 3% coupons at a 4% yield to maturity or better. We have a few weeks to get all this done, but the sooner we start, the more time we have to be thoughtful and execute these trades as best as possible. I know that you realize how much time goes into these tax swaps. It's not just wholesale hit the bid and wholesale buy the offer. You really want to put these together to protect the account and make sure that the integrity of the average life maturity quality also relatively close Thanks.

Alan Eppers: 30:05

Thank you for listening to Mr Keith Lanton. This podcast is available on most platforms, including Apple Podcasts, Spotify and Pandora. For more information, please visit our website at www. heroldlantern. com.

Sophie Cohen: 30:23

Opinions expressed herein are subject to change and not necessarily the opinion of the firm. Past performance is no guarantee of future results. The information presented herein is for informational purposes only and is not intended to provide personal investment advice. It is important that you consider your tolerance for risk and investment goals when making investment decisions. Investing in securities does involve risk and the potential of losing money. The material does not constitute research, investment advice or trade recommendations.