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Market Outlook – Q4, 2021

- October 1, 2021

I don’t think [the bond vigilantes] are dead. Anecdotally, my 22-year-old son walked into my home office. He just got a haircut. He said they raised the price from $20 to $26. When the barbers start raising prices, you have to worry about broad-based inflation.

–Ed Yardeni, American Economist and Strategist

SUMMARY

It has been nearly 18 months since COVID-19 hit the U.S., and even with two-thirds of American adults fully vaccinated, the recovery is disjointed and will remain so for the foreseeable future. The virus forced many companies and people to make dramatic changes, and as time goes on, it appears that some of the changes may be more structural than temporary. Given this uncertain economic backdrop, policymakers are unwilling to withdraw a meaningful level of accommodation. This inaction could spur a certain class of fixed income investor, referred to as “the bond vigilantes,” to stir. When these investors deem monetary and fiscal policies as inflationary, they sell bonds, and yields rise in turn. Viewed over the long term, bond vigilantes are a positive force to maintain fiscal and financial stability; however, in the short term, they can create a skittish bond market and interest rate volatility, which can wreak havoc on financial asset returns. The interest rates of bonds reflect th marginal costs of a crucial source of funding for governments (Treasuries), businesses (corporate bonds), and even consumers (mortgage rates). The economic significance of large moves in interest rates cannot be overstated. However, so far, the bond vigilantes have not shown up. The 10-year U.S. Treasury yield was relatively unchanged during the quarter. The quarter started with a yield of 1.45% and subsequently declined to 1.19% on a closing basis in early August. Since then, the yield rose to end the quarter at 1.52%. 16 This is remarkable given the backdrop of massive fiscal spending and elevated inflation. Since COVID-19, the amount of fiscal debt has jumped to 125% of gross domestic product while at the same time the Congressional Budget Office estimates deficits will now average well over $1 trillion annually through 2031. This translates to net treasury debt issuance of more than $4 trillion last year and an estimated $2.1 trillion for this year. 20 Perhaps even more astonishin , the last time the Consumer Price Index was up more than 5% on a year-over-year basis, as it has been for the last two months, was in September 2008. Back then, the 10-year U.S. Treasury yield was in the mid-to-high 3% range—more than double what it is today. Energy plays a key role in economic growth and inflation and that has been impacted by supply chain issues. As of the end of the quarter, a barrel of WTI Crude Oil was trading at a little over $75, a price we have not exceeded since 2014. Similarly, the national average gas price is at just over $3 per gallon, a seven-year high. Finally, natural gas prices are at 13-year highs. Given these price levels, we expect market participants—and the bond vigilantes—will begin to pay more attention to future price moves in the energy complex. We remain keenly interested in how Congress will deal with the federal debt ceiling and how this issue will affect Treasury issuance (supply) for the coming quarters. From an economic and market pers ective, interest rates must remain contained. The Treasury has been unable to move forward with the majority of its scheduled second-half debt issuance, roughly $1 trillion, due to the debt ceiling. That said, we do not have concerns that the federal government will fail to pay its bills—the debt ceiling has been raised twenty-nine times since 1990. If bond vigilantes stay quiet, unsustainable policy accommodation can likely continue. If they do not, investors should expect elevated volatility, at least relative to what has been an extraordinarily good year for asset prices.

A generally weak quarter for risk assets, especially ex-U.S.; commodities were the top performer and balanced portfolios declined 0.5%

Source: Bloomberg

Key markets near all-time highs with inflation running well above “target” exposes the impossible challenge policymakers face

Source: Bloomberg
S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index data is as of 7/31/2021.

About half of the overall increase in grocery prices can be attributed to beef, pork and poultry… in fact, if you take out those three categories, price increases are more in line with historical norms. And if you look at eggs, the price has actually come down in recent months.

– Brian Deese, White House Director of the National Economic Council

Growth and inflation both expected to slow, but to remain above average for next several quarters

Source: Bloomberg

Inflation and inflation expectations are still somewhat contained, but potentially on the cusp of multi-decade breakout

Source: FRED
*UofM data as of 8/31/2021

Adjusted for U.S. housing price appreciation, inflation would be significantly higher due to the lag in reporting of shelter in CPI

Source: Bloomberg, SpringTide calculations. Shelter price adjustment assumes U.S. housing price appreciation (Case-Shiller U.S. Housing Price Index) replaces Shelter (CPI
sub-category) at an average weight of 32% (current).

Rising energy prices will continue to be a hot topic for consumers and the current administration

Source: Bloomberg

From here, it will take 18 months to achieve the Federal Reserve’s goal of full employment, assuming a pace of 250,000 additions per month

Source: Bloomberg

Companies getting creative in attempts to attract workers in a challenging labor market environment that is very different from the ‘09-’11 recovery

Source: Bloomberg

Voters aren’t just comfortable with further stimulus; they are anticipating it and may expect or demand it in the next downturn

Source: Google Trends

Varied pace of global vaccination rollout and government response creating uneven pace of reopening and economic recovery

Source: New York Times, Our World in Data

Urban transit ridership and other consumer data shows disjointed recovery heavily impacted by policy initiatives

Source: U.S. Department of Transportation, OpenTable, Reuters

Quarantine Stock Basket continues to trail the broader U.S. stock market

Source: Bloomberg

Makeup of the Fed should remain at least as dovish as it is now in coming years

Source: ITC, Bloomberg

Manufacturers are dealing with profound labor, commodity, and supply chain issues

  • “Many electronic components and assemblies shortages showing up (due to) port issues, lack of containers and other issues. Problematic, but
    nothing completely shut down yet. Watching COVID-19 restrictions country by country.” [Computer & Electronic Products]
  • “The impacts from Hurricane Ida on the petrochemical industry has put additional stress on an already fragile supply chain. Logistics with
    intermodal containers and motor carriers continues to be a challenge for planning deliveries of materials.” [Chemical Products]
  • “In the U.S., labor availability is the most significant supply challenge for our company, with raw materials just behind. Plastic resin,
    polyurethanes, small-volume steel purchases and electronics are the biggest material challenges.” [Transportation Equipment]
  • “Lack of labor and escalating costs from every direction are very concerning.” [Food, Beverage & Tobacco Products]
  • “Ocean freight delays creating disruptions in many areas. Southeast Asia supply continues to be challenged due to COVID-19 outbreaks.”
    [Furniture & Related Products]
  • “Delivery and availability of raw materials, primarily carbon steel, are becoming more and more difficult to source. This has resulted in delaying
    order deliveries. Computer numerical control (CNC) machining services are at a premium; it’s difficult to get the deliveries needed to complete jobs.
    Traditional in-house machining now has to be outsourced due to a lack of experienced machinists. All this has had a negative impact on production
    throughput.” [Fabricated Metal Products]
  • “Customer demand continues to swell as we prepare for the fourth quarter, and overall growth has been extremely good for the year. Supply chain
    concerns are growing beyond electronics and chips into most other commodities. Lead times are extending, shipping lanes are slowing, and we
    will not see an end to this in 2021.” [Electrical Equipment, Appliances & Components]
  • “We are still amazed by the labor market. We used to have 100 applicants for an opening; we are now seeing about 10 — and often, the
    applicant does not show for the interview.” [Paper Products]
  • “Our company’s entire supply chain continues to have significant challenges getting manpower, which is impacting production of parts and ability to
    meet daily build schedules. Additionally, the logistics problems — especially port delays and a shortage of shipping containers — are significantly
    impacting inbound and outbound shipments. Raw materials costs still are at record highs, and we have raised customer pricing, with additional
    increases in the near future due to labor costs going up. Huge customer orders are nine months out (due to) backorders. Seeing this domestically
    and internationally.” [Machinery]
  • “Global supply chain constraints are still a major concern and focus. Inventory builds continue to compensate for potential supply disruption.”
    [Miscellaneous Manufacturing]

Source: ISM

Services PMI: “Demand far outweighs supply for goods and services”

  • “Transportation bottlenecks are increasing, resulting in longer lead times and missed appointments.” [Accommodation & Food Services]
  • “Constraints on logistics from a cost and availability standpoint continue to be an issue.” [Construction]
  • “Lead times on electronics and computer chips have greatly increased. Outlook for higher education remains flat for most colleges, not including
    elite and Ivy League institutions.” [Educational Services]
  • “Retaining clinical and temporary staffing is critical at this time. With the Delta variant’s spread, we continue to see increased (COVID-19) cases, but
    not as bad as January 2021. Vaccinations are clearly working. Most inpatient hospitalizations are of unvaccinated patients. The supply chain is still
    being impacted significantly by increased lead times for equipment and supplies.” [Health Care & Social Assistance]
  • “The semiconductor (shortage is) impacting server delivery. Alternate parts and engineering efforts are being used to create workaround solutions.”
    [Information]
  • “Both domestic and international logistics are increasing lead times about six weeks for ocean freight and two weeks for domestic freight.”
    [Management of Companies & Support Services]
  • “Inventories shrinking due to global shipping logistics being a seller’s/provider’s market, with primary focus on yield versus market expansion.”
    [Professional, Scientific & Technical Services]
  • “Lead times have improved slightly over the last period, but still remain lengthy relative to pre-pandemic levels. We continue to see rising costs for
    both supply and service inputs. The effects of these price increases have the potential to significantly impact our operations through the end of
    the year, especially if seasonal trends prove exceptionally strong.” [Public Administration]
  • “Business volumes remain remarkably high, although material shortages persist.” [Real Estate, Rental & Leasing]
  • “Still experiencing very strong demand. Supply chain is still a challenge.” [Retail Trade]
  • “Demand far outweighs supply for goods and services.” [Transportation & Warehousing]
  • “We continue to deal with extended delivery lead times and high costs. Stress on the supply chain beginning to be reflected in the quality of
    products offered and delivered. Current buying strategy is to wait — except with equipment, as (price) increases are expected.” [Utilities]
  • “Continued constrained supply of many key product groups. Also, inflationary pressures in most areas of the business keep driving costs higher.
    Inconsistent COVID-19 restrictions throughout the country are creating unstable business conditions that are concerning. However, business
    continues to be strong overall.” [Wholesale Trade]

Source: ISM

There are expected to be more than $1.0 trillion of stock buybacks in the S&P 500 this year – more than all the annual coupon income in the US Treasury, IG and HY markets combined.

-Lu Wang, Bloomberg Markets columnist

U.S. stocks managed to net out a modestly positive return for the quarter while U.S. small cap, international and emerging markets declined

Source: Bloomberg
Returns for periods greater than one year are annualized.

Earnings estimates for S&P 500 continue to rise, outpacing prices as valuations compressed during the quarter; VIX rose to 23

Source: Bloomberg

Relative to earnings estimates, emerging & frontier market stocks are cheapest; relative to sales, U.S. Large Cap stocks appear very expensive

Source: Bloomberg

Companies bought back $200 billion of stock in Q2, Tech companies accounted for nearly one third of those buybacks

Source: Bloomberg

Buyback and dividend yields for U.S. large cap stocks have come down due to the rally in equities and the lagging impact of cuts in early 2020

Source: Bloomberg. Buyback and dividend yields are calculated using trailing four quarter data and the aggregate equity marke t cap as of each quarter end.

Frothy public markets lead to largest IPO year on record

Source: Pitchbook, Bloomberg
*Data as of September 30, 2021

Pent-up pandemic demand has pushed 2021 venture activity to shatter previous records through just three quarters

Source: Pitchbook
*Data as of Sept 30, 2021

Momentum persists at late stage of venture activity

Source: Pitchbook, Bloomberg
*Data as of September 30, 2021

I came of age and studied economics in the 1970s and I remember what that terrible period was like. No one wants to see that happen again.

– Janet Yellen, Treasury Secretary, May 2021

U.S. fixed income and credit protected against a modest risk-off quarter; weakness continued in international developed bonds

Source: Bloomberg
Returns for periods greater than one year are annualized

U.S. Treasury yield curve has steepened modestly this year while credit spreads have remained at or near historically tight levels

Source: Bloomberg

Recent bear flattening, if it continues, could spell the end of this cycle via suggests potential trouble ahead for the Fed and the economy

Source: Bloomberg
S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index data is as of 7/31/2021.

Treasuries increasingly becoming the largest segment of the now $52 trillion fixed income and credit securities market

Source: SIFMA
2021 issuance data is year-to-date through 10/13/2021.

Credit spreads below median across sectors with very few pockets of opportunity

Source: Bloomberg. High Yield Muni Spread data is relative to Bloomberg Municipal Bond Index. Yield spread data is from 2004 – current.

U.S. remains high yield relatively speaking, could keep U.S. rates contained

Source: Bloomberg

Frontier market bonds offer significantly more yield per unit of duration (interest rate risk)

Source: Bloomberg 

The treasury market has been an enabler of increasing deficit spending and debt levels… when it will become a “vigilante”?

Source: Bloomberg, whitehouse.gov

Issuance continues to be pushed out as the U.S. Treasury draws down its cash balance

Source: Bloomberg

Issuance continues to be pushed out as the U.S. Treasury draws down its cash balance

Source: Bloomberg

Powell is right: this time isn’t like the 1970s…from a capital allocation standpoint it’s worse

Source: Bloomberg

Private debt fundraising on pace for lowest year since 2016, potentially a sign of future opportunity

Source: pitchbook

Private debt fundraising on pace for lowest year since 2016, potentially a sign of future opportunity

Private debt funds are their lowest proportion of private assets since 2012, also potentially a sign of an opportunity

When you look at real interest rates on long-date Treasuries, it looks like Jimmy Carter area. We’re talking about the CPI at 5.4%, and if we want to use the 10-year Treasury it’s not even at 1.4%, that’s a negative 4% interest rate. That’s Jimmy Carteresque.

-Jeffrey Gundlach, DoubleLine Capital CEO, July 15, 2021

Real assets had a mixed quarter; commodities continued higher as supply chain issues persist with significant implications for future inflation

Commodities have outperformed stocks through the COVID-19 crisis

Oil and natural gas producers have been cautious to bring rigs back online despite rising prices

REITs are no longer compelling, even compared to the low yields provided by U.S. 60/40 portfolios

Natural Gas inventories are lower relative to prior years heading into winter, leading to a spike in prices

Crude oil inventories had their largest build since March, demand for refined oil remains strong

Midstream yields remain substantially above REITs, free cash flow yields of real assets and infrastructure category remain attractive

Gold miner performance has diverged from fundamentals, producing attractive FCF/share and higher FCF yields than the S&P 500

Real yields rose modestly, and aggregate amount of global negative yielding debt fell in September

Longer-term (lagged) returns for various private real estate markets show the impact of going-in cap rates on subsequent returns

The odds of 1970s era inflation are] very, very unlikely. [We have] a central bank that is committed to price stability and has defined what price stability is and will use its tools to keep us around 2% inflation. I don’t expect anything like that to happen.

– Jerome Powell, Federal Reserve Chairman, June 2021

Closed-end funds continued to benefit from broad market gains and narrowing discounts, other asset classes more mixed

Retail mania has mostly faded for now

Muni credit sentiment remains elevated, historically associated with lowerthan-average forward returns

Crypto bull rally: buy the hype or sell the news?

Asset allocation is the tool that you use to determine the risk and return characteristics of your portfolio. It’s overwhelmingly important in terms of the results you achieve. In fact, studies show that asset allocation is responsible for more than 100 percent of the positive returns generated by investors.

– David F. Swensen, American investor and endowment fund manager

Expected 10-year returns for most risky assets rose as valuations declined and spreads widened modestly

Longer-term return expectations held relatively stable as the mean reversion of higher valuations is distributed over a longer holding period

DISCLAIMER

Magnus Financial Group LLC (“Magnus”) did not produce and bears no responsibility for any part of this report whatsoever, including but not limited to any macroeconomic views, inaccuracies or any errors or omissions. Research and data used in the presentation have come from third-party sources that Magnus has not independently verified presentation and the opinions expressed are not by Magnus or its employees and are current only as of the time made and are subject to change without notice.

This report may include estimates, projections or other forward-looking statements, however, due to numerous factors, actual events may differ substantially from those presented. The graphs and tables making up this report have been based on unaudited, third-party data and performance information provided to us by one or more commercial databases. Except for the historical information contained in this report, certain matters are forward-looking statements or projections that are dependent upon risks and uncertainties, including but not limited to factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle.
Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results and historical information provided displayed herein may have been
adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be inferred that these results are indicative of the future performance of any strategy, index, fund, manager or group of managers. Index benchmarks contained in this report are provided so that performance can be compared with the performance of well-known and widely recognized indices. Index results assume the reinvestment of all dividends and interest.

The information provided is not intended to be, and should not be construed as, investment, legal or tax advice nor should su ch information contained herein be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. An investor should consult with their financial advisor to determine the appropriate investment strategies and investment vehicles. Investment decisions should be made based on the nvestor’s specific financial needs and objectives, goals, time horizon and risk olerance. This presentation makes no implied or express recommendations concerning the way any client’s accounts should or would be handled, as appropriate investment decision s depend upon the client’s specific investment objectives.

Investment advisory services offered through Magnus; securities offered through third party custodial relationships. More information about Magnus can be found on its Form ADV at www.adviserinfo.sec.gov.

TERMS OF USE

This report is intended solely for the use of its recipient. There is a fee associated with the access to this report and the information and materials presented herein. Re-distribution or republication of this report and its contents are prohibited. Expert use is implied.

DISCLAIMER

Magnus Financial Group LLC (“Magnus”) did not produce and bears no responsibility for any part of this report whatsoever, including but not limited to any macroeconomic views, inaccuracies or any errors or omissions. Research and data used in the presentation have come from third-party sources that Magnus has not independently verified presentation and the opinions expressed are not by Magnus or its employees and are current only as of the time made and are subject to change without notice.

This report may include estimates, projections or other forward-looking statements, however, due to numerous factors, actual events may differ substantially from those presented. The graphs and tables making up this report have been based on unaudited, third-party data and performance information provided to us by one or more commercial databases. Except for the historical information contained in this report, certain matters are forward looking statements or projections that are dependent upon risks and uncertainties, including but not limited to factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle.

Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results and historical information provided displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be inferred that these results are indicative of the future performance of any strategy, index, fund, manager or group of managers. Index benchmarks contained in this report are provided so that performance can be compared with the performance of well-known and widely recognized indices. Index results assume the re-investment of all dividends and interest.

The information provided is not intended to be, and should not be construed as, investment, legal or tax advice nor should such information contained herein be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. An investor should consult with their financial advisor to determine the appropriate investment strategies and investment vehicles. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. This presentation makes no implied or express recommendations concerning the way any client’s accounts should or would be handled, as appropriate investment decisions depend upon the client’s specific investment objectives.

Investment advisory services offered through Magnus; securities offered through third party custodial relationships. More information about Magnus can be found on its Form ADV at www.adviserinfo.sec.gov.

TERMS OF USE

This report is intended solely for the use of its recipient. There is a fee associated with the access to this report and the information and materials presented herein. Re-distribution or republication of this report and its contents are prohibited. Expert use is implied.

DEFINITIONS

Asset class performance was measured using the following benchmarks: U.S. Large Cap Stocks: S&P 500 TR Index; U.S. Small & Micro Cap: Russell 2000 TR Index; Intl Dev Large Cap Stocks: MSCI EAFE GR Index; Emerging & Frontier Market Stocks: MSCI Emerging Markets GR Index; U.S. Intermediate-Term Muni Bonds: Bloomberg Barclays 1-10 (1-12 Yr) Muni Bond TR Index; U.S. Intermediate-Term Bonds: Bloomberg Barclays U.S. Aggregate Bond TR Index; U.S. High Yield Bonds: Bloomberg Barclays U.S. Corporate High Yield TR Index; U.S. Bank Loans: S&P/LSTA U.S. Leveraged Loan Index; Intl Developed Bonds: Bloomberg Barclays Global Aggregate ex-U.S. Index; Emerging & Frontier Market Bonds: JPMorgan EMBI Global Diversified TR Index; U.S. REITs: MSCI U.S. REIT GR Index, Ex U.S. Real Estate Securities: S&P Global Ex-U.S. Property TR Index; Commodity Futures: Bloomberg Commodity TR Index; Midstream Energy: Alerian MLP TR Index; Gold: LBMA Gold Price, U.S. 60/40: 60% S&P 500 TR Index; 40% Bloomberg Barclays U.S. Aggregate Bond TR Index; Global 60/40: 60% MSCI ACWI GR Index; 40% Bloomberg Barclays Global Aggregate Bond TR Index.