• Stocks chopped higher in February as the market digested higher ISM readings and stagnant inflation. There are some signs the economy is re-accelerating even with the Federal Funds rate well above 5%.

• Bonds weakened slightly on the same data indicating economic strength.

• Once again, leading indicators show a recession is imminent, yet GDP growth and corporate profits continue to muddle along.

Table 1: Market performance estimate as of 2/29/2024 (LIMW)

How long will the leading indicators be wrong?

For a long time, the best leading indicators have been forecasting economic problems. Yet, so far, nothing bad has happened. Is this cycle different?

Historically, there have been times when the lead time on each of our favorite indicators has been very long. The Conference Board's Leading Economic Indicator (LEI) just set a new record of 24 months, meaning no recession 24 months after the indicator declined. The last record was 22 months in 2007. The yield curve inversion signal is 14 months old and counting, but the record was 16 months between signal and recession in 1989.

These signals have been reliable indicators in prior cycles. It is possible that the plethora of stimulus spending has extended the current cycle. However, we believe that the Fed will eventually have its way in the end: lower growth and lower inflation.

Table 2: Comparison of current indicator lead times (LIWM)

Figure 1: Leading Economic Indicator (Conference Board)

Figure 2: 10-year/3-month Treasury Yield Curve Inversion (LIWM)

Employment and ISM data do not indicate recession

Employment is a lagging indicator and the business surveys collected by the Institute for Supply Management (ISM) are coincident indicators. Neither indicator is showing signs of recession. This disparity between the leading, lagging and coincident indicators is normal. It is only when the cycle has turned down that we will be able to look back and agree that the leading indicators were right again.

It is frustrating to see the economy chug along slowly when the leading indicators are so dire. We share your frustration.

Figure 3: ISM Purchasing Manager Indexes (PMI) for Manufacturing and Service (LIWM)

Figure 4: Unemployment Rate vs. S&P 500 (LIWM)

Federal tax receipts are surprisingly weak

Most of the taxes in the United States are paid by the middle class. The poor and corporations are taxed at very favorable (low) rates. The rich are taxed at higher rates for income, but their investments receive preferrable tax treatment in the form of capital gains taxes. For example, the highest capital gains tax rates are 20% while the highest earned income tax rates are 37%.

It is interesting to look at the growth rate of taxes that are actually getting paid because in recessions, we typically see federal tax revenues fall as unemployment rises. Curiously, in this cycle we see federal revenues falling while employment remains strong. There has been a pattern of full time workers moving to part time work. Perhaps they are working for less pay and benefits.

Here is an analysis of the year-on-year change in federal tax receipts up to September 2023. This chart contradicts the strong-GDP-strong-economy narrative we see in the news.

Figure 5: Year-over-year change in federal tax receipts (LIWM)

The cost of illegal immigration and its impact on the economy

By now, everyone is aware that we have an immigration problem in our country. Not only are the borders wide open, but programs for the poor are targeting these folks when they come into the country. As with many welfare programs, they are automatically funded when an eligible beneficiary applies. In cities like New York, they are creating new programs in addition to the federal ones.

Obviously, this impacts consumer spending. If consumers are given cash by the government, they spend it. This stimulates growth and sustains the inflation we see in the economy. When the government gives immigrants money; they spend it. Immigrant spending of government money is one of the factors holding up economic growth.

Strangely, it is very difficult to get good numbers on how big this spending is. Here is our estimate, cobbled together from a variety of sources. Some estimates are from 2019 and do not include the increase from recent inflows. Speaking of inflows, the estimate number of illegal immigrants reported by the Border Patrol is 7,298,486 since 2021 (Fox News). This is an unbelievably large number, greater than the size of many cities and states.

The source document for this analysis is Congressional testimony from January 2024 by Steven Camarota, the Director of Research at the Center for Immigration Studies. It is an interesting and short read.

The Cost of Illegal Immigration to Taxpayers

At a minimum, we are spending $120 billion/year on immigrants, while they pay about $26 billion/year in taxes.

Table 3: Minimum government costs of immigration (LIWM)

Inflation update

The most important inflation data point for the Fed is Core Personal Consumption Expenditure (PCE) inflation which was reported at 2.8% year-over-year on February 29th. From the Fed's perspective, inflation continues to slowly fall to their 2% target.

It is unclear whether this will incentivize the Fed to cut interest rates earlier in 2024. The bond market is expecting rate cuts by summertime. The more important question is what will be the reaction function of the Fed if we fall into recession?

In the 1970's, a well meaning Fed cut interest rates aggressively in each of the 3 recessions (1970, 1974 and 1980). Unfortunately for the country, each rate cut cycle increased the inflationary pressures on the economy forcing higher interest rates later to counter the prior stimulus.

We won't know if we replay the 1970's experience for a few years.

Figure 6: Federal Funds rate (FF), 10-year Treasury Yields and Consumer Price Inflation (CPI) 1960-1980 (LIWM)

Office property market update

This may be a unique situation, but a New York office property was just sold for $1 by a Canadian pension fund. This fund has sold other properties for a significant discount recently.

Office properties are an important part of the commercial real estate market. At this time, the financial system risk appears to be concentrated in pension funds and regional banks. It is too early to tell if this is an early sign of broader property valuation problems or a narrow issue resulting from the switch to remote work for traditional office workers.

Figure 7: 360 Park Avenue South, recently sold for $1 (zerohedge)

The market top of 2000

Stanley Druckenmiller made a name for himself as head trader for George Soros's Quantum Fund. This successful hedge fund was known for its outsized and controversial bets to make money for their investors. Druckenmiller is widely recognized as one of the best traders and macro-economic analysts in the business, but he lost $3 billion and his job trading the market top of 2000 wrong. Here is his story as he told it in 2015:

"...in 1999 after Yahoo and America Online had already gone up tenfold, I got the bright idea at Soros to short internet stocks. I put $200 million in them about February and by mid-March the $200 million short had lost $600 million, gotten completely beat up, and was down 15% on the year. And I was very proud of the fact that I never had a down year, and I thought well, I'm finished.

So the next thing that happens is - I can't remember whether I went to Silicon Valley or talked to some 22-year-old with Asperger's - but whoever it was, they convinced me about this new tech boom that was going to take place. So I went and hired a couple of gun slingers because we only knew about IBM and Hewlett Packard. I needed Veritas and Verisign...So, we hired these guys and ended up on the year - we had been down 15% - we ended up like 35% on the year. The Nasdaq had gone up like 400%.

So, I'll never forget it. January of 2000 I go into Soros's office and I say I'm selling all the tech stocks, selling everything. This is crazy. This is nuts. Just kind of as I explained earlier, we're going to step aside, wait for the next fat pitch. I didn't fire the two gun slingers. They didn't have enough money to really hurt the fund, but they started making 3% a day and I'm out. It is driving me nuts. I mean their little account is like up 50% on the year.

I think Quantum was up 7%. It's just sitting there. So around March I could feel it coming. I just had to play. I couldn't help myself. And three times during the same week I pick up a - don't do it. Don't do it. Anyway, I picked up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks and in six weeks I had left Soros and lost $3 billion in that one play.

You asked me what I learned. I didn't learn anything. I already knew that I wasn't supposed to do that. I was just an emotional basket case and couldn't help myself. So, maybe I learned not to do it again, but I already knew that.

This is one of the BEST investors in the world and he got it completely wrong in 2000.

What can we learn from his mistakes?

1. Emotional decisions are usually bad decisions.
2. Don't ignore economic signals of future problems.
3. Don't make all-or-nothing investment decisions.
4. Don't fight the Fed.

There were many stocks that bedazzled investors in 2000. Here is one that every tech investor knew very well: JDS Uniphase. At the time, companies like Verizon, Worldcom and AT&T were in a race to build and install fiber-optic networks. Companies like JDS, Lucent and Cisco were busy feeding that demand. But at some point, the endless orders and insatiable demand evaporated and the deep pockets that had driven capex stopped spending. The stock fell almost all the way to its pre-bubble levels.

The narrative that artifical intelligence is going to change the world is eerily similar to the stories surrounding the internet and fiber optic bandwidth stocks of 2000. Don't get me wrong, the products those companies produced in the 1990's DID change the world, but the expectations of profit and revenue growth were extremely over-estimated.

Today's situation is different than that of the 2000 tech bubble top, but there are some strong similarities. We encourage those investing in these themes to be very careful with these stocks.

Figure 8: Viavi Solutions 1998-2003 (JDS Uniphase's new name) (LIWM)

Large insider sales of company stock

It is normal for company executives to sell their vested stock as the market rises. Stock grants are just part of total compensation and we encourage our clients to think about their company stock in precisely this manner.

Insiders are required to disclose to the SEC when and how much they are selling. For this reason, analysts can look at which executives are good at harvesting profits or buying when the stock is undervalued.

Recently, we've had a spate of executives selling extremely large amounts of stock. It is likely they are keenly aware of when their company stock is over or under valued given economic conditions. We are not the only analysts commenting on Fed policy and market valuations.

In particular, Jeff Bezos historically demonstrated a knack for selling his Amazon stock at attractive prices and recently sold heavily. The Walton family made one of the largest sales ever of Walmart from their family office. Jamie Dimon sold vested JP Morgan stock for the first time ever. Jeffrey Ubben at Exxonmobil sold his entire Exxonmobil position. The smart money is selling.

Table 4: Large insider sales last 3 months (LIWM)

Equity markets rose again in February

Equity markets rose again in February. Since December 2023's Fed meeting, the market has eagerly lapped up every headline indicating that Fed rate cuts will start soon and that GDP growth will not slow down.

The market rally is being driven by a handful of technology stocks that carry the heaviest weights within the index. In the investing world, we call this a "narrowing" of the market. Ideally, long-term investors want to see a broad market rally with all sectors participating. That is not what we see today.

The risk is that with revenue and earnings growth coming from a few companies, any disruption to their growth will affect the headline market indexes. Most of these companies rely on revenues that are tied to the economic cycle and consumer spending: Apple, Amazon, Google, Facebook, Tesla, and Nvidia. Microsoft has less cyclical exposure because of their focus on enterprise software and services.

Technology is a cyclical sector that historically rises and falls with the economy. It is interest rate sensitive. Could this cycle be different? Sure, but that would be a break from decades of past performance.

Remember the most dangerous four words in investing are "It's different this time."

Figure 9: S&P 500 2020-2024 (LIWM)

Bond markets fell in February

Bond markets fell slightly in February, but we see a favorable pattern of consolidation and lower volume in key parts of the bond market. In other words, the panic selling that dominated 2022 and 2023 seems to have abated.

In particular, while the yields on Treasury bonds are attractive, we are nervous about how little investors are paid to take extra risk in investment grade and non-investment grade debt. Typically, these corporate bonds perform poorly in recessionary environments, while Treasuries do well.

Figure 10: 20-year Treasury bond ETF TLT (LIWM)

Final thoughts

Leading indicators still warn of trouble; the coincident and lagging indicators are saying everything is fine. So far this year, the market is watching the latter. It is possible the leading indicators are wrong, but not likely, in our view.

If you'd like to discuss any of our research, please feel free to reach out to us.

Rob 281-402-8284

Chris 281-547-7542

Rob Lloyd, CFA^®

Lloyds Intrepid Wealth Management

1330 Lake Robbins Dr., Suite 560

The Woodlands, TX  77380

281-402-8284

Robert.Lloyd@lloydsintrepid.com

www.lloydsintrepid.com

Christopher Lloyd, CFP ^®

Vice President and Senior Wealth Planner

Lloyds Intrepid Wealth Management

1330 Lake Robbins Dr., Suite 560

The Woodlands, TX  77380

281-547-7542

Chris.Lloyd@lloydsintrepid.com

www.lloydsintrepid.com

Lloyds Intrepid LLC is an Investment Advisor registered with the State of Texas, where it is doing business as Lloyds Intrepid Wealth Management. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy, or the completeness of, any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Please contact us at 281.886.3039 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from Lloyds Intrepid LLC with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request, and on our website, www.LloydsIntrepid.com. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.