Market Commentary

29 Jul MARKET UPDATE: A GREAT ROTATION?

Markets broadly continued to trend higher throughout the second quarter and into the start of the third quarter, despite some pockets of weakness. Throughout the second quarter of 2024, US large-cap stocks advanced while their small and midcap counterparts trailed. Emerging market equities were the best performing of the major asset classes, jumping 5.4% after lagging other major equity markets to start the year. Fixed income remains slightly positive on the year as higher yields have lessened the impact of rates moving higher.

Valuations

The start to the third quarter was strong as well, with both equity and fixed income markets advancing. We have seen a slight rotation out of large-cap growth and into large-cap value and small-cap equities to start the quarter. This is part of a normal market cycle and frankly a welcome sign for the health of the overall equity market. We entered the third quarter with S&P 500® valuations well ahead of historical averages. This was especially true of US large-cap growth stocks who sported a price to earnings ratio of 28.4x. This was 150% of the historical 20-year average of 19x earnings. While there is no single most important metric for evaluating the overall valuation of the equity market, price to earnings gives a good representation of the premium you are paying for earnings today versus what a “normal” market environment looks like. These P/E Ratios are historically a good predictor of future returns and with valuations where they were at the start of Q3, future return expectations were becoming limited.

While valuations grew richer for US large-cap growth stocks, we saw market concentration climb as well, reaching levels last seen in the 1960’s. The top 10 names in the S&P 500® made up 37% of the index at the end of the second quarter. It is no secret that names like Nvidia, Microsoft, and Meta have been leading markets to new all-time highs throughout the last year. The growth of the “Mag-7” (Microsoft, Apple, Nvidia, Amazon, Alphabet, Meta, and Tesla) has been immense, with valuations and index weightings climbing as these stocks continued to hold the lion’s share of earnings. Investor attraction to these names left the remaining 493 stocks in the S&P 500® producing muted returns, with the average stock up just 5% year to date. As of the end of the second quarter, the percentage of S&P 500 stocks outperforming the index was at a record low.

The last time valuation dispersions were similarly extreme, and leadership was this narrow, was during the 90’s Technology Bubble. Those who ignored valuation and bought into the bubble missed investment themes that lasted more than a decade. The chart below compares the total returns of the S&P 500® Value Index and the S&P 500® Growth Index from the Tech Bubble’s peak in March 2000. From that date, value cumulatively outperformed growth for the next 20 years and 2 months. It wasn’t until the recent post-pandemic period that growth cumulatively regained the performance lead from that start point.

A Market Rotation

The start of Q3 has been an evolving story as there has been a sharp market rotation over the last few weeks. The market rotation really started on July 10th, when mega cap names fell, and the broader market moved higher. Since that time, growth stocks are down -5.5% while value is up +2.41%. Additionally, small-cap stocks have outperformed large-cap stocks by nearly 9 percentage points (+6.62% vs. -2.2%) in just eight trading days. Mag 7 stocks have borne the brunt of this rotation, with Nvidia down -12.6%, Meta down -10.8%, and Amazon down -8.3%. Apple has held up the best of the bunch (-3.72%) but still trails the benchmark over that period.

The cause of this rotation is not fully known or understood by experts at this time. While everyone wants to point to one specific thing, there are several different reasons why this could happen and could continue. Was it softening inflation numbers and a change to the Fed’s anticipated monetary policy stance? Was it the coming election cycle and associated candidate rhetoric about potential policy for the next 4 years? Was it simply rebalancing from large market participants (i.e. hedge funds) as growth stocks notched a stellar 1st half? Or did the technology trade get crowded, and investors went searching for other opportunities? In any event it was certainly a momentum crash as that is the dominant factor within the large-cap growth space.

While eight trading days is not long enough to identify a trend, or a new market regime, the speed of the market reaction is a good reminder to investors as to why we maintain diversified portfolios. One single market is not always going to be king. Some rotations are fast, some are slow; some are long-lived, while others are just a flash in the pan. Our goal is to maintain exposure to all these markets to achieve long term portfolio growth no matter who or what is leading the market on any given day.

Is Value Dead

Given that backdrop, it is worthwhile to raise a question that has been posed by many: is value dead? It is a fair question to ask in light of growth stocks outperforming value over a 10-year rolling time period.

The basic assumption to traditional value investing is that capitalism is an ongoing economic structure, and one should be optimistic about the future. Value investing believes that investors should search for undervalued growth because many companies within the economy will grow. It also is a belief that markets are not always efficient, and opportunities are available to those who remain patient.

Many investors believe that growth investing is only about an exciting future, growth investing is now largely based on the notion that only a select universe of companies can actually grow. Be it a single sector or industry. That rather pessimistic view of the lack of the overall diversity of potential earnings growth has become unrealistic (there are currently about 160 companies within the S&P 500® with earnings growth of 25% or more), and that extreme view has led growth investors to generally ignore valuation.

So, a key difference between the two strategies is that value investing believes that many companies will grow, and one should look for the cheapest investment to partake in that growth, whereas growth investing believes only a small universe of companies have growth potential and one should downplay value because earnings growth is a relatively scarce commodity.

The father of growth investing, T. Rowe Price Jr., didn’t believe that growth should be bought at any price. Rather, he was a proponent of buying superior growing companies whose earnings and dividends could be bought at reasonable valuations given their superior growth.

Election

Are you not entertained? In an election cycle that was undoubtedly going to be filled with twists and turns, June and July have contained a series of historical events that will be talked about and shape history for years to come. In June, a less than stellar performance from President Biden in a debate with President Trump left much to be desired from the democratic candidate. Immediately following the debate and the weeks following, Trump’s odds of winning the presidency jumped to over 60%. Calls for President Biden to suspend his campaign intensified in the weeks following with odds of other democratic nominees rising and even surpassing Biden’s chances in early July.

Then, an assassination attempt on President Trump at his rally in Pennsylvania added more fuel to the fire of the republican base. The events led to a week of unity for the republican party as many came to show support for Trump, culminating with Trump’s acceptance of the GOP nomination at the Republican National Convention.

Ever increasing calls by high-ranking democratic officials for Biden to step aside intensified over the same week, with Biden suspending his campaign for President on July 21st. Vice President Kamala Harris is now almost certain to be the democratic nominee following these events, securing endorsements, delegates, and funding rapidly.

What do the next 3-4 months look like? It’s simply anyone’s guess. We continue to believe that politics and elections do not drive market performance. We are closely monitoring and watching the events for selective opportunities, but we do not believe material allocation changes should be based on who is president. This viewpoint is based on historical fact. Markets tend to be forward-looking and driven by economic conditions. While rhetoric can shake markets leading up to the election, we continue to focus on longer term trends and economic conditions to drive our asset allocation strategies. Ultimately, CEOs and small business owners alike want to know what rules to expect for the next 4 years, and they will be able to plan for profit accordingly.

Fed

With our focus more on long-term trends and economic conditions, it is important to turn attention towards the Federal Reserve and the outlook for monetary policy.

The inflation picture so far this year has been mixed but trending in the right direction. The first quarter of 2024 reported CPI numbers higher than expectations which cooled the probability of 6+ rate cuts that were expected at the start the year. Second quarter CPI has come closer to trend and fed futures markets have now priced in almost 100% probability of a rate cut in September which is parallel to fed indications.

The expectation is that inflation will continue to fall closer to the Fed target of 2-2.5% for the remainder of the year. If true, the fed will likely continue with their predetermined path to moderately reduce rates later in the year and into 2025.

Employment

Employment continues to soften from the post pandemic hiring spree. The unemployment rate, while still very low, has come in at 4.1%, up from a low of 3.4% a year earlier. Much of this recent increase in unemployment is due to the increase in the labor participation rate from the lows of Covid, a metric that has not yet returned to pre-covid participation levels. Given that backdrop we expect the participation rate to continue to tick higher and employment figures to normalize between 4-5%.

Consumer

Personal consumption expenditures continue to look strong in the rear-view mirror, although we know that consumer product companies have been warning of a slowdown. Visa reported earnings with a rare top-line miss, they noted that higher borrowing costs are affecting consumer spending. Also, a few retailers have lowered their earnings guidance for this year as the consumer product industry softens.

A large part of the recent multi-year spending surge was due to the excess savings and pent-up demand created during Covid. If we look at the national savings rate, which spiked to all-time highs of 30% (of disposable income) during the pandemic, we can see that it has come down to 3.9% in the most recent reading, well below our historical average.

While this story rings true to many across the nation, we still see unprecedented demand for high-end retail. The luxury retailer LVMH (Louis Vuitton Moet Hennessey) reported increased sales in the US for the first half of the year. Ferrari reported double digit growth in sales in the US in 1Q24. Housing has taken a small step back as existing home sales fell 5.4% while the national average price reached a new all-time high of $426,900. The lack of inventory and expectation of lower rates in the near term continue to push prices higher in housing. It is difficult to get a clear view of how housing prices will become more affordable for the average American without a significant surge in available inventory.

In summary, the Procyon Investment Committee has strong conviction around the broadening of market leadership outside of large growth companies because valuation matters, rate cuts coming later this year, and the lack of major market impacts related to which party wins the election. Our cumulative experience and academic study have provided our committee with the opportunity for strong debates around these key issues and we look forward to providing you updates as the second half of 2024 unfolds.

IMPORTANT DISCLAIMERS AND DISCLOSURES:

The information contained in this presentation has been gathered from sources we believe to be reliable, but we do not guarantee the accuracy or completeness of such information, and we assume no liability for damages resulting from or arising out of the use of such information. Past performance is not indicative of future results.

The views expressed in the referenced materials are subject to change based on market and other conditions. This document may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. The information provided herein does not constitute investment advice and is not a solicitation to buy or sell securities.

Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, investment model, or products, including the investments, investment strategies or investment themes referenced herein, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for a particular portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.

Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be direct investment, accounting, tax, or legal advice to any one investor. Consult with an accountant or attorney regarding individual accounting, tax, or legal advice. No advice may be rendered unless a client service agreement is in place.

Procyon Advisors, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission (“SEC”). This report is provided for informational purposes only and for the intended recipient[s] only. This report is derived from numerous sources, which are believed to be reliable, but not audited by Procyon for accuracy. This report may also include opinions and forward-looking statements which may not come to pass. Information is at a point in time and subject to change.

06 May MARKET UPDATE: ALL ABOUT INTEREST RATES

Equity markets continued their advance throughout the 1st quarter of 2024 as the rally that started in October of last year extended. The S&P 500 was up 10.56% in the 1st quarter, and up 28.5% since October, 27th of 2023. If you recall, this market rally was kicked off by the US Federal Reserve indicating that they were at the end of their rate hiking cycle and signaling up to three rate cuts by the end of 2024. While equity markets rallied across the board on this move, the start to this year has not been created equal for all markets. US small cap stocks were up 5.18% in Q1, international developed stocks were up 5.93% and Emerging Markets were up just 2.44%.

Fixed income markets saw volatility throughout the quarter. While they experienced a similar rally to equity markets in Q4 of last year as the Fed pivoted their policy stance, the start of this year has been negative for fixed income markets. The Bloomberg Aggregate Bond index was down -0.78% in the quarter, global bonds were down -2.08%, and municipal bonds were down -0.39%. The only positive performance within fixed income was from high yield bonds, whose higher correlation with equity markets led to some price appreciation during the quarter.

Markets have generally been driven by interest rate expectations over the last five months. The Fed’s signal towards cutting interest rates in 2024 was generally well received by the market. However, markets continued to price in cuts to a level above and beyond what the Fed had signaled. Early in the 1st quarter, the federal funds futures market had priced in up to six rate cuts this year.

We believed the public markets got too far ahead of the Fed at that point. We continued to keep our portfolios in a position that would be less sensitive to changes in interest rates as we believed the market needed to come closer to the Fed’s indication. If the markets were correct, and we received six rate cuts this year, we would expect a significant economic event to take place that would force the Fed to aggressively support the economy in short order. However, the underlying employment picture remains strong, and inflation remains at elevated levels (relative to the Fed’s inflation target). This equation simply would not add up to six, and possibly not even three, rate cuts in 2024.

Our focus continues to be on the inflation numbers. Remember when inflation was described as “transitory” back in 2021? We are a long way from that and transitory has extended into a multiyear battle with the Fed pulling out all the stops to try to bring inflation back down to its 2% long term target. While progress has been made, inflation continues to sit between 3-4%, with the most recent CPI reading coming in at 3.5%. The numbers have been closely scrutinized, with many indicating the sticky shelter component of the inflation report as the culprit for higher readings for longer. The fact of the matter is, the economy is strong, and inflation will continue to be higher if demand continues to be present. We saw strong retail sales numbers in March, home prices continue to be sticky, and energy prices are once again on the rise. We don’t expect the inflation readings to be at the Fed’s 2% target any time soon under these conditions. Below is the expected path for core inflation over the next year given various monthly changes in the price index (which has been growing at about 0.3% per month on average over the last 6 months):

Where does this leave us for the remainder of 2024? A strong economic backdrop, robust corporate earnings, and a pivoting fed should mean all systems go. That being said, we have learned over the last several years that the market does an incredible job at pricing in events extremely quickly, and with the strong, rate-driven market rally over the last 5 months, it seems like most of the good news has been largely priced in. The start of the second quarter has not been as friendly to equity markets as participants start to readdress expectations in light of evolving fundamentals.

• As we enter the second quarter, equity market valuations are elevated relative to historical averages across the board with the highest valuations coming from the large cap growth space. Since the start of the new quarter (through 4/19), US Large Cap stocks are down -5.4% (with growth stocks down -6.15%). US small caps are down -8.29%, international markets are down -4.1%.
• Fixed income markets were pricing in as many as six rate cuts this year early in 2024. As of 4/19, markets are now pricing in just one cut this year. This is a significant change, and while the probabilities for the end of this year are wide, the highest probability is just one cut (even lower than what the Fed has indicated for 2024).

We expected this year to be volatile across the public markets. The lack of volatility over the past 5 months is not normal. It has been a steady climb since October 27th of last year. Market pullbacks are healthy for long term market efficiency as it gives investors and companies a chance to catch their breath – you can’t sprint your way through a marathon. We have been cautious in our investment approach this year as the market performance drivers have been narrow since last October.

More specifically as it relates to the public equity markets, we have steered away from the obvious higher- valuation names within the market and remain underweight to some of the tech names that have led this market higher.

We have focused more on some markets that we view as undervalued – small cap stocks continue to present a nice entry point for long term investors, international stocks present nice value opportunities, and even within US large caps there are some underappreciated companies that we focus in on.

On the fixed-income side, we have been keeping a close eye on the average maturity, credit quality and duration of our portfolio relative to our benchmark. As market participants aggressively priced in the growing potential for rate cuts, we shortened our duration (limiting our sensitivity to interest rate increases) as we expected rates to find an equilibrium at a level more in line with what the Fed had indicated. We have also since added duration as rate cut expectations have decreased and fallen closer to the Fed target.

What’s next for 2024? We continue to expect market volatility throughout the second, and perhaps third quarters of this year. The ever-escalating events that have transpired between Iran and Israel over the last couple of weeks and months have increased this belief. The looming US Presidential election will also undoubtably drive some market volatility as we get closer as well. Historically a divided government between the White House and Congress has the most statistically significant impact on markets in the 3 months following the elections as shown here:

However, all our collective experience and rigorous study has strengthened a core belief that investing based solely on potential political outcomes or the fear of geopolitical events is not a reliable investment strategy over the long run. We continue to focus on fundamental measures of sustainability and value, including free-cash-flow, revenue and earnings growth, balance sheet quality, and executive leadership. Fundamentally we remain confident in the underlying macro-economic picture. As the volatility unfolds, we will add to equity allocations opportunistically, and prudently across market sectors we see as driving performance in the coming year.

IMPORTANT DISCLAIMERS AND DISCLOSURES:

The information contained in this presentation has been gathered from sources we believe to be reliable, but we do not guarantee the accuracy or completeness of such information, and we assume no liability for damages resulting from or arising out of the use of such information. Past performance is not indicative of future results.

The views expressed in the referenced materials are subject to change based on market and other conditions. This document may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. The information provided herein does not constitute investment advice and is not a solicitation to buy or sell securities.

Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, investment model, or products, including the investments, investment strategies or investment themes referenced herein, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for a particular portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.

Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be direct investment, accounting, tax, or legal advice to any one investor. Consult with an accountant or attorney regarding individual accounting, tax, or legal advice. No advice may be rendered unless a client service agreement is in place.

Procyon Advisors, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission (“SEC”). This report is provided for informational purposes only and for the intended recipient[s] only. This report is derived from numerous sources, which are believed to be reliable, but not audited by Procyon for accuracy. This report may also include opinions and forward-looking statements which may not come to pass. Information is at a point in time and subject to change.

25 Jan MARKET UPDATE: WHAT A DIFFERENCE A YEAR MAKES!

Coming into 2023, market sentiment was broadly negative following the worst year for a diversified portfolio in 40 years. In 2022, we saw equity markets fall -18% and fixed income markets drop a staggering -13% as the Federal Reserve acted aggressively to combat rising inflation. There weren’t many places to hide, and despite a market rally in the 4th quarter of 2022, market participants entered 2023 with concerns that this year would be more of the same. Many strategists were speculating that the Fed’s historically aggressive interest rate hiking policy would end in a “hard landing” and eventual recession.

Boy were they wrong…equity markets broadly rallied in 2023, with US markets up +25.96% (Russell 3000) and international equities up 16.21% (MSCI ACWI Ex USA). Fixed income markets were choppy to start the year but ended the year up 5.53% (Bloomberg Aggregate) as a result of a significant rally in the 4th quarter. The conviction in a “hard landing” fell precipitously throughout the year as inflation fell, the consumer stayed strong, and the labor market continued to show gains. Dreams of a “soft landing” (small recession) and “immaculate landing” (continued economic growth) began to take hold. The Fed added some fuel to this growing positive sentiment by indicating that they were reaching the end of their rate hiking cycle, and actually signaling a few rate cuts in 2024. This led to a significant market rally during the 4th quarter where we saw equity markets broadly up +11.15% (MSCI ACWI) and fixed income markets up 6.82%.

It is worth noting how narrow equity market performance was in 2023 however, with just seven names making up nearly all of the positive performance in the S&P 500. These names happen to be the seven largest in the market and have been referred to as the “Magnificent 7” throughout the year; Microsoft, Apple, Amazon, Alphabet, Nvidia, Meta, and Tesla. This type of narrow market leadership is not common historically, and we do not expect this to continue throughout 2024. We continue to believe that diversified portfolios with allocations to small caps and international markets (in addition to large cap equities) will be best suited for long-term growth and income.

The Federal Reserve continues to be a focal point of this market with their policy actions and commentary under a watchful eye as inflation continues to trend towards their 2% target. While the Fed continued to raise interest rates throughout 2023, long term rates were left little changed as market participants expect interest rate cuts to commence in early 2024. The Fed confirmed that cuts were on the horizon in their December meeting, with their dot plot (the survey of Fed officials on where interest rates will be at the end of the following year) showing the highest probability of three 0.25% rate cuts in 2024. While the direction was confirmed by nearly all FOMC participants, the range of how many cuts was large.

The Federal Funds Futures market, on the other hand, is currently signaling six 0.25% rate cuts in 2024. We continue to believe that the market is well ahead of the Fed and are more confident in what the Fed has projected over what the market is telling us. The dislocation between the two represents a risk that we could see throughout 2024 as the market brings longer term rates higher to meet where the Fed is at. While there are a lot of factors that go into this, the Procyon investment committee has this relationship at the top of its watchlist in 2024.

With the strong end to 2023, it is difficult to remember any volatile periods during the year. The volatility index tends to confirm this as well, falling throughout the year and ending the year at levels last seen prior to the market sell off in 2020. There was a fair amount of volatility throughout the year however, as markets tried their best to price in a number of events including: failures of Silicon Valley Bank & Signature Bank, continued war in Ukraine, conflict between Israel and Hamas, above target inflation, the inverted yield curve, and the rise of artificial intelligence.

As we enter 2024, there are a number of key topics that have our attention in what we expect to be a volatile year.
Here are a few that remain at the top of our list:

• 2024 Presidential Election – There is no surprise that this would be first on our list of what to watch in 2024. In what is currently shaping up as another Biden vs. Trump election, there will be uncertainty that leads to volatility in financial markets throughout the year. While markets tend to be forward looking and will quickly look past the election, results can have major implications on the future of companies. With debt levels soaring and the 2017 tax cuts set to expire in 2026, the next president will have large decisions to make. Leading up to the election, we expect rhetoric on hot topic issues such as health care, big tech, and the broader economy to gain market attention. As the election gets closer, we will start to get a clearer picture of what the next 2-4 years will look like. The market has historically been choppy during an election year, with positive performance later in the year once the uncertainty of the election cycle passes. Additionally, the market has historically performed best under a split government in the subsequent years.

• The Fed – While we expect the Federal Reserve to largely step out of the way in the election year, their actions and commentary will undoubtedly continue to have an impact on markets. With inflation still running above their 2% target and a strong labor market, the Fed continues to have room to act. We will continue to monitor this along with any impact on the economic picture stemming from the lagged effects of their historically fast rate hiking cycle. All in all, we believe that the Fed is closer to the end of their tightening cycle than the beginning. The market is currently pricing in several rate cuts before the end of next year. At this point, we think those expectations are a little lofty and we wouldn’t be surprised to see the Fed keep rates steady throughout much of next year.
• Geopolitical Tensions – With the Russia/Ukraine war continuing on and the rising conflict in the middle east, we believe that these tensions will likely persist throughout much of next year. There continues to be concern that these wars can spread, with other players taking action. While obviously difficult to predict, we continue to watch developments closely with a specific focus on interactions between the US and China relative to Taiwan. Reshoring of operations should help limit the impact of any conflict to global companies, but the risks still remain. We are closely watching manufacturing trends and energy prices as these conflicts continue.

As we evaluate the number of scenarios that could happen in 2024, we anticipate one of the following three to unfold:

• Optimistic – Soft landing, Inflation comes down to 2%, GDP grows, jobs remain stable.
• Pessimistic – Fed has increased rates too far already, GDP falls, unemployment increases, but inflation comes down.
• Realistic – Soft landing but, inflation stuck at 2.5% and we can live with it, unemployment goes up but not much, new rates stay higher than rates since 2007, GDP grows modestly.

We believe the positioning as it relates to these potential outcomes is first and foremost a function of the investor’s time horizon as markets can be unrelenting. However, our committee is taking the positioning that most equities, excluding the mega cap tech stocks, in the public markets are fairly valued or undervalued and we remain neutral in the face of potential headwinds. Our fixed income allocation is short, high quality, and underweight due to an overweight to cash with good yields while our alternatives allocation is overweight where appropriate given the
opportunity set.

IMPORTANT DISCLAIMERS AND DISCLOSURES:
The information contained in this presentation has been gathered from sources we believe to be reliable, but we do not guarantee the accuracy or completeness of such information, and we assume no liability for damages resulting from or arising out of the use of such information. Past performance is not indicative of future results.

The views expressed in the referenced materials are subject to change based on market and other conditions. This document may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. The information provided herein does not constitute
investment advice and is not a solicitation to buy or sell securities.

Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, investment model, or products, including the investments, investment strategies or investment themes referenced herein, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for a particular portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no
longer be reflective of current opinions or positions.

Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be direct investment, accounting, tax, or legal advice to any one investor. Consult with an accountant or attorney regarding individual accounting, tax, or legal advice. No advice may be rendered unless a client service agreement is in place.

Procyon Advisors, LLC is a registered investment advisor with the U.S. Securities and Exchange Commission (“SEC”). This report is provided for informational purposes only and for the intended recipient[s] only. This report is derived from numerous sources, which are believed to be reliable, but not audited by Procyon for accuracy. This report may also include opinions and forward-looking statements which may not come to pass. Information is at a point in time and subject to change.

17 Apr MARKET UPDATE: ”THEY BROKE SOMETHING”

Stocks saw major dispersion in the first quarter of 2023, with the Nasdaq rallying 17.1% for its best quarter since 2020. Meanwhile, Large Value lagged (+1.0%), primarily due to underperformance in Financials, which were down (-5.6%). Small Caps (+2.7%) also lagged, as Financials make up a larger percentage of the Russell 2000 Index versus the S&P 500. Overall, the S&P 500 finished the quarter up 7.5%. As shown below, five of the seven best performing stocks in the S&P 500 were in the Tech sector, while six of the seven worst performing stocks were in the Financial sector. Historically a strong first quarter bodes well for the remainder of the year. Since 1950, when the S&P 500 gained over 7% in the first quarter, the full year has never been negative.

The issues that plagued Silicon Valley Bank (SVB) are also a challenge throughout the financial industry to varying degrees. Banks like SVB saw enormous success and a surge in deposits in the years leading up to 2022, in part due to an era of zero interest rates and quantitative easing. As a result, banks invested this excess cash in Treasuries and other similar securities, but some banks reached for yield and invested in longer duration securities. A sudden pivot by the Fed away from low rates (due to surging inflation) led to large unrealized losses in these securities as yields surged and bond values decreased. Banks are normally able to use an accounting method called “Held to Maturity” (HTM) to avoid losses, as long as these bonds are held until maturity. The surge in Treasury yields since 2022 left many bank’s HTM securities massively underwater, and a run on smaller banks forced them to unload their HTM securities at a loss in order to replenish deposit ratios.

• It’s important to note the government guaranteed all deposits for SVB and Signature Bank because they were in receivership and deemed a “systematic risk exception.”
• Over the past few weeks, Banks have seen their deposits decline by a record $300 Billion. After SVB went under, some deposits that left Small Banks went into Large Banks. Other deposits moved to higher yielding Money Market Funds, with a record $5.2 Trillion in these funds (see Chart #1).
• To improve liquidity and stability, Banks utilized the Fed’s Discount Window and the Fed’s newly established Bank Term Funding Program (BTFP). Both allow Banks to borrow short-term loans from the Fed by providing collateral (i.e. Government Bonds) at Face Value, regardless of market price. This resulted in the biggest surge in borrowing using the Discount Window since 2008 (see Chart #2).
• Usage of the Fed’s Facilities resulted in a jump in the Fed’s Balance Sheet by $300 billion, despite QT.
• The Dodd-Frank Act tried to reduce concentration among Banks, but we expect further consolidation now.
• According to Apollo, tighter financial conditions and lending standards equates to an additional 150 basis points in the Fed Funds Rate. Already, Bank Lending has plummeted (see chart #3).

• Alternative Assets are seeing continued demand from asset flows as investors look to diversify their return streams. Venture Capital and Private Equity are likely to see underperformance in the short term as multiple compression can have a lagged effect from the public to private markets, and this will likely provide liquidity in the form of supply to the secondary market. Private credit, lending, and non-residential real estate remain stable as this asset class operates parallel to bank and public market lending. We have seen a broad dispersion of hedge fund performance in 2022 with some funds logging their best numbers in many years with leveraged short positions on the bond market, while others, with large investments in Big Tech and Crypto, fell 90%+. For 2023, it is unclear whether we can have a repeat performance of hedge fund managers, or if that dispersion will narrow. 

It’s not unusual for a Tightening Cycle to result in a Financial Crisis. In response, the Fed has historically either Eased or Paused. In some instances, a Recession was avoided (i.e. 1984 Failure of Continental Illinois), while other times a Recession quickly followed (i.e. Global Financial Crisis).

In the past, a financial shock/crisis has never ended until the Fed paused or cut rates. The Fed’s response to the recent Banking Crisis is highly unusual, as the Fed hiked rates 25 basis points in March and continued Quantitative Tightening. Prior to the Banking Crisis, markets were pricing in a 50 basis point hike, but financial stability took precedence over price stability. The Fed continues to be in the difficult position of trying to battle high inflation while also managing a crisis in the Regional Banking system. Procyon believes the Fed is nearing the end of its tightening cycle, especially with a deep inversion of the yield curve continuing.

In March, the Fed raised rates to a range of 4.75-5.00% and released its updated “Dot Plot,” which showed a majority of FOMC participants forecasting just one additional rate hike in 2023. The market continues to price in a much different outlook for rates, with expectations of multiple rate cuts in the second half of 2023. In looking at the past 30 years (going back to 1994), there have been five prior rate hiking cycles – including the current cycle.

In the prior four cycles, equities rallied after the last rate hike except in 2000 during the bursting of the Tech Bubble. The end of the current rate hiking cycle could be bullish for equities.

The resulting implication on the CMBS market has been a large increase in the perceived risk of those commercial loans and the widening of option-adjusted spreads. Essentially repricing the cost of borrowing for commercial borrowers, relative to other borrowers. Our committee is monitoring the broader credit markets as we see potential for pockets of risk to be identified through the current rate hiking cycle. More recently the Procyon Investment Committee dug deeper into the Commercial Mortgage-backed Securities market to gain some insight on what appears to be a potential headwind to economic growth in the US in the coming quarters. It is important to note that while the overall CMBS market has shown a steady delinquency rate over the last twelve months, we are seeing delinquencies rise in office space specifically. As borrowing rates have risen and post-pandemic work habits have taken some time to unwind, the demand for office space has not bounced back as fast as landlords would have liked.

The resulting implication on the CMBS market has been a large increase in the perceived risk of those commercial loans and the widening of option-adjusted spreads. Essentially repricing the cost of borrowing for commercial borrowers, relative to other borrowers.

Our committee is monitoring the broader credit markets as we see potential for pockets of risk to be identified through the current rate hiking cycle.

Scenarios

As we have mentioned in previous commentary, there are some key tenets we are basing our current Macro Economic scenarios on and a quick review is as follows:

• We believe the Fed. If the FED says they will fight inflation, then they are committed to conducting policy with that outcome in focus. The Fed market “put” is gone.
• In order for interest rates to remain as they are i.e. the end of the hiking cycle one of two things needs to occur:
  • Inflation (CPI) falls below 4% on an annualized basis and is sustained for several readings
  • Unemployment will need to go above 5% and be sustained for multiple readings
  • Current CPI is 5% Annualized as of March 23 and the unemployment rate is currently sitting at 3.5%
• In order for Interest rates to decline:
  • A deep recession needs to occur for the FED to consider inflation a lesser threat to prosperity.
  • Major bank failure: a major bank failure would create a sufficient decline in economic activity as to counteract inflation and would result in a tightening effect.
  • Recent regional bank failures may provide some economic slowing. The overall environment in the markets continues to present a unique landscape. While we continue to see macroeconomic expectations overwhelming the headlines, we continue to focus on diversification, quality and cash flows as we act prudently in this challenging period for our clients. As you enter new periods in your life with new goals and evolving risk tolerances, we encourage to contact your advisor as proactive planning and risk management are key values at Procyon. Thank you for the trust you place in us.

10 Feb “Transient”?! – 2022 Inflation & Beyond

As we reflect on the markets from 2022, we are forced to think back a bit further to the initial onset of zero rates and Fed balance sheet expansion that began more than a decade earlier. Through several cycles both economic and geopolitical, including a period of rapid globalization beginning in 2009, low inflation persisted in the aftermath of the Great Financial Crisis through most of the 2010s. Interest rates were headed higher for a short time to correct the glut of liquidity when the Covid-19 Pandemic led us back down the road to even easier liquidity and lower rates.

2020 and 2021 saw the benefits of these efforts with massive gains across most asset classes as liquidity, in the form of both monetary and fiscal support flooded the economy and markets. Economies around the world closed and reopened as they battled waves of Covid-19; all while seeing demand for countless consumer products increase around the globe.

As the demand pressures mounted during 2021 Treasury Secretary Janet Yellen made the distinction that the visible price increases were “transient”, and the core measures of inflation were more stable. As we now understand, “transient” is no longer an appropriate term to characterize the current inflationary environment. In 2022, we saw the Federal Reserve increase rates at a pace never seen before as they attempted to stomp out the inflationary pressures becoming embedded in the US economy. We have seen asset prices react negatively across the board as a result of the tightening of monetary policy.

As we review 2022, it’s clear that the implications of investor responses around major events can become complex. On the following page we’ve included an interesting exhibit that summarizes how an investor may have responded to major events from last year, and how the market subsequently reacted as well.

The Fed’s Fight Against Inflation

After a 7.1% YoY CPI reading in November, the Fed slowed down its level of rate hike to 50 basis points (from 75 bps). Beginning in 2023, the Fed also slowed its rate hike to 25 basis points, starting at the first Fed meeting on February 1st. Despite the slowdown in the size of rate hikes, Fed Chair Powell has been firm in his stance of expecting higher rates for longer. While the market expects rate cuts in 2023, the FOMC’s latest quarterly projections highlight the Fed Funds Rate ending 2023 at a level of 5-5.25%.

China’s COVID Policies 

China maintained strict Covid-policies in 2022, resulting in a slowing of the world’s second-largest economy and even civil unrest. Late in Q4 2022, reports surfaced that China was planning to significantly roll back these strict policies in early 2023. Since then, China has scrapped its 8-day inbound quarantine requirement for travelers, facilitated visa applications for foreigners, and stated there would be no limit to gathering in public. These early attempts to reopen have been met with a surge in COVID cases throughout the country, testing the government’s commitment to this shift in policy. 

Russia-Ukraine War

The Russia-Ukraine War continues with no end in sight. Along with geopolitical concerns, the War has destabilized the energy & commodities market, particularly in Europe. Further escalation with nuclear weapons remains the biggest threat. A ceasefire remains unlikely in the short-term. Russia remains adamant that Ukraine recognizes annexed territories such as Donetsk & Luhansk, while Ukraine refuses to cede territory to Russia in any negotiations. Longerterm, the health of the Russian Economy, Army, and Vladmir Putin could be a catalyst for an end to the War. 

A resolution to any of these could be a bullish for the markets in 2023. 

The December CPI report showed inflation decreased to – 0.1% month-over-month, its lowest level of 2022. Inflation is down from a peak level of 9.1% in June 2022, as the Fed has undergone one of the fastest hiking cycles in 40 years (from roughly 0% to 4.50-4.75%). Goods inflation has continued to decelerate (i.e., used autos), but rent prices and wages are proving to be stickier. Wage inflation is of particular focus to the Fed, as it attempts to cool down a tight labor market. Along with raising rates, the Fed is draining liquidity in the system through Quantitative Tightening. As described at the beginning of this commentary, the Fed responded to previous shocks to the financial system (2008 & 2020) with “Quantitative Easing”; and the Fed Balance Sheet ballooned from less than $1 Trillion in 2008 to roughly $9 Trillion. In June 2022, the Fed officially reversed course and turned to Quantitative Tightening by letting Treasuries & Mortgage- Backed Securities mature without reinvestment. Finally, another tool at the Fed’s disposal is the use of forward guidance. At its December 14th meeting, the Fed released projections that showed FOMC participants expected rates to finish 2023 at a range of 5-5.25%. This was higher than anticipated, but perhaps even worse, this forecast implied no rate cuts in 2023 (differing from market expectations). This forecast was a major catalyst for the year-end selloff. 

The Good: Labor Market 

One constant strength in the overall economy in 2022 was the Labor market. Nonfarm Payrolls have been resilient all year despite negative headlines regarding layoffs (specifically in the Tech sector) and job openings still outnumber the unemployed by roughly 4 million. This is illustrated in Chart 1 below. 

The Bad: Equity Market 

Equity markets were quite resilient in the face of geopolitical worries, lockdowns in China, and the fastest tightening cycle in decades. Still, 2023 earnings expectations have been revised downward, and dispersion remains high. Large Value (-7.5%) outperformed Large Growth (-29.1%) in 2022 by the widest margin since 2000, and Energy was the top performing sector (up 65.7%), while Communications was the biggest laggard (-39.9%). 

The Ugly: Bond Market 

Bond markets experienced one of their worst years in history, as treasury yields surged. The 2-year Treasury yield spiked in 2022 from a low of 0.73% to a peak of 4.41%, while the 10-year yield rose from 1.52% to 3.88%. Even more concerning, a large majority of the Treasury curve is inverted. While not every yield curve inversion signals a Recession, the 10 year-3 month yield curve is deeply inverted by 54 basis points – which is its most inverted level since the Financial Crisis and Tech Bubble (see Chart 2). 

Looking Ahead to 2023

In 2023 we expect the US Federal Reserve will face a choice between accepting a higher average level of inflation (3.5- 4%) or drive the US economy towards recession by sticking to their 2% inflation mandate. By contrast, most other major economies have already passed this junction, and have made their choices. In Europe, the choice was a recession, and it was not made by governments or central bankers but imposed by Vladimir Putin. In China, the choice of recession was driven not by economics but by the draconian politics of Covid. Japan’s 30 years of deflation made inflation the obvious choice. Britain, meanwhile, has bounced from Liz Truss’s tolerance of inflation to recessionary austerity under Rishi Sunak. The US is unique in having a central bank, a government, and most major sell-side Economists all arguing a painful choice will not be required between high inflation and severe recession. If this is right, and the US reduces its inflation without experiencing a severe recession—and without even imposing positive real interest rates—it will be an unprecedented achievement. But if the belief in painless disinflation is wrong, the US economy and financial markets will need to adjust when this choice between recession and inflation becomes unavoidable. The biggest challenge for financial markets is that the prospect of 2-3.5% inflation is not in the foreseeable future. Markets keep expecting a dovish Fed, but the Fed has told us they will tighten to a terminal rate of 5-5.25%. Ultimately the big question is whether the Fed will accept a higher plateau of inflation of 4+% vs the original 2% target? The Fed is trying to project an image of hawkishness but also looking to avoid a severe recession at all costs. 

Investment Implications

• If investors accept that there will now be a higher US inflation plateau, that means higher US 10-year yields. This adds risk to the long maturities of the bond market.

• U.S equities have seen severe valuation compression – especially in the Tech sector. Given the move in short risk-free rates, it appears that this valuation compression is rational and justified. For 2023, we believe earnings becomes the focus for investors as the ability to manage through a higher rate environment becomes evident.

• Two widely respected names in the industry, David Tepper and Jeremy Siegel, have vastly different forecasts for 2023. On the bullish side, Jeremy Siegel believes the market deserves a 20x multiple and there will be upside to 2023 Earnings (i.e., $240), which would result in a possible S&P 500 price of 4,800 (20 * 240 = 4,800). David Tepper, on the other hand, is bearish and believes the market deserves a 12x multiple on lower 2023 Earnings. If we use $225 for 2023 EPS, this would result in an S&P 500 price of 2,700 (12 & 225 = 2,700). These two examples show the discrepancy in forecasts for next year.

• A market multiple of roughly 16-17x next year’s earnings is fair based on interest rate levels (see chart 3), but 2023 Earnings Expectations may continue to be revised downward as higher interest rates take their toll on the economy.

• Equity rotation from Growth to Value is a continued focus as the US economy stays stronger for longer and China reopens. Major long-term rotation continues from Growth stocks/COVID gainers to Value stocks with growing earnings expectations. We remain cautious on Large Cap Technology. This sector is valuation-challenged at a time when fundamentals, especially around online advertising, and social media, are still deteriorating and competition is increasing. Additionally, we continue to think that globally, greater government regulation of Tech is increasingly on the table at a time when global geopolitical competition is heating up.

• US Small Caps are getting interesting for long-term investors. The Russell 2000’s forward 12 months P/E ratio has fallen to 10.8x, its lowest level since 1990 and 30% below its long-term average. On a relative basis, the Russell 2000’s forward 12-month P/E is trading at the lowest level versus large-cap stocks since the Tech Bubble.

• China and commodity producing EM’s should outperform the US and Europe. Cyclical hedges that might work as the dollar weakens, include select EM and Commodities (such as Oil and Copper). Most investors, regardless of region, are overweight dollar-based assets. This decision has been the right one in recent years, but the technical picture is indicative to us that we should add additional exposure in the form of select EM markets.

• Alternative Assets are seeing continued demand from asset flows as investors look to diversify their return streams. Venture Capital and Private Equity are likely to see underperformance in the short term as multiple compression can have a lagged effect from the public to private markets, and this will likely provide liquidity in the form of supply to the secondary market. Private credit, lending, and non-residential real estate remain stable as this asset class operates parallel to bank and public market lending. We have seen a broad dispersion of hedge fund performance in 2022 with some funds logging their best numbers in many years with leveraged short positions on the bond market, while others, with large investments in Big Tech and Crypto, fell 90%+. For 2023, it is unclear whether we can have a repeat performance of hedge fund managers, or if that dispersion will narrow. 

Major Risks to Expectations for 2023

1. Growth Collapses – The US GDP growth expectation (JP Morgan) for 2023 is 1%, which is a slowdown from 2022. If the US has a deep recession as a result of overtightening and asset prices collapse the equity markets will have a difficult time. 

2. Inflation Crashes – In this case the Fed would not be forced to raise rates further and we can return to a <2% inflationary environment. If this were to occur, then Large Cap Growth stocks would be preferred as asset-light companies may reemerge to outperform. 

Please contact your Wealth Advisor at Procyon Partners to discuss how this review may apply to your personal investment objectives. We appreciate your trust through these difficult periods of market stress. As always, we will continue to navigate the sometimes-treacherous waters of the global investment environment on your behalf.

Thank you for your continued support and confidence in the Procyon team.

Best Regards,

Procyon Partners 

14 Oct MARKET UPDATE: “THE BEST TIME TO PLANT A TREE WAS 20 YEARS AGO, THE SECOND-BEST TIME TO DO SO IS TODAY.” – ANCIENT CHINESE PROVERB

As we witnessed the most significant drawdown in wealth since the 2008 financial crisis, the first three quarters of 2022 have collectively cost investors more than $9.5 trillion from the market’s high-water mark at the end of 2021. This includes the market value declines in both the public equity and fixed income markets.

The drawdown has been felt for both aggressive and conservative investors alike, as nominal and real rates of return are negative across almost all major public markets.
In times of stress our behaviors can dictate our outcomes and remaining patient through turbulent times has been a fundamental tenant throughout our investing careers. As difficult as it may sometimes be, we find that through active management and avoiding large behavioral mistakes we can navigate through market stress quite effectively. This is predicated on the ability of investors to be patient and allow time for asset prices to recover.

What do we think about stock prices today?

Fundamentally, current valuations can help derive future expectations for market returns. For several years, valuations in equity markets appeared stretched and a protracted Fed policy of zero-interest rates helped facilitate those valuations. That was true for a very long period. If we can remember, those policies began 14 years ago with the Great Financial Crisis. Ushered in by then Fed Chair Ben Bernanke, who just recently received the Nobel Prize in Economics for that very work.

That regime appears to have ended as we enter a new, more normal, period of higher rates. As this occurs asset prices recalibrate, and stock market valuations appear to be the first casualty as the market price-to-earnings (P/E) ratio has come down along with the Cyclically Adjusted P/E (CAPE) ratio and several other key valuations measures. Now that we’re experiencing this regime change and a fundamental reset of asset prices, we can gather and interpret some data to help us discern what current levels may indicate about future returns.

As shown on the following page, the two charts are rolling 1 and 5 year returns from August of 1997 through September of 2022. On the left axis are the returns and the bottom axis are valuations.

On the following chart, you can see the current forward P/E ratio for the S&P 500 is ~15.1x , and indicates positive future returns for both the 1 and 5 year time periods. This means that we are seeing a readjustment of the number of years in advance an investor is willing to pay for today’s earnings. Even the highest valuation stocks have seen a recent contraction as illustrated in the valuation dispersion chart here.

Corporate Earnings:

Our team expects a mixed bag for earnings this quarter as we see the effects of inventory buildups in reaction to supply chain lags filter through the largest firms. Input costs have come down in recent months helping to dampen some of the expense pressures in critical markets, however wage growth will continue to weigh on earnings.

While the expectations for 3Q earnings have come down this year, the reported data and forward guidance will have a big influence on returns over the course of this earnings season. Price volatility is expected to continue. We do expect that earnings in cyclical sectors will tell us a bit more about where the economy stands and how consumers are making spending decisions.

Spending decisions are of course the US Central Bank’s end target. With rapidly rising prices stressing the budgets of the general population, the central bank is focused on increasing the cost of borrowing to dampen demand, and therefore the prices of goods and services. The current rate of price increases, 8.2% from the previous year as of September, is increasingly harmful if sustained over long periods.

To combat this dynamic the US central bank is making money more difficult to obtain. The potential for continued inflationary pressures signals that this interest rate cycle could last longer than some of the rising rate cycles in recent memory. There have been six “Fed Pivots” since interest rates peaked in 1984, and while there may be some starts and stops to the recent upward trend, the trend is clearly upward. While most asset allocators have had this expectation for some time it has come to fruition very quickly in 2022.

Recession & Jobs:

The topic of a recession in the US has been debated exhaustively by economists and commentators on business news. The fundamental definition of a recession is two consecutive quarters of GDP contraction, and as currently reported that is what we experienced in the first half of this year. The debate around whether we are experiencing a recession consistent with that definition really hinges on the prevailing low unemployment numbers across the country. Be that as it may, the job market is still quite robust by all measures. For example, there are currently 1.87 job openings per job seeker (USDL, JPM) which has been a key driver of wage growth. By way of comparison, the previous peak was just before the pandemic at ~1.25 jobs available per seeker. These numbers are likely to come down as the post pandemic economy normalizes further.

Our expectation is that the unemployment rate in the US will tick higher, job openings will contract, and wage growth will moderate in the coming quarters. While this may be truer for some industries versus others, we do expect a broad moderation in the job market across the US over the next year.

Base Case:

The Procyon Investment Committee has established a base case scenario for our economic expectations over both the short and long term. Over the short-term we believe the Fed will likely continue to increase rates until one of two scenarios come about:

1. CPI data trends below 6% for multiple months
2. Unemployment rises above 5%

There continues to be some potential for a “soft landing” if inflation slowly reverts to it’s mean at closer to 3.5% over a 1- 3 year period, but recent data suggests that is becoming harder and harder to achieve.

Higher rates are likely to place continued pressure on equity valuations and earnings in the coming quarters and as we enter the holiday spending season. As a result, our short-term tactical allocations reflect more conservative equity and fixed income positioning.

Over the long-term, we look to relative valuations for our expected returns, and continue to believe that broad asset allocation across small, mid and large cap equities will provide higher returns in the future. Accordingly, we have increased our exposure to areas where valuations are at historical lows relative to their long-term average, as well as the quality of core portfolio investments in recognition that more effective firm management teams should fare better in an environment defined by increasing costs to do business.

We also acknowledge that markets are a forecasting mechanism and that the rally in equities will likely begin before jobs losses reach their peak. We will of course continue to monitor the changes in the economy closely as we look for compelling opportunistic investments.

In addition, we remain positioned more heavily on the shorter end of the fixed income maturity ladder with rates expected to continue moving higher. High credit quality and active management provide long-term benefits in the bond market, and we are committed to making changes where necessary. We also see the potential for credit deterioration and have reduced our investments in high-yield securities in recent quarters as a result.

In summary for 3Q22:

• We saw a continued reduction in public asset prices,
• Valuations have come back down to their historical averages after being elevated throughout the “zero interest rate environment”,
• 3Q earnings and 4Q shopping season are in focus,
• The Fed is committed to rate increases until data suggests they stop, and
• Portfolio positioning is conservative with a focus on higher

The Procyon Investment Committee is committed to providing insightful market analysis as we assess the evolving investment landscape. As fiduciaries, we are dedicated to our clients’ best interests and our principal goal is to make sure that we deliver exceptional advice to every client. We thank you for the continued trust you place in us as we help you navigate this challenging environment. If you have any questions or would like to discuss your financial goals or investment portfolio, please don’t hesitate to let us know.

Best Regards,

Procyon Partners

20 Jul MARKET UPDATE: THE HEAT IS ON!

Happy 246th Birthday to the United States of America! Paraphrasing the incomparable Erma Louise Bombeck (1927- 1996): “You have to love a Nation that celebrates its Independence every July 4…with family picnics where kids throw Frisbees, the potato salad gets iffy, and the flies die from happiness. You may think you have overeaten, but it is patriotism.” And especially in the U.S. equity markets, June has generated considerable fireworks. Declining -8.4% in price in June and -20.6% for the first half of 2022, the S&P 500 index finished its worst first half performance in 52 years (in 1970; and it is worth keeping in mind that in the second half of that year, the S&P 500 generated a price gain of +27%).

For the 12 S&P 500 bear markets since World War II — excluding this year’s — the price decline has averaged -34% and the bear market length has averaged 10 months. If the current bear market adheres to this average performance, approximately 61% of the total damage has occurred, and approximately 70% of the bear market’s time duration has transpired.

The S&P 500‘s decline represents its fourth-worst first-half performance ever, only behind the price losses in 1932 (- 45.4%), 1962 (-23.5%), and 1970 (-21.0%). Also,

• Investors reacted to still elevated inflation readings; softening retail sales; slowing PMI services and manufacturing data; the Federal Reserve’s 75-basis point policy rate increase on June 15th; very gradual reopening signs in the pandemic lockdown in China; and back-and-forth news in the Ukraine
• In descending  order,  the  June  price  performance  of  the  11  S&P  500  industry  sectors  was:  Healthcare  -2.5%; Consumer  Staples  -2.8%;  Communication  Services  -6.2%;  Utilities  -6.2%;  Real  Estate  -7.5%;  Industrials  -7.8%; Information Technology -8.2%; Consumer Discretionary -9.5%; Financials -10.3%; Materials-13.0%; and Energy -15.3%.

As highlighted in the nearby price performance table, after a volatile trading month in June, the S&P 500 finished down -8.4% (3785.38 on June 30th versus 4132.95 on May 31st). The Nasdaq Composite registered an -8.7% decline in June, and the Russell 2000 index of small- and mid-cap companies fell -8.4% over the month.

Over the course of June, West Texas Intermediate crude oil prices declined -7.8%, from $114.67 per barrel on May 31st to $105.76 per barrel on June 30th. The global oil demand continues to reflect signs of China’s Covid-19 lockdowns easing; slowing momentum in the global economy; fuel shortages; low levels of inventories and spare capacity limited to a few countries; and precautionary buying, while supply is impacted by :

• the four-month Russia-Ukraine conflict continues to create significant demand and supply disruptions;
• several nations, especially the U.S. and including certain allies, have launched the release of crude oil from their respective strategic reserves
• consolidating S. shale producers have not excessively increased output in reaction to higher crude prices (as shown in the nearby chart) and have followed production discipline and exerted capital spending restraint; and
• following the OPEC and non-OPEC ministerial meeting on Thursday, June 30th, the group (which includes Saudi Arabia, Russia, the United Arab Emirates, Kuwait, Iraq, and other countries) agreed to keep the rate of their monthly output increases at an agreed pace of 648,000 barrels per day in August of this year, with Saudi Arabia and the United Arab Emirates likely to account for most of the supply increases.

The next OPEC+ Ministerial Meeting is scheduled for Wednesday, August 3rd, when the organization is expected to decide on production quotas for September.

Inflation

As a widely used input in the construction industry and in many manufacturing processes, so-called “Dr. Copper” is reputed to have a “Ph. D. in economics” because of the red metal’s perceived ability to foretell turning points in the global economy. The nearby chart shows that copper prices have exhibited a declining trend of late, perhaps reflecting lessening shortages, bottlenecks, and other supply-driven inflationary forces.

And copper is not the only commodity to have exhibited recent price weakness. As depicted in the nearby chart, versus their 52-week highs, numerous other commodities have declined to a considerable degree versus their 52-week highs in the energy, precious metals, base metals, and agricultural sectors.

These declines notwithstanding, their still-high absolute levels and especially, rising labor and occupancy costs have contributed to businesses’ and consumers’ elevated inflation expectations. These future price beliefs are monitored closely by the Federal Reserve to ascertain whether high inflation expectations are getting anchored in: (i) wage and salary expectations; (ii) consumers’ spending patterns, and (iii) corporate pricing behavior.

Monetary Policy and Interest Rates

As shown in the nearby charts, following a significant interval of very low nominal yields throughout most of the 2020-2021 Covid-pandemic experience, short- and intermediate-term U.S. Treasury interest rates have risen significantly in 2022.

These increased yields have been in response to: (i) quickening U.S. economic activity; (ii) rising expectations of inflation; and (iii) increasingly restrictive monetary policy.

At the end of June, three-month nominal U.S. Treasury bill yields had risen to 1.69%, versus 0.06% on December 31, 2021, and 10-year U.S. Treasury yields had increased to nearly 3.50% by mid-June, up from 1.52% on December 31, 2021.

Following a 75-basis point increase on June 14-15 in the FOMC’s fed funds target monetary policy rate, to a 1.50%- 1.75% range, a number of FOMC voting members have been advocating for a second 75-basis point hike in the target fed funds rate at the upcoming July 26-27 meeting. If enacted, that would lift the target monetary policy rate to a 2.25–2.50% range by the end of July.

At this point, we are of the opinion that the Fed is likely inclined to continue monetary tightening in order to:

• slow inflation through (a) the direct effect of higher interest rates on the real economy, as well as through (b) asset price declines in the highly financialized S. economy;
• buttress the central bank’s inflation fighting credentials; and
• “store up” higher levels of policy interest rates in order to be able to stimulate the economy through interest rate cuts as recessionary episodes

The economy may continue to slow in response to:

• elevated rates of inflation crimping overall demand;
• continued increases in monetary policy interest rates; and
• Quantitative Tightening (monthly reductions in the Federal Reserve’s balance sheet, increasing from a $47.5 billion rate in June, July, and August to a monthly rate of $95.0 billion commencing September 1), our stance at this point is to remain flexible and data dependent, before beginning in the coming year to modestly add funds to longer duration fixed-income securities and to other beneficiaries of declining interest rates.

Economy and Corporate Profits

The IMF projects +3.7% real GDP growth for the U.S. in 2022 and +2.3% in 2023 (versus the FOMC’s median projection of +1.7% real GDP growth for the U.S. in 2022 and +1.7% in 2023). Also worth noting in the chart are significant slowdowns in World Output (+3.6% in 2022, versus +6.1% in 2021), as well as in the GDP of the Euro Area (+2.8%, down from +5.3% in 2021), China (+4.4%, down from +8.1% in 2021), Brazil (+0.8%, down from + 4.6% in 2021), Mexico (+2.0%, down from +4.8% in 2021), and South Africa (+1.9%, down from +4.9% in 2021). Against a backdrop of slowing Purchasing Managers Indices (Manufacturing, as well as Services), and possibly a recessionary GDP path unfolding, we are focused on the implications for corporate earnings per share results.

According to analysts’ estimates collected by I/B/E/S Refinitiv and tabulated by Yardeni Research, S&P 500 earnings per share are projected to grow +11.6% in 1Q22, +5.1% in 2Q22, +10.7% in 3Q22, and +10.0% in 4Q22, with full-year earnings growth projected to be +9.9% in 2022 and +9.7% in 2023. The nearby chart shows the possibility of downward revisions to earnings per share growth in the coming quarters and call for vigilant attention to be paid to Chief Executive Officers’ and Chief Financial Officers’ comments about the forward outlook on their companies’ earnings calls which will begin in the middle of July.

Our Team has further developed our scenario set to reflect the current environment:

We will monitor these developments as they continue to unfold in the coming quarters. Given the risks that may lie ahead, here is a summary of our MACRO portfolio positioning as it stands within our committee.

The pockets of market and economic difficulty continue to come and go as the world continues to reshuffle after the shock of the pandemic shutdown more than two years ago. While this has persisted in some parts of the world, we are often reminded that we must move forward and deal with issues at hand through the institutions we’ve created. The mid-term elections are coming up fast and we will once again undoubtedly turn our eyes towards Washington in the coming months, thirsty for leadership in the face of inflation and divisiveness.

Procyon serves as a fiduciary to our clients, and making sure that each family, business, and individual is well looked after is at the heart of what we do. During these difficult markets we are prudently operating on your behalf, as well as those who rely on you for many years into the future. Please contact us if you have questions about how the current environment is impacting your investments.

Thank you for the trust you place in us.

Best Regards,

Procyon Partners

15 Jun MARKET UPDATE: A TIME TO BE HUMBLE

The US Stock market entered a bear market recently, dropping -20% from the previous high which occurred on January 3rd. We’re now five months into the bear market which we know doesn’t feel good for anyone. Our Investment Committee has composed the following information for you in the hope of providing some helpful perspective on the current market environment.

This year stock and bond markets are clearly responding to high inflation, the Federal Reserve’s effort to cool inflation with rate hikes, and the growing threat of a recession from said rate hikes.

Most recently the May inflation reading was higher than expected and the Fed reacted on Wednesday June 15th by raising interest rates by 75 bps, 25 bps more than was expected a week ago. But the market initially took that as a good sign that the Fed can tame inflation, with the S&P 500 rising 1.4% for the day. Showcasing that sometimes “bad news” is “good news” for the markets in a perverse sort of way.

Let’s look at the volatility we’ve been experiencing and what today’s realities are.

Pessimism is high, markets have been shaken, consumers are paying more for everything and for several months the Fed has been playing “catch-up”. Trying to slow inflation back to its target of 2% on average and now we’re in a “bear market” to boot! To define that term, a bear market is the “experience when securities prices fall by 20% or more over a sustained period of time.” Bear markets are also generally accompanied by possible economic downturns, widespread pessimism, and negative investor sentiment.

The nearby table highlights some recent bear markets and how different sectors performed. Sometimes they can last years, other times, like in 2020, they were over in a month with the median length being seven months.

While painful, bear markets are a natural part of investing. They are not completely unexpected, and we have been discussing the increasing probability of a recession for a few quarters now. We’d like to highlight a quote from famed value investor Shelby Cullom Davis “You make most of your money in a bear market, you just don’t realize it at the time.” He was referring to both the new opportunities created by buying quality companies at cheaper prices, as well as having the discipline to stick it out.

So, let’s dig into that a bit more. Bear markets occur more often than most realize.

As the table illustrates, we have had sixteen bear markets since 1950. The most infamous bear market occurred during the great depression from 1929 to 1932, when stocks fell 84% from their highs and did not fully recover until 1945. In the 1960’s there were two difficult bear markets as the Fed grappled with inflationary pressures during that period. In the 1970s, due to continued high inflation, an oil crisis, and the collapse of key economic agreements between nations, stocks fell about 50% from their peak in 1973. 2000 was the three- year dot-com bust, 2008 was the great recession from the mortgage crisis and then of course 2020’s covid bear.

What has the Procyon Investment Committee been doing?

Over the last several quarters our expectation for continued inflation and market turbulence has risen steadily. While our portfolios have experienced a reduction in market values, we have made and continue to make changes in anticipation of the volatility. The main allocation factors in place throughout our portfolio construction and management have been the following:

While we are happy with some results, others have not protected portfolios as much as we would have hoped. Bonds have experienced the worst start to the year in decades, failing to act as a hedge for portfolios as equities fell. As an example, the 7-10 year Treasury Bond ETF (IEF) has a YTD return of -13.49%, with the 20+ Year Treasury Bond ETF (TLT) down -25.06% year to date. Over most periods of economic turbulence these widely held investments provide a risk-off ballast to a difficult equity market and will tend to hold their value – that has not been the case thus far in 2022.

We often say the markets are forward-looking and respond to the prospects of the situation getting marginally better or worse; not a straight “good or bad,” but rather how are things changing at the margin and what is our trajectory? Given what we face today there are some important investing points to consider as we position portfolios. We also tend to think in terms of probabilities of outcomes; not absolutes.

While fiscal and monetary stimulus had a role in spiking inflation, both of those are now reversing. The Fed is raising rates, reducing monetary stimulus, and the US Congress is no longer actively discussing further fiscal stimulus. While new variants of covid continue to pop up, the pandemic shock is receding, and supply chains are trending towards normal. Also on the positive side is the low level of unemployment and the increasing participation rate with workers drawn back into the workforce by higher wages.

Recently the 30-year mortgage rate reached 6%! Existing home sales are down -5.9% (a/o 4/22) versus a year earlier, and vehicle purchases have screeched to a halt just recently. While this is bad if you want to buy a new house, it will slow the housing market helping to cool inflation pressures.

Consumer sentiment has also slipped to a trough of 58.4 (shown above). Consumer confidence metrics point to the potential for higher expected equity market returns in the future as well.

As we write this, markets are reacting positively to the rate news as they cheer on the commitment to reducing inflation by the Fed. The coming days and months will prove how effective the Fed can be in mitigating inflationary pressures, but we are confident an aggressive approach is prudent. What remains to be seen is whether they will be able to achieve their “soft landing” of slowing inflation without causing a recession.

We will conclude with a final reminder that Procyon uses a client’s financial plan as the bedrock of any investment strategy. Helping clients achieve their goals with their own individual risk appetite is important. The financial plan itself makes use of Monte Carlo statistical probabilities to incorporate these inevitable bear market slumps that occur along the way into our long-term planning.

In July please be on the lookout for our full analysis of the second quarter and a more complete discussion on the possible outcomes ahead as we see them. As always thank you for the trust and confidence; we will get through this period together. Please call us if you have any questions, concerns, or to simply talk further.

The Procyon Investment Committee

10 Mar MARKET SPOTLIGHT: RUSSIA IN UKRAINE

As the Russia-Ukraine war continues and uncertainty builds across global markets, we have compiled some thoughts for you regarding the direct and indirect risks we see unfolding, including sanctions, oil prices, commodities, and investor sentiment. Of course, it goes without saying that this situation is very fluid, and things can change by the hour.

What does Vladimir Putin want?

It’s a question a lot of people are asking. At this point, there really appears to be no path for a “victory” – however one defines that. For starters, Putin wants Ukraine President Volodymyr Zelensky out, and the annihilation of the Ukrainian military. Neither has been achieved as of today (March 8). Therefore, he appears to need an off ramp and recognizing that he really has none, is now really being compelled to double down.

What is Putin’s list of demands? He wants Ukraine to concede Crimea to Russia along with a land bridge to Odessa. The Donbas region will also need to be recognized as Russian. Furthermore, Ukraine will also need to make a commitment not to join NATO. Putin also ultimately wants regime change as well but ousting Zelensky and installing a puppet government will never yield authority or credibility in Ukraine. With the tenacity and will of the Ukrainian people, he will never be able to govern Ukraine with an occupying force. It will be nearly impossible.

Longer term should Russia continue its military push, we could very well see the Zelensky government move to Lviv and then to Poland where they could operate in exile. If Russia’s occupation fails, the Zelensky government could then return.

Unintended consequences of Russia’s invasion

• The US, UK and EU are now unified like never before
• NATO has been revitalized and has a new outlook on life
• Ukraine is being pushed more and more to the West
• Military spending in Europe is now expected to ramp back up
• The national “debt brake” that limits borrowing in countries like Germany and others across the EU might be amended to allow more government-financed spending on Defense

Sanction effects

The goal of the West is to restrict Russia’s economic and military development to limit Putin’s ability to continue his current pursuits, and further repeat this move in the future. The immediate effect is likely to push Russia more and more eastward to become more dependent on China.

With the US move to ban high-tech exports such as semiconductor exports to Russia, Russia’s attempted shift from a fossil fuel-driven economy to a tech-based one faces headwinds. We suspect Russia will likely turn to Chinese chip technology, but the Chinese chips are generations behind the US alternatives.

For the sanctions to be effective, the Russian population will need to blame Putin for their hardships, not the West. We’ve already seen the Duma approve a 15-year prison sentence on anyone reporting any alternative narrative to the war other than the farcical ones approved by the Putin regime.

While the multilateral financial sanctions ramped up quite quickly, the more eye-opening development has been the self-sanctioning taking place by the private sector. Multinational firms are choosing to divest their Russia ventures, as well as refusing to do business with Russia-linked firms.

Sanctions are an important tool for negotiations – think of them as a carrot and stick approach:

• If you do this, we will do this. If you withdraw from Ukraine, we will rescind banning your banks from
• But with Putin seemingly doubling down, the odds of the sanctions becoming permanent continue to
• From a technical perspective, Europe must reapply these sanctions every 6 months and for the US, it’s every
• And with self-sanctioning, reversals may never even We’ve already seen many large oil names permanently exiting the market and many other companies suspending sales with no guarantee these decisions will be reversed anytime soon.
• The question then shifts: With rising energy costs, how long will the population be willing to assume the financial hit before they start to withdraw their support for their local politicians?

Energy exports: the Holy Grail

• Given that the US does very little business with Russia, unilateral sanctions would not be nearly as Europe needs to be the driving force behind this.
  • A US ban of Russian gas imports could begin to drive a wedge between the US and its Western

• Europe limiting or embargoing Russian imports is
  • The impact across the EU varies from product to
  • Because of this, it will be challenging to find a consensus across all member EU states
  • The EU itself does not have the ability to impose energy policy on national

• As such, any agreement on the direction of limits or embargoes would need unanimity across all member states unless some were prepared to go the course

• The move to remove some Russian banks from the SWIFT payment messaging system was calculated, as Western allies have been loath to choke off the Russian energy
  • The incremental risk – Putin decides to stop supplying gas to
  • Think about it – he is receiving revenues from these sales that he simply cannot use. So what’s the point?
• Offsetting this backdrop – winter is almost over, and it has been less
  • Should a ban persist, however, this would prevent gas reserves from being stockpiled for the next winter
• While the US and its allies have not yet unilaterally imposed penalties on Russian oil and gas, the self- sanctioning aspect has made an impact:
  • Russian oil loadings for March show a sharp drop with a number of ship owners reluctant to
  • The extent to which this self-sanctioning accelerates and widens, we believe, will be a key linchpin in the severity and duration of the energy

Commodities crunch

Oil price increases could certainly bite into global growth and cause further inflationary pressures. But here are some other commodities that may be at risk:

• Platinum and    palladium   –    impacting   catalytic converters and putting auto production at
• Neon – a major export from the region and a key input for semiconductor
• Wheat, corn, and sunflowers are all at
  • Many emerging economies are wheat importers and likely to be hurt more from rising food costs. In fact, Egypt, Indonesia, and Turkey are the largest wheat importers in the
• Ammonia – with natural gas prices on the rise, it is now becoming cost-prohibitive to
• Potash – Russia and Belarus account for about one- third of global trade in this commodity – a key ingredient in

How can the world replace oil supply?

• Should Russian oil get cut off, there are some means to replace the
• Iran nuclear deal – Iran has some 180 million barrels ready to go, sitting on floating ships already. They could also ramp up a large amount of supply over the course of a year. So, it seems that it would be in Russia’s best interest to make fresh demands here to slow the progress of negotiations – which is exactly what they are doing.
• Global Strategic Petroleum Reserves (SPRs) stand at about 16 billion barrels, with 1.5 billion of that held by governments. If needed, roughly 60 million barrels could be delivered per month.
• OPEC has spare capacity to ramp up some 6 million barrels per day.
• US shale could increase – but producers have commented that they cannot produce output fast enough to compensate for lost Russian oil, citing lack of labor and raw material issues like steel and cement.
• Libya’s political crisis is causing output to
• The US has sent a delegation to Venezuela – the highest-level trip in years. The reasoning, it seems, is to isolate one of Moscow’s remaining allies in the world, as well as possibly replace Russian oil

Oligarch offensive

Western countries have begun creating task forces to determine which Russian oligarch owns what. Jets and yachts being seized makes for good theater. And the court of public opinion is certainly having an impact here, with many high-profile seizures hitting the news in the past week. But will the Russian elite apply enough pressure to the Putin regime to effect change?

Thus far, the answer is NO. Most oligarchs have called for an end to the escalation but have fallen well short of criticizing Putin. What’s their upside in doing so? They know who made them rich and they know who can make their lives difficult.

Demise of the US dollar? Not so fast

With the US dollar becoming weaponized, there has been quite a bit written about the overall impact. The common thread is that more and more countries will begin to move away from the USD and weaken its status as the world’s reserve currency. We’ve heard this for decades now and it has been nothing more than clickbait.

China’s CNY has been the rumored replacement for those seeking diversification. We believe the flaw in this logic is that the CNY is simply not a fully convertible currency. With capital restrictions on the currency, it hinders its liquidity, making it a nonstarter. CNY accounts for just 3% of all foreign currency transactions – while the USD accounts for over 40%. Also, to replace the buck on the global stage you would have to replace contracts and payment systems that have been in place for years. This would be a decade-long venture and not something that can be done overnight.

More importantly, in times of global crisis, having one currency dominate the international financial system makes it easier to backstop the system.

With the Fed always standing at the ready to provide global liquidity for the USD, this has been the saving grace time and time again, preventing a major collapse of the global financial system. We believe this backstop is an important misunderstanding for those calling for the end of the US dollar as the reserve currency of the world.

Market perspectives

• From February 24th, 2022, the day Russia invaded Ukraine, through March 9, 2022 US equities as measured by the S&P 500 are -0.21%. Up until now, Russia has been more of a news event for US firms rather than an economic
• Much more relevant has been the pending shift in monetary policy as managed by the US Federal Reserve
• Historical intra-year declines also help remind investors of the actual volatility that occurs in the public markets:
• Unfortunately, we can also review statistics regarding large scale global warfare and terrorism as well as its effects on financial market
• The euro continues to slip relative to the dollar with higher oil This creates the doom loop – oil prices rise, EUR weakens which puts increased upside pressure on inflation as a weaker EUR makes imports more expensive. Also, commodities are priced in USD and rising prices against a falling EUR only exacerbate the issue.

• Surging prices across all commodities will eat away at consumer purchasing power and intensify the inflation
  • Keep in mind, however, that US household and corporate balance sheets have never been better – helping to cushion rising
  • Stagflation calls might be getting a bit ahead of themselves in the Nominal growth is at a much higher starting point these days, and this should not be forgotten. Real rates are still negative. And the US is now a major oil producer, not importer.

• Energy has turned from unloved to crowded. We think any resolution could see a sharp correction in energy prices given
• Financial contagion still seems muted, and the odds of a Lehman-style meltdown remain
• Europe is the most exposed – there are upside risks to inflation and downside risks to growth. Plain and Financials may also be at risk, not from Russia exposure, but from slower economic growth.

Big picture themes

Overall, it is tough to see a resolution of the Russia- Ukraine crisis anytime soon. We expect it could be several more months. With that in mind, the macro themes we expect to play out include:

• Increased defense and cybersecurity spending
• Elevated commodity prices for an extended period
• Supply chain headaches persisting

Final thoughts

Will Putin declare war on a NATO country? This would certainly provide him additional cover, framing some “incident” to justify actions to the Russian people. The upside to this: NATO is aware and will likely not play along. Again, this unfortunate situation is very fluid, and things can change by the hour. With that in mind, our views and market perspectives may change as well.

Procyon’s Investment Committee is carefully digesting the information as it is produced. We will be watching the economic readings and high frequency data as it continues to provide us insight into areas of the market where opportunities lie and where risk may be increasing. We are interpreting this shock to the geopolitical landscape as it happens in real time and are careful not to pretend to know every possible outcome as we balance the need for capital preservation, income and growth. However, we understand our clients better than anyone and are locked into making sound and prudent decisions for them as we navigate the rough seas of 2022 and beyond.

We appreciate your continued trust and for taking time to read our intra-quarter update.

Best Regards,

Procyon Partners

20 Jan THE INFLUENCE OF BIG TECH

2021 was a recovery year for this economy. The “reopen” trade was on and it was time to see if those big tech companies who benefitted so much due to the skyrocketing demand for everything technology, could in fact continue their limitless trajectory. The businesses who were previously forced to close spent the year reopening and readjusting their business plans. We hope those clients who were affected in this manner in 2020, were able to spend 2021 taking advantage of opportunities as entrepreneurs do.

What’s Driving Markets?

The influence of big tech on market performance has been increasingly heightened over the last 12 months. Only 7 companies currently comprise 27% of the S&P 500 Index. The combined market values of Apple Inc, Microsoft, Alphabet, Amazon and Meta Platforms, stand at $10.1 trillion as of end of the year. That is up from $7.5 trillion from the start of the year. That 35% gain in market value exceeds the gain of the Dow, S&P 500 and Nasdaq Composite for 2021, which was another strong year for markets across the board.

This run puts a larger portion of the market under the sway of a few big names. The aforementioned five — along with Tesla and chip maker Nvidia — now comprise more than 27% of the S&P 500’s total value. And that seems likely to grow even further. Apple alone is on the cusp of reaching the $3 trillion mark, and at least 13 analysts have price targets on the stock that would put the company’s market value well past that milestone. Further, Wall Street’s median price target of $4,000 for Amazon’s shares would put the e-commerce giant past the $2 trillion mark—up 17% from its current value.
The year also closed with yet another quarter of strong performance, which has become a familiar sight since the market pullback at the onset of the pandemic in 2020. In Exhibit 1, you can see performance for many of the major asset classes across different time frames. The US has led the way and the 4th quarter was no exception.

International market performance was mixed in the most recent quarter and continues to trail the US over the longer term. Within the fixed income markets, rising yields created a broad headwind for the taxable fixed income space (treasuries, corporate bonds, securitized products, etc.) however upgrades to municipal credit qualities and limited supply created a tailwind for municipal bonds. This resulted in positive performance for municipal bonds while their taxable counterparts were negative for the year.

Since the onset of the pandemic and the initial decline in the equity markets, fiscal and monetary stimulus have supported seven consecutive quarters of equity market advances. This has left many investors in a strong place heading into 2022 and has created, for better or for worse, a sense of comfort in a level of risk that may or may not be appropriate.

To provide some context, we believe the most influential factor driving performance over the last couple of years has been monetary and fiscal stimulus. On the fiscal side (Government action), nearly $6 trillion in COVID related stimulus has filtered through the system and further action on this front continues to be discussed. Additionally, the $1.2 Trillion infrastructure package has been passed and its details have largely been priced into the impacted industries.

As far as monetary policy (Federal Reserve action), the Fed has set forth a path to ending their bond buying program and starting to tighten the money supply through the eventual raising of interest rates.

A hotter and more persistent inflation rate, as measured by CPI (above) has accelerated their plans and 2022 appears as though it will be a pivot point to begin tightening monetary policy.

As the Federal Reserve removes the “punch bowl” we are left with a market that appears to have limited drivers of future returns. When that is the case, you must turn to the market fundamentals to ensure that you continue to hold strong companies, with reasonable valuations, considering the change in policy stance. On the following pages we plan on updating you on some of these fundamental drivers, our economic scenario assumptions, and some commentary on what to expect in 2022.

Economic Backdrop:

Let’s first discuss the background that the Federal Reserve is working with entering 2022, and what’s really paving the way for this more hawkish policy stance. The Fed operates under a dual mandate of full employment and price stability.

On the employment side, there has been significant improvement in the unemployment rate since the highs last April, and while there continues to be some slack in the labor market, it is currently a source of economic strength. From a price stability standpoint (more often referred to as inflation), prices across many sectors of the economy continue to be on the rise.

As we discussed during our previous commentary, these higher prices have been driven by a variety of forces including, but not limited to, supply chain bottlenecks.

Inflation continues to be on the rise year over year, with the most current reading showing an increase of 7.0% from the year prior.

These higher inflation readings coupled with the strong labor market have given the Federal Reserve the ability to act in line with their dual mandate by tightening monetary policy efforts in order to combat higher prices across the economy.

The market has reacted in line with Federal Open Market Committee (FOMC) projections at this point, pricing in roughly three 25-basis point interest rate hikes by the

end of 2022. The market has yet to price in longer-term rate hikes to this point, possibly signaling that they believe the Fed’s near-term efforts will be enough to combat the higher inflation that we have seen.

As the Procyon Investment Committee continues to dissect the signals provided by the US Central Bank, equity markets, rates and the ever-evolving public health crisis that began almost two years ago, we have developed a set of scenarios that represent the potential outcomes we face in the coming quarters and beyond:

Base Case – Continued Incremental Improvement

Our base case scenario is our investment focus and helps inform our decision-making in the coming quarters. We view this as the most likely scenario to play out given the short, but vast amount of data generated over the recent pandemic:

• No major interest rate surprises impacting the bond or stock markets
• Inflationary pressure begins to subside and does not negatively affect GDP growth in any material

High-frequency data

Year-over-year % change; Year-over-2 year after 3/15/21*

Source: Chase, OpenTable, STR, Transportation Security Administration (TSA), J.P. Morgan Asset Management. *Beginning 3/15/2021, all indicators compare 2021 to 2019. Prior to 3/15/2021, figures are year-over-year. Consumer debit/credit transactions, U.S. seated diners and TSA traveler traffic are 7-day moving averages. Consumer spending: This report uses rigorous security protocols for selected data sourced from Chase credit and debit card transactions to ensure all information is kept confidential and secure. All selected data are highly aggregated and all unique identifiable information—including names, account numbers, addresses, dates of birth and Social Security Numbers—is removed from the data before the report’s author receives it.

Guide to the Markets – U.S. Data are as of December 31, 2021.

• COVID variants continue to be present, much like the Flu, and the economy continues to adapt to that reality more effectively
• Vaccines, and treatments, continue to improve (see below)

Overreaching Fed – Worst Case

Under the circumstances outlined here we would expect a decline in equity prices, a quick reversal in interest rates and a reset in the economic growth achieved over the last several quarters. While we feel this has less likelihood of occurring, there is some evidence that the Fed has done this in the past. Most recently in 1999/2000 as a reaction to what was coined by then Fed Chair Alan Greenspan “irrational exuberance” at the time. Markets can force the Fed’s hand in this case and the consequences are often a contraction of GDP:

• Fed hikes rates too high, too soon
• Another, more threatening COVID variant arises
• Demand for goods and services dries up quickly
• Unemployment rises
• Gov’t has limited tools available
• GDP contracts late in 2022, early 2023
• Housing begins to reverse
• Geopolitical issues remain

Surprising Resilience – Better Than Expected

We have been surprised several times in recent history at the market resilience in the face of a dramatic economic backdrop. While that is true, it is mainly centered around the idea that the government can step in whenever needed. If we find ourselves in an economy that continues to rapidly improve there would potentially need to be a set of global catalysts propelling it. Some of these could include:

• Virus subsides, COVID variants less threatening
• Political environment cools
• Supply chains reestablish efficiency
• Interest rate increases are effective
• Healthcare recovers
• Global economy resumes rapid growth trajectory

Staying Vigilant

As 2022 begins we are remaining increasingly vigilant due to some of the major divergences in normal market returns across the globe.

For example, the US markets have outpaced the rest of globe over the last 10 years but not during the 15 years prior to that. While we recognize that the fundamentals of the US economy have played a large part in the outperformance, we also recognize that economies operate in cycles.

While 2022 may prove challenging due to some of the issues we’ve mentioned above, our long-term expectations remain intact.

We have taken steps to position your portfolios in line with our expectations for the markets, as well as your personal goals. Remaining ever-vigilant to market changes as the world adjusts to some new version of normal is our role over the coming year.
Thank you for the trust you place in us.

11 Nov “A SMOOTH SEA NEVER MADE A SKILLED SAILOR” – FRANKLIN D. ROOSEVELT

For many of us up North, October represents a time of change as we prepare for the chillier weather to take hold, the leaves to start falling from the trees, and preparations for the holiday season begin. In the financial markets, however, October felt like a return to what we have grown accustomed to over the course of the year. Low volatility and equity market strength has characterized this market for much of 2021 and, after a small dip in September, we saw much of the same in October.

Equity markets broadly moved higher within the month with domestic equity markets posting the strongest performance of the major equity asset classes. International markets, while underperforming domestic equity in the month, were positive as well. Emerging market equity is still down on the year, however, as China (which makes up approximately 40% of the benchmark) has weighed down the broader index performance. Growth and value continue to be an attention-grabbing subject line as they have flipped and flopped all year, with value style equities leading the way early and growth style outperforming more recently.

Fixed income markets were slightly negative in October and remain mixed year to date. Taxable fixed income has trailed municipal fixed income year to date as exposure to treasury markets has been a headwind. Interest rates moved slightly higher throughout the month and have trended higher throughout the year as a whole.

This has had a direct negative impact on treasury markets and has been reflected in the asset class returns year to date. Municipal bond markets have remained resilient in the face of these increasing rates as a strong demand for these securities amidst talks of additional spending and tax increases have helped municipal bonds outperform taxable year to date. High yield markets have had a strong year as well. While these securities tend to be more sensitive to changes in interest rates, a narrowing spread has led to positive performance.

Finally, if you tuned into our 3rd quarter investment committee webinar, we discussed alternative investments at length and how they may fit within a portfolio specifically as an uncorrelated return source. The universe of diversified liquid alternative strategies was up during the month and is positive year to date.

Earnings:

October returns have been driven by Q3 earnings (among other catalysts) which continue to be historically strong. The 3-month rolling earnings beat rate currently sits at 71%, nearly 12 percentage points higher than its historical average. Revenue beat rate has been equally as impressive lately, with 73% of companies posting a sales beat on a rolling 3-month basis, again, well above historical averages. It is worth noting that both of these numbers have been falling recently as companies have continued to adjust their estimates coming out of the pandemic environment. While these earnings and revenue beats have helped boost the market, more companies have issued negative guidance this quarter than in previous, and negative earnings guidance has outpaced positive. This is worth watching as companies try to balance supply chain issues with their future growth opportunities.

Valuations:

As the markets have continued to move higher, valuations have continued to look broadly unattractive on paper. The S&P 500 is currently showing a forward price to earnings ratio (P/E) of 21.40x, well above the 25-year historical average of 16.80x, indicating that you have to pay more of a premium for earnings in today’s environment. Additionally, valuations domestically look expensive across all market capitalizations when comparing today to historical averages. However, we believe that this is a time to be selective in your equity allocation rather than shying away due to valuations. Here are a few items to note:

1. 1. When comparing equities to fixed income, equities look more attractive from a valuation standpoint. Despite interest rates being at a lower level overall, the market is incredibly rich and a lot of those securities are trading at even higher valuations than what we are seeing in the equity markets.
   2. The spread in valuations remain Said simply, companies with the highest valuations are trading at an extreme premium while  the companies with lower valuations remain around historical averages.
   3. The valuation on the top 10 stocks in the S&P are significantly elevated relative to the remaining stocks in the The top 10 stocks have an average P/E of 32.2x while the remaining stocks in the index have an average P/E of 19.7x. This is highlighted in the chart to the right.
   4. International markets continue to trade at a significant discount relative to domestic equity While this is true historically, this discount is usually in the ballpark of about a -13% discount. Today the discount is closer to -27%.

Economic Growth:

Following two strong quarters of GDP growth at the start of the year, slowing consumer spending combined with larger-than-expected effects from the Covid-19 Delta variant caused a series of downward revisions to the 3rd quarter GDP estimate prior to it being released in October. These reduced estimates turned out to be accurate as 3rd quarter GDP growth came in at 2.0% annualized compared to the 1.9% estimates. The market broadly shook this off since that number had been priced in throughout much of the previous month. Looking beyond 2021, the Conference Board forecasts that the US economy will grow by +3.8% year-over-year (YoY) in 2022 and +3.0% YoY in 2023. This would represent real GDP growth above the +2% trend we have seen since the turn of the millennium.

The Federal Reserve:

While economic growth is what we are looking for at the end of the day, there are many inputs that go into that number that we monitor monthly to evaluate whether those growth expectations can be met. As many are aware, the Federal Reserve (Fed) operates with a dual mandate of stable prices and full employment, as they believe managing these two factors will lead to long
term growth for the economy overall. The employment picture continues to improve, albeit at a slower pace than anticipated coming out of the pandemic. In October, the unemploy- ment rate edged lower to 4.6% with job growth seen across a multitude of economic sectors.
However, the labor force participation rate remains short of pre-pandemic levels, sitting at 61.6% as of October. At the same time job openings are

sitting near an all time high, at just shy of 10.5 million jobs. Many employers have highlighted the lack of workers in industry surveys, contributing to some of the supply chain disruption we have seen throughout the year.

Supply chain issues have been one of the major drivers of higher inflation which has taken hold this year after years of inflation recording in the 0-2% range. While each industry is experiencing their own microeconomic supply chain frictions, the macroeconomic issue has to do with the overall flow of goods throughout the economy. As a direct result of the pandemic companies are looking to bolster their inventories in the near term as many were caught running too lean when consumer demand came back stronger and faster than expected. This has resulted in an enormous influx of shipments into US ports and a backlog of cargo ships waiting off our shores. In the simplest form, we can look at those ports and come to a conclusion that they must not have enough workers to unload these ships. However, when digging deeper it becomes clear that the ports do not have the warehouse space to ease the bottleneck. Simply put, the strong demand from the consumer has led to a significant influx of goods into the US and there are simply not enough shipping companies to support the flow of goods. Add onto this the fact that oil prices have continued to move higher throughout the year, contributing to higher shipping and input costs. All of this has led to an October inflation reading of 4.6% when you exclude food and energy prices, which tend to be more volatile (this is the Fed’s preferred measure).

When accounting for higher food and energy prices, the average American is seeing prices which are roughly 6.2% higher than last year.

So where does this leave us? Well, it leaves us in the hands of the Federal Reserve, who hold the master key to this puzzle. When it became apparent that inflation was likely to increase from recent levels, the Fed made a key change to its mandate to target an “average of 2% inflation” rather than an explicit 2% target. This gave wiggle room to be flexible with their policy decisions and allowed them to label inflation as “transitory”. This term has been scrutinized as it implies that it will be short lived. Chairman Powell has had to adjust his stance and clarify that, according to the Fed, transitory means that higher prices have been caused by an event that is not sustainable, adding that we should expect inflation to stick around “longer than initially expected”. The significant demand that we have seen from the consumer, coming from a period of time where demand was very low, has caused a shock to many markets. This includes the housing market (which is seeing YoY prices increase nearly 19.9% as measured by the Case-Shiller Home Price Index), the auto market (with used car prices up 26.4% YoY and new car prices up 9.8% YoY), the energy market (up 30.0% YoY), and others. Some of these prices will subside as demand normalizes and supply chain bottlenecks get worked out, while others may stick around for longer. While this remains to be seen, it will be worth watching will be how 1- inflation makes its way though companies balance sheets, 2- which companies will easily be able to pass through costs to the consumer, and 3- if higher prices lead to wage inflation (which could be a catalyst for more persistent higher inflation).

This brings us back to what we said above, the Fed holds the master key. Inflation is a byproduct of a strong economy that is running hot. While monetary policy (the Fed’s tools to control the money supply) has been easing since the pandemic, a strengthening labor market, continued economic growth, and hotter inflation open the door for the Fed to start tightening their policy stance. This will happen in a couple of stages, outlined by the Fed Chairman a week ago. First, they will start scaling back their bond-buying stimulus program (a policy put in place to provide liquidity during the pandemic, commonly known as quantitative easing) starting later this month and likely ending sometime in mid-2022. From there, the Fed will start to look to raise the federal funds rate to further contract the money supply. The market is currently pricing in two rate hikes by the end of 2022.

Washington:

With election day casting a shadow of doubt over the Democrats’ policy efforts, there was some progress in early November on the fiscal policy front as President Biden scored a bipartisan infrastructure win. The $650 billion bill takes aim at traditional infrastructure projects, with funds allocated towards clean drinking water, high-speed internet, road/bridge repair, airport and port upgrades, and even electric vehicle charging networks. While this bill has been sent to the President’s desk for signature, the Build Back Better (BBB) plan seems to be in shambles as it has failed to gain support across the democratic party in its current form. Speaker Pelosi continues to push forward with attempts to pass the bill and plans on holding another vote in the coming weeks. With no support expected from Republicans, the package cannot lose more than three democratic votes to pass. While this is a big question in and of itself, the plan does not seem to have the support of the Senate either, with Sen. Manchin of West Virginia and Sen. Sinema of Arizona both voicing to objections to the proposal. House democrats have most recently demanded to see an assessment from the Congressional Budget Office projecting the costs and how far tax hikes will go to offset them. While the focus has been on Build Back Better, President Biden’s tax law changes are an underlying key component to funding the massive spending bill. With BBB’s outlook getting dimmer and dimmer, the odds that tax changes in their current form get pushed across the finish line are looking slim. It now looks like any increases will not be as substantial as initially expected.

What’s Next?

We started this commentary with a quote from Franklin
D. Roosevelt; “A smooth sea never made a skilled sailor”. Since the market lows on March 23rd of 2020, it has been an extremely smooth ride with the occasional bout of short-lived volatility. The largest pullback in the S&P that we have experienced year-to-date has been -5%. To put that in perspective, this is just the second time in the last 26 years in which the largest intra-year decline in the S&P was 5% or less.

Simply put, we have been extremely fortunate to have smooth waters over the course of the last 19 months and the market dynamics have supported this environment. Every now and then we have to pinch ourselves to remind us that this is a not a market that you experience every year.

With the supply chain issues that continue to persist in the economy, inflation running higher than what we are used to, stretched valuations in certain companies and industries, a likely tightening of monetary policy, and several items up in the air in Washington, the odds are high that next year will not look like the year we are currently experiencing. The Procyon Investment Committee is balancing these changing inputs on a daily basis and positioning portfolios not only for times of market strength, but for times of market weakness as well. As we march towards the end of the year and head into 2022, we will continue to adjust portfolio allocations to ensure we are in a position to benefit where possible.

Wishing you and your family a peaceful holiday season.

Procyon Partners

15 Jul IT’S SUMMERTIME!

During this Quarterly Commentary we would like to shed some light on a few topics that are top of mind this summer:

• Global vaccination rates
• Stock Markets
• Bond Markets
• Personal Finance

Where are we with vaccination rates?

The US has done a good job of delivering and administering the Covid-19 vaccines. The Biden administration and the WHO is continuing to warn against the Covid-
19 Delta variants, especially for younger people. While the major push to continue Covid-19 vaccinations in the US is pressing forward we wanted to look at the rest of the world as a proxy for how the US is coming along. These are the latest numbers on how the world is faring:

As we come through a historic cultural and societal phenomenon, we are also witnessing some economic and market effects that are unprecedented. We have seen commodity prices fluctuate wildly as evidenced by lumber prices in the enclosed chart. What seems most evident is the massive effects of printed currency, extensive fiscal borrowing, and remarkable market support by investors across many economic stakeholders. Monetary policy does not seem to be changing any time soon, although tapering discussions have already begun at the FED.

World3.51bn39.3%17.5%

Market Overview:

Investors turned their focus towards inflation, interest rates, and the Federal Reserve throughout the 2nd quarter as the economic recovery continued to gain steam. Strengthening consumer confidence throughout the quarter led to increased demand for durable goods early, followed by services and travel later in the quarter as vaccination rates moved higher and re-openings swept across the country. This backdrop paved the way for strengthening economic data while the Fed continues to express patience and a willingness to remain accommodative in the face of evolving data and growing inflation.

Equity markets across the globe were lifted throughout the second quarter on the back of surging demand for both durable goods and services combined with an accommodative monetary policy. US large cap equities saw the largest return out of the major equity markets during the quarter, advancing +8.55% and are now up 15.25% year to date. While US small and mid-cap stocks have outperformed their large cap counterparts year to date, they trailed in the quarter, advancing +5.44%. International markets also moved higher across the board with both international developed and emerging market equities advancing just over 5% during Q2.

Fixed Income markets were positive in the month as well as yields fell off of their recent highs, leading to price appreciation across both the taxable and municipal bond markets. The Bloomberg Barclays US Aggregate Bond index finished the quarter up +1.83% but is still down – 1.60% year to date after a challenging 1st quarter when

interest rates were on the rise. The Bloomberg Barclays Municipal Bond index was up +1.42% in the quarter and is up +1.06% year to date. High Yield fixed income continued to move higher as the risk-on market environment has prevailed throughout the first six months of the year. The BofA US High Yield Index is now up +3.70% year to date after moving +2.77% higher during the 2nd quarter.

Fixed income markets continued to defy expectations as yields across the board fell from already low levels. While pundits of all stripes vigorously debated whether nascent inflation was merely a temporary phenomenon or something more long term, bond markets ignored the noise and focused on the Fed’s confident insistence that this bout of higher prices had more to do with supply chain issues than anything else. Some feared that the Fed had overstayed its welcome by filling the ever-expanding punch bowl of monetary stimulus and that Washington ‘s spending binge would result in a suffocating level of Federal debt. But bond investors pushed back, and bonds ended up having a surprisingly strong quarter.

The June FED meeting gave important insight into what to expect going forward. In March, the survey of Fed members reflected no rate hikes until after 2023. After the June meeting, the survey reflected two hikes sometime in 2023. With a slightly less dovish stance, they also announced that a timetable for tapering bond purchases is now being discussed as the economy has a more optimistic outlook.

Lower bond yields inherently set the stage for higher bond price volatility. Year to date the bond market has experienced its ups and downs, being punished by volatility in Q1 and rewarded in Q2. The Fed has stated that long-term it wants 2% inflation and will tolerate higher inflation if it reduces unemployment. It should be noted that the yield on the benchmark index currently sits below the 2% inflation target, meaning that without price appreciation bonds will not keep up with inflation. As the economic recovery takes hold, bond investors might think about buckling their seat belts.

Earnings

As we move into the 2Q21 earning season, we anticipate mixed earnings results given the year-over- year comparisons from 2020. 2020 was a record year for many firms that benefited from the “stay-at-home” orders issued for most of the world. Our committee spends a lot of time understanding how demand from the future was pulled forward by the global pandemic for certain goods and services; we have referenced this phenomenon in previous Quarterly Commentaries as well as our Investment Committee webinars over the last year.

What we expect to see during earnings reporting is a mixed bag for the next 2-3 quarters, that will consist of earnings comparisons from companies who were completely shut down last year versus those that saw unprecedented spikes in demand for their products. Many “re-opening” companies such as travel and entertainment may have positive comparisons whereas cloud storage and video software are making comparisons to their best quarters from 2020. There is no line in the sand as to who may be able to keep up their growth figures and who may not, however the coming quarters will allow us to see if some of the new demand is permanent or transient within some of these services.

Personal Finance – Change of Pace!

We ask that you take a break from the headlines and markets from time to time to focus on you and your personal finances. A mid-year review of your personal finances is always a great idea to make sure you are on track to meet your goals and objectives. Before you go enjoy the sun and take that much needed family vacation, run through a quick checklist to make sure you are not playing catch-up in December. Here are some ideas to get you started, off the back of conversations we are having with clients right now:

1. How are your cash flows?

• Is your spending starting to change as the economy continues to re-open?
• Are you finding yourself increasingly responsible for the finances for loved ones?

2. Are you taking full advantage of retirement savings opportunities?

• It is a good time to review your budget and potentially increase your savings rate in your retirement plan. Helpful tip: if you are in the 28% tax bracket, you save roughly $280 dollars in taxes for every $1,000 you contribute pre-tax.
• 2021 Contribution Limits are as follows
  • 401(k) plans, 403(b) plans, 457 and SARSEPs: $19,500 with an additional $6,000 if you are over age 50. Other plans like
  • Traditional or ROTH IRA $6,000 with an additional $1,000 if you are over age 50.
  • SIMPLE IRA $13,500 with an additional $3000 if you are over age 50
  • SEP IRA $58,000
  • Individual or Solo 401(k) is $58,000 with an additional $6,500 if you are over age 50
  • Defined benefit plans are $230,000 depending on a few factors

3. Are you being as tax efficient as you can be in your financial decisions?

• There is a potential for some tax law changes to impact your portfolio. Capital gains taxes for high income earners are proposed to increase to 39%. While this aggressive plan is unlikely, it is very possible for some incremental increases from the current
• It is a good time to review your realized and unrealized gains or losses to see if there are any opportunities for tax loss harvesting. Many investment firms only do this at the end of the We advise reviewing this at least twice per year. This can help offset future capital gains later in the year in your taxable accounts. Remember, it’s not only about what you earn, but what you keep from an after-tax return standpoint.
• Now might also be a good time to revisit your plans to contribute to charitable organizations and take advantage of tax-efficient ways to donate, including through Donor Advised Funds, Qualified Charitable Distributions from your IRA, or via highly appreciated stock
• Are you taking advantage of the annual gift tax exclusion?
• If you have loved ones with 529 plans, are you contributing to them?

4. Are you looking at the debt side of your finances?

• We often focus on the above-mentioned items but with attractive interest rates many households might want to consider if refinancing or taking out a home equity line of credit makes sense while interest rates are still
• It is important to have the conversation because many of the factors that play into these decisions can impact your overall financial

5. Life Insurance, Long Term Care & Estate Planning

• COVID-19 has prompted many to question whether they have appropriate life insurance coverage, if long term care insurance should be considered or if changes need to be made to their estate plan or wills
• We understand that these are broad topics and there are a lot of details that need to be discussed but it is essential to start the conversation so you can make informed financial

As always, we hope you have found our quarterly commentary informative. The Procyon Investment Committee, as well as the entire Procyon family, wishes you and your families an enjoyable summer. We look forward to seeing you soon!