The team at Infrastructure Capital Advisors provides key insights and advice on current market conditions and economic outlook for this month and the coming months. See this months report below but be sure to register to join our August Market & Economic Outlook Webinar where Jay Hatfield, CEO/CIO, provides updates and insight to this report for this and coming months.
The US is not in a Recession but Europe is likely heading into a Recession. The bulk of US quantitative tightening is behind us.
The Fed raised rates by the expected 75 basis points but recognized that the economy is softening while the job market remains strong. The July Fed statement was slightly dovish and bolstered the tech-led stock rally. We expect inflation to decline in the fall following the July PPI report. The Fed has reduced the money supply by over 15% this year, marking the fastest decline since the great depression.
The reduction in the money supply has caused the dollar to surge up almost 10% for the year. The strong dollar has caused commodities to drop substantially over the last month. In addition, the $900 billion of quantitative tightening has caused mortgage yields to rise from an all-time low below 3% to over 5.5% which is likely to cool off the housing market. We anticipate that the drop in commodity prices will first be reflected in the July PPI report and will slowly be reflected in CPI.
All 11 post WWII recessions were precipitated by a Fed tightening cycle that caused a crash in the housing and auto markets due to rapidly rising rates. In those recessions, excess inventories of homes and automobiles resulted in mass layoffs of construction and auto manufacturing workers.
Due to the cooling of inflation, the Fed is likely to be able to slow rate hikes to 25bp per meeting after the September meeting.
Reviewing the 2nd Quarter GDP results, consumer demand grew .7% vs. 1.2% in the first quarter. Business investment was negative at .7% vs. a 1.3% increase last quarter. The biggest detractor from GDP was a 2% reduction of inventories. A reduction in inventory is a bullish sign for growth as it indicates that demand is strong and production needs to accelerate to meet that demand.
In a recession, inventories normally rise as the economy slows. Although the US entered into a technical recession after two consecutive quarters of negative growth, we remain optimistic as first quarter GDP was estimated to be weak solely due to a decline in net exports but showed strong domestic demand. In addition, first quarter GDP estimates have been empirically demonstrated to have a negative bias. An alternative estimate of national product published by the commerce department, Gross Domestic Income, increased by 1.8%, indicating that the official GDP estimate may be inaccurate.
The US currently has an all-time seasonal low of existing homes at 1.26MM homes vs. a normal average of 2.35MM and a peak of 4MM homes during the financial crisis. Auto inventories are currently at approximately 86,000 vs. average historical inventory of 1,277,000. These low inventories further support GDP growth in the third and fourth quarter if levels increase to meet demand.
Stock Market Outlook:
Our models show that the S&P is approximately fairly valued at 4,500, based on the current 10-year interest rate of 3%, implying 10% upside.
But if the 10 year rises to a yield of 4.0%, fair value on the S&P would drop by over 10% to 3,500. We continue to believe it is beneficial to focus on defensive dividend stocks such as preferred stocks, utilities, telecom services, pipelines, and consumer staple stocks with significant dividends, which will benefit under this environment. We also believe covered call writing strategies can be useful as stock returns are likely to be low or negative and volatility is likely to be elevated.
Most large capitalization stocks, including tech stocks, have similar duration and sensitivity to changes in interest rates with a .5% treasury rate increase lowering the theoretical value of a typical stock by approximately 7.5%.
Allocations to certain Regional Banks and select REIT sectors may continue to perform well. For example, we expect to see continued performance from Regional Banks that benefit from increasing net interest margin and that are less exposed to the downturn in investment banking and REITs that are still benefiting from a Pandemic recovery (such as hotels, select office exposure, retail or entertainment).
We believe 10-year interest rates will head higher as the Fed starts to taper and inflation continues to accelerate, however, they do have a ceiling. We are forecasting 10-year rates will top out in the 3% range.
Tighter Fed policy is likely to flatten the yield curve which will keep a lid on long term rates. The Fed has moved past its level of maximum hawkish rhetoric, so we believe it can no longer drive long-term rates higher.
The US 10-year is still approximately 1.0% higher than German 10-year and Japanese bonds are near zero.
Most investors do not recognize that high European natural gas prices drive demand for global refined products as distillate/fuel oil can be used as a substitute for natural gas and distillate can be easily shipped without cooling or compression.
In late July, European natural gas prices spiked to $57 per MCF as Russia reduced natural gas supplies. The $57/MCF mark is more than 6 times the US price and is the energy equivalent of oil trading above $300/barrel. The increase in demand for distillate also drives gasoline prices higher as refiners make more distillate at the expense of gasoline. Current wholesale gasoline prices in the US imply that retail gasoline prices will rise to $4.50/gallon from the current $4.33/gallon. We still see oil trading in the $100-120 range while the Ukraine war continues and in the $80-100 range if there is a resolution in 2022.
Wind and solar only provide 4% of total US energy, while energy is growing at 10%. There is a use for cap and trade or carbon tax to comprehensively reduce carbon emissions as no one solution, such as charging stations, will make a significant impact.
The European energy crisis is likely to add over 1% to global demand for oil as companies switch from natural gas (trading at an oil equivalent price of over $130 per barrel) to oil.
The 3rd quarter growth rate will be a better indicator of the direction of economic growth. We remain conservative in our allocations, reducing position concentrations when advantageous and diversifying when sectors are relatively discounted.
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Infrastructure Capital Advisors, LLC (ICA) is an SEC-registered investment advisor that manages exchange traded funds (ETFs) and a series of hedge funds. The firm was formed in 2012 and is based in New York City. ICA seeks current income opportunities as a primary objective in most, but not all, of ICA's investing activities.
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PFFR Exchange-Traded Funds (ETF): The value of an ETF may be more volatile than the underlying portfolio of securities it is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities. Preferred Stocks: Preferred stocks may decline in price, fail to pay dividends, or be illiquid. Real Estate Investments: The Fund may be negatively affected by factors specific to the real estate market, including interest rates, leverage, property, and management. Industry/Sector Concentration: A Fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated Fund. Passive Strategy/Index Risk: A passive investment strategy seeking to track the performance of the underlying index may result in the Fund holding securities regardless of market conditions or their current or projected performance. This could cause the Fund’s returns to be lower than if the Fund employed an active strategy. Correlation to Index: The performance of the Fund and its index may vary somewhat due to factors such as Fund flows, transaction costs, and timing differences associated with additions to and deletions from its index. Market Volatility: Securities in the Fund may go up or down in response to the prospects of individual companies and general economic conditions. Price changes may be short or long term. Prospectus: For additional information on risks, please see the Fund’s prospectus.
AMZA Exchange Traded Funds (ETF): The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities. MLP Interest Rates: As yield-based investments, MLPs carry interest rate risk and may underperform in rising interest rate environments. Additionally, when investors have heightened fears about the economy, the risk spread between MLPs and competing investment options can widen, which may have an adverse effect on the stock price of MLPs. Rising interest rates may increase the potential cost of MLPs financing projects or cost of operations, and may affect the demand for MLP investments, either of which may result in lower performance by or distributions from the Fund’s MLP investments. Industry/Sector Concentration: A fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated fund. Short Sales: The Fund may engage in short sales, and may experience a loss if the price of a borrowed security increases before the date on which the Fund replaces the security. Leverage: When a Fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded. Derivatives: Investments in derivatives such as futures, options, forwards, and swaps may increase volatility or cause a loss greater than the principal investment. MLPs: Investments in Master Limited Partnerships may be adversely impacted by tax law changes, regulation, or factors affecting underlying assets. No Guarantee: There is no guarantee that the portfolio will meet its objective. Performance Data: Performance data quoted backtested results. Backtested Performance was derived from the retroactive application of a model developed with the benefit of hindsight. Backtested performance is no guarantee of future results and current performance may be higher or lower than the performance shown. Investment return and principal value will fluctuate so your shares, when redeemed, may be worth more or less than their original cost. Please visit https://www.virtus.com/products/virtus-infracap-us-preferred-stock-etf#shareclass.742/period.quarterly for performance data current to the most recent month-end and the Fund’s standard performance information. You should consider the Fund’s investment objectives, risks, charges and expenses carefully before investing. For PFFA, PFFR, and AMZA funds, contact VP Distributors LLC at 1-888-383-4184 or visit www.virtusetfs.com to obtain a prospectus which contains this and other information about the Fund. The prospectus should be read carefully before investing.
Virtus ETF Advisers, LLC serves as the investment advisor and Infrastructure Capital Advisors, LLC serves as the subadviser to PFFA, PFFR and AMZA. These three funds are distributed by VP Distributors, LLC, member FINRA and subsidiary of Virtus Investment Partners, Inc.
Past performance is not indicative of future results.
The links to the fund fact sheets will provide standardized performance and risk disclosures.
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