The market rallied strongly last week after better than expectation inflation levels with the June CPI and PPI reports. All the major indexes ended the week up a bit over 2%. There was even some breadth to the rally for a nice change of pace, with the small-cap Russell 2000 participating in the rise. Hopes continue to grow that the Federal Reserve will be able to engineer a soft landing.
That would be the ideal outcome for investors. However, it is a scenario I am still quite skeptical on given the numerous policy mistakes of the central bank in recent years. More importantly, the impacts of raising the Fed Funds rate by 500 bps over five quarters has yet to be fully felt across the economy. The last time this rate broached 5% was in 2007, and we all remember how that worked out. It is not like the government, the consumer or corporations have significantly delivered since then either.
I don't see how much of the commercial real estate sector doesn't go through a long, dark winter and how that doesn't spill over into the broader economy and markets. Delinquency rates with commercial mortgage-backed securities or CMBS for the office sector has nearly tripled so far this year to 4.5% in June. I expect that number to rise above 10% over the next year.
I don't see defaults being avoided by 'extend and pretend' tactics as a lot of these properties' values have been permanently impaired by the explosion in the virtual workforce and hybrid work models since the pandemic.
Given this view, I have had very few "high conviction" investment picks over the past few months.
The easiest investment decision I have made was selling my property here in Delray Beach in May. It was a great rental and a fantastic place. However, anytime you can more than triple your 25% equity stake in a property in just two and a half years, you should be moved to act. This is especially the case when you believe you will be able to buy a similar property for at least a 25% discount over the next few years as housing prices fall to more rational levels.
The second high conviction investment I have is around short-term Treasuries which now make up approximately half of my overall portfolio. They yield just north of 5%, which is now comfortably above the rate of inflation. These instruments are also extremely liquid and completely "risk-free." They are a great place to hang out waiting for what I believe in an inevitable market correction sometime in the next few quarters.
I also have a few out of the money bear spreads on overvalued parts of the market like the Invesco QQQ Trust ETF (QQQ) , 5% cash with the other 40% or so of my portfolio within covered call positions around names with rock-solid balance sheets like Exelixis (EXEL) .
Not exactly a sexy portfolio but a prudent one given my bearish outlook. This portfolio configuration returned right at 7% in the first half of 2023. While that pales in comparison to the 15.9% return in the first six months of the year from the S&P 500, it easily beats the average return from the bottom 493 S&P companies in the index by market cap, which was slightly negative.
