Light At The End Of The Tunnel

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group

Markets have held up reasonably well in light of the inflationary data this week, but have still followed some seasonality patterns.  The bears would point to a recession they claim is imminent, but most signs do not support that view.  In fact, there are several things that point to light at the end of the September tunnel.  The inspiration for this week's musings is the 1984 film, "Dune."  The movie was not a box office success, but has subsequently become a "cult classic."  However, the 2021 remake was wildly successful, and, not a bad version in my opinion.  Many do not care for the film or the sci-fi genre.  However, this film blends many different genres - action, romance, suspense, and sci-fi into one movie.  Here's some trivia about the film:

• The film required 80 different sets, built on 16 sound stages, with a crew of 1,700, and over 20,000 extras.  This was the primary reason for the large film budget.
• During filming, two hundred workers spent two months hand-clearing three square miles of Mexican desert for location shots.
• The following actors turned down roles in Dune:
  • Jodie Foster, Michelle Pfeiffer, Meg Ryan, & Sarah Jessica Parker (Princess Irulan)
  • Val Kilmer and Rob Lowe (Paul Atreides)
• The futuristic language in Dune is made up of a combination of French, Hebrew, Arabic, and English words.

Here's what we've seen so far this week...

Fear Is The Mind-Killer.  Sometimes we have to put away our fears and focus on the here and now.  The future is often scary because we cannot see it, nor accurately predict it.  It reminds me of a great scene in "Dune" when Paul Atreides is put to a painful test by a Bene Besserit witch.  As his mind is being manipulated to believe the skin on his hand is melting off, he tells himself the following:

    "I must not fear. Fear is the mind-killer. Fear is the little-death that brings total obliteration. I will face my fear. I will let it pass over me and through me. And when it has passed I will turn the inner eye to see its path. Where it has gone, there will be nothing. Only I will remain."

Last week, fear ruled the hearts and minds of investors as higher interest rates for longer was the primary concern.  Those fears have subsided for the time being as the market is now beginning to price in a pause next week and a pause in November.  The inflation numbers came out this week and were largely in-line with expectations.  CPI for August came in +0.6%, which was the expected number.  While the increase was markedly higher than the previous month, the vast majority of the increase had to do with energy prices and not basic consumer needs such as food, basic utilities, and clothing.  The PPI numbers for August were in-line with CPI, as energy was the primary culprit (+2.3% in August), while food input costs were lower.  This is why interest rate fears have shifted.  By the end of last week, futures on the Fed rate hike for next week were at 92% probability of no rate hike.  Today they sit at 97% probability of no rate hike.  One week ago, the probability of no rate hike at the Fed's November meeting was 53% probability.  Today, that probability has risen to 68%.  It's time for investors to relax a little bit and realize there is some seasonality to markets and we haven't reached a level where recessionary alarm bells are yet ringing.  If we look at the National Financial Conditions Index and the Financial Stress Index, both tracked by the Fed, neither look like they did in previous pre-recessionary periods.  You'll notice that during the last 3 major bear markets - Dot-com Bust, 2008 Financial Crisis, and the Pandemic, both indices were positive, which means financial conditions were not loose but were tight.  Currently, both indices are in negative territory, meaning the economy is in good shape at the moment.  Could things change - certainly.  However, we should understand that there's not a lot of panic in markets today and we should invest accordingly.

Are Markets Getting Ready to Awaken?  After being attacked and marooned in the desert, Paul Atreides decides to challenge himself to either become the person he's meant to be or suffer a painful death.  He takes the "water of life" and becomes the "kwisatz haderach" (supreme being).  Upon surviving the ordeal and realizing who he is he states, "Father!  The sleeper has awakened!"  It's possible that markets have reached such an inflection point.  It should be no surprise that markets are experiencing volatility in September, as we recently pointed out that September is one of the worst months of the year for equity markets.  In fact, today is one of the biggest days of the year for volatility as $3.4 trillion in options expire on what is known as "triple witching day."  This marks the largest September options expiration in history.  As the Fed prepares to end its rate hiking cycle (or, perhaps already has ended), the light at the end of the tunnel for consumers and investors may be at hand.  Historically, after we emerge from the month of September, markets tend to out-perform in the 4th quarter.  When the S&P 500 Index has achieved better than a 10% return in the first 3 quarters of the year, the average return is +4.6%.  If you've been keeping score this year, the S&P is up 18.7% already, so another 4.6% would bring the full year 2023 return up to 21.7%.  This past week, we saw equity funds with their largest inflows in more than 18 months.  On top of that, we're about to enter another corporate stock buyback window commonly referred to as the "blackout period."  This will add to volatility as corporations won't be able to buy their stock back.  However, the last period for corporate buybacks (Nov-Dec) is typically the highest with regard to executions.  This is another positive for a potential strong finish to the year.  Investors need to remain focused on their long-term financial plans and less concerned with catchy headlines and perma bears.

The words that Paul speaks to himself are not only good for investors to remember, but for us all to keep in mind.  Especially those who struggle with depression or fear, for it is the mind killer...

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Disclosures

The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

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