Clients of the Firm,  

Frequently, we are met with the profound musing of some pundit or another about the future path of the economy.  Often, these predictions are either excessively dire or overly rosy.  Market sentiment shifts as frequently as the winds off Gloucester harbor outside our office. Warm morning zephyrs are too often met with a cold northeast wind by market close.  When it comes to predicting short-term market outcomes, an investor’s compass can be equally unreliable. Therefore, we build arks for coming storms rather than trying to predict the weather.  For this we use value and GARP equity methodologies alongside active fixed income management.  We augment these strategies at times with macro and micro hedges to prepare for potential storms.    

In the past few weeks, the prediction of storms as a result of Federal Reserve rate hikes and the bank failures of SVB and Signature Bank has steadily increased.  Concurrently, I have been reading a text on European history before bed each night and I was reminded of the phrase “Après nous, le déluge” translated “after us the flood”.  The phrase is attributed to Louis XV in reference to his relationship with Madame De Pompadour.  It is generally regarded as an expression of indifference to what will happen after one is gone.  It is also seen as foreshadowing the French Revolution and the eventual downfall of the French monarchy.  A modern-day equivalent might be YOLO (you only live once), a popular meme among the social media generation.   

Upon reflection, a corollary to markets emerged in my reading.  What floods may erupt from the termination of easy money policy?  It seems Fed policy may finally be breaking the back of the “lower for longer” asset price bid, affectionately known as the Fed put.  This policy gave rise to the TINA, there is no alternative, (to equities) argument.  With interest rates pegged near zero over the past 12 years, many sought returns in equities and alternative assets to try to achieve positive results and thus prices increased steadily in yield producing assets.  In some cases, prices became unreasonably high.   

Now Fed policy has reversed course, giving rise to a compelling alternative in money markets and Treasury bonds.  With rates in the mid 4% range for these alternatives, stocks have re-rated from a valuation perspective.  Higher than normal P/E values are no longer justified in a slower growth inflationary environment.  Companies without earnings saw their stock prices get severely punished, while regional banks were equally pained by the corresponding exposure to their balance sheets from higher rates.  While defaults on loans remain low, investors have become concerned about the coming flood. Solvency and liquidity at smaller banks became an issue in mid-March 2023 as a result.   

Appropriate arks for such storms include investment in money center banks that have wider diversification of deposit and credit risk and other complimentary financial services such as asset management, trading and treasury management.  Bar-belling these holdings with a general S&P 500 put option or betting against high yield debt at certain levels can also help us weather the rising waters.         

Further, large technology companies positioned to take advantage of generative AI, the likely next technology revolution beyond cloud are other equity holdings to consider.  During the tech selloff of 2022, many of the highest quality best balance sheet companies sold off with the weaker no profit firms.  With large cash balances and the ability to invest in R&D, these firms will likely emerge from the torrent stronger and better aligned with the next growth phase in tech. This ark is one prepared to sail across very rough seas due to incredible balance sheet strength and recurring high margin revenue streams.       

Fixed income is far more investable than a year ago. Projected cash flows for many clients have increased due to our positioning on the short end of the yield curve, which has avoided much of the price decline in bonds while increasing our interest income.  Here we employ continuous reinvestment and active management to optimize yields.  We see the arks here as very high quality credit such as U.S. Treasuries and very high grade debt, where default risk is exceedingly low.  In addition, short positioning against high yield, covenant-light or high risk paper continues to make sense in a higher rate, higher risk environment. 

While many pundits see the Fed cutting rates soon, our view continues to be a “higher for longer, but not that high” rate outlook. This opinion portends an environment where growth slows and inflation comes down slowly, but not in a straight line.  This will require the Fed to pause soon but keep rates near current levels to ensure inflation moderates and becomes more stable.  We are seeing signs of this in the recent CPI prints and other economic data, but we believe more data needs to emerge for the Fed to even pause hikes, let alone cut them.   How the long end of the curve responds is highly uncertain.  We will look to take advantage of any correction to increase duration and to try to maximize yields and total returns in bond portfolios.      

In France, Louis VX’s comment from 1757 is usually taken out of context in the modern era. The King wasn’t referring to a coming French revolution, but Haley’s comet which was predicted to pass by that year.  At the time, it was commonly blamed for the Genesis flood.  The comet actually arrived in 1759 amidst much anxiety but caused no floods.  

We hope to be as fortunate as Fed policy takes hold.  We will build our arks just in case.  

Sincerely,

Peter C. Wernau

President, CEO
Wernau Asset Management

http://www.wernauassetmanagement.com/
 
Office: 617.871.0029 
Fax: 617.507.8155
 
This e-mail may be considered advertising under federal law. If you prefer not to receive information about Wernau Asset Management services and information via e-mail please reply to this e-mail and type "REMOVE" in the subject line.
 
The information in this transmittal (including attachments, if any) is privileged and confidential and is intended only for the recipient(s) listed above.  Any review, use, disclosure, distribution or copying of this transmittal is prohibited except by or on behalf of the intended recipient.  If you have received this transmittal in error, please notify me immediately by reply email and destroy all copies of the mistaken transmittal.  Thank you.

This e-mail may be considered advertising under federal law. If you prefer not to receive information about Wernau Asset Management services and information via e-mail please reply to this e-mail and type "REMOVE" in the subject line.
 
The information in this transmittal (including attachments, if any) is privileged and confidential and is intended only for the recipient(s) listed above.  Any review, use, disclosure, distribution or copying of this transmittal is prohibited except by or on behalf of the intended recipient.  If you have received this transmittal in error, please notify me immediately by reply email and destroy all copies of the mistaken transmittal.  Thank you.

Important Legal Disclosure 

This letter contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Wernau Asset Management, Inc. ("Wernau Asset Management) is a registered investment adviser with its principal place of business in the Commonwealth of Massachusetts. Wernau Asset Management and its representatives are in compliance with the current registration requirements imposed upon registered investment advisers by those states in which Wernau Asset Management maintains clients. Wernau Asset Management may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. This letter is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Wernau Asset Management with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Wernau Asset Management, please contact Wernau Asset Management or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Wernau Asset Management, including fees and services, send for our disclosure statement as set forth on Form ADV from Wernau Asset Management using the contact information herein. Please read the disclosure statement carefully before you invest or send money.   

Wernau Asset Management

30 Western Ave Suite 206

Gloucester, MA 01930