It looks like it’s time to celebrate.
After months of anticipating a massive recession… then a medium recession… and finally a mild recession… All the data now points to a soft landing.
In today’s weekly update, Chief Analyst Adam Galas walks through all the latest numbers and shares why the most anticipated recession in American history will be almost insignificant.
Adam also points out the best deal in Fortress Portfolio right now and why you should be excited about it.
Click below to watch the video or scroll down to read the transcript.
Happy SWAN (sleep well at night) investing,
Brad Thomas Editor, Fortress Portfolio
Transcript
Welcome Fortress Portfolio members to another weekly video.
Now, I've done plenty of videos just analyzing economic data. I've done lots of them warning you about tough times for the economy and the markets ahead.
Well, today, I want to share some wonderful news because, for the first time in two years, the data is moving in the right direction.
So, let me give you a summary of why a soft landing is now likely and what it means for the Fortress Portfolio.
But I also want to share why I'm excited to pound the table about the single best deal in the portfolio.
So first, let's talk about why a soft landing is now more likely.
So, for months, the stock market has been rallying on hopes of a soft landing.
We're talking about immaculate disinflation and how the economy doesn't stop growing.
In fact, it doesn't even really slow down. Earnings keep on growing. Inflation comes down.
The Fed is cutting pretty much a wish list of what you could possibly hope for to make the stock market go up. Even into quantitative tightening and reverse money printing.
Well, that pipe dream was something most economists and I were highly skeptical of.
Here’s why.
As you can see, there has never – in human history – been a period in which U.S. inflation was above 5% and the Fed was able to bring that back down without causing a recession.
(Source: Truist Advisory Services via The Daily Shot)
But, of course, the pandemic broke all our models because we threw $9 trillion of stimulus at the problem.
So, let's take a look here at what this economic data is that has me so excited.
Well, this is the baseline and rate of change grid that we talked about last week. But here you can see that that green dot (LD) is now above the baseline, not by a lot, but it is above it.
(Source: Econ P.I.)
But more importantly, it's now growing and getting stronger at 15% month over month.
So, it's saying that it appears that the economy has bottomed and is now starting to accelerate to the upside.
We can see the same thing from the Atlanta Fed, which over the last year has nailed 95% accuracy for how fast the economy has been growing in real-time, now saying we're accelerating up to 2.4%.
(Source: Atlanta Federal Reserve)
And the blue-chip consensus from economist teams that Bloomberg says are historically the most accurate also would confirm we appear to be now bottoming and growing faster.
We also have the New York Fed confirming 2.4% growth. And this is adjusted for inflation, not simply slightly negative growth plus inflation. No, this is inflation adjusted. In fact, it appears that we're growing at 4–5% non-inflation adjusted.
(Source: New York Federal Reserve)
And that, of course, is good news for the stock market. Because, remember, earnings are never inflation-adjusted.
So, the thing that has Wall Street so excited – the Fed pivot that really kicked off this rally towards the end of the year –is also justified by the fundamentals.
And here's why.
Oxford Economics estimates that if the Fed were to keep rates here completely with no cuts, that peak restrictiveness – tightness in the economy from Fed rate hikes – will arrive around July and then it will start to taper off.
You might be wondering how it is possible if interest rates stay this high, the highest they have been in 20 years?
Well, think of it this way. People who, for years, could not get any kind of yield in their bank now can get over 5%.
That income that the government and the banks are paying is money in their pockets.
And in fact, Metlife's chief investment officer recently said on Bloomberg that he's done an analysis with his team. They found that historically, ten-year Treasury yields – a proxy for long term rates – when at 4% is consistent with optimal and maximum consumer spending.
Because if rates are nothing, well, guess what?
In Europe, they had negative rates. People didn't spend more. They had to save more. Because if I have to save for my kid's college or for retirement, I'm not about to put that money into Tesla just because rates are negative.
No. So now there's 4%. People have money to actually spend.
So that is one thing to consider. You might be wondering about inflation at today's levels and interest rates at 3–5%.
Well, as you can see, historically, interest rates have actually been around 6% and inflation-adjusted about 2.3%.
(Source: J.P. Morgan Asset Management)
Now, we're at 1.8% right now and we hit 2.3% back in October at the peak of this cycle.
So, these interest rates are just historically normal.
And I would like to remind you that in the Roaring 1990s, with the booming economy and the biggest tech stock bubble in history, interest rates were 6%.
But now, think of it this way, the Fed just went on a warpath.
There were 521 rate hikes. That is the fastest rate pace in 40 years.
That is also the biggest reverse money printing in history with $90 billion a month, $1 trillion a year, being sucked out of the economy.
Don't forget, the government was also sucking money out in the last six months.
We had an industrial recession. We had an earnings recession. We had the vibe session where even though the economy was the strongest in 83 years, we all felt like it was a recession.
And yet the job market held up, people's wages are now growing faster than inflation, and consumer confidence is picking up.
So, what does that actually mean? Well, here we can see the bond market is expecting five rate cuts from the Fed. Not seven, as it initially thought, but very steady.
(Source: CME Group)
Now, the point here is if all those bad things were not enough to cause a recession, now we have the Fed actually cutting rates this year.
The timing doesn't really matter. We know that the Fed is planning to cut and, next year, stop reverse money printing with more rate cuts.
Now, as you can see here, historically, when the Fed starts cutting, money starts to flow from high-yield savings and money market funds into the rest of the economy, including some into stocks.
(Source: ICI, Haver Analytics, and Morgan Stanley Research via The Daily Shot)
Now, don't get suckered into this idea that stocks are going to be flying at 30% like last year.
As you can see here, the Wall Street Journal points out there's about $9 trillion in money market funds, high-yield savings, and CDs.
But again, this is milk money. This is basically money for Grandma’s medications.
She's not about to invest that into Nvidia just because rates come down. But here is what happens.
Normally, people would invest in long-term bonds because you want to lock in those yields. But people were so terrified because Jamie Dimon was saying rates could go to 7%.
Well, no one wants to touch long bonds if that could happen.
But now we know rates can only stay this high or come down. There is basically no upside risk.
So, when the Fed starts cutting and confirming rates have only one direction down, suddenly all those people with money in those money market funds at 5.5% say, “I’ve got to lock in these yields.”
So, what have to do is buy long bonds at 10, 20, or 30 years.
Those are the real interest rates for the economy. That's what affects corporate borrowing costs and mortgage rates.
Suddenly, we're looking at ten-year yields and mortgage rates dropping 1%.
Suddenly, auto loan rates are dropping 2% or more. Now that's adding more juice to the economy.
And take a look at this. I mentioned before the vibe session is over.
(Source: The Daily Shot)
Well, consumer sentiment is largely driven by lower inflation expectations.
Now, that is largely driven by gasoline prices, which we know are volatile.
That could potentially turn around if the economy does heat up.
But for now, it appears that consumer confidence is reversing. All those headwinds are starting to reverse.
And what we saw with the economic data is what we're starting to see for the overall big picture.
Now, I know what you're thinking: “Now, hold on a second. How can I possibly be bullish? Didn't the market just hit a record high, in fact, two record highs back-to-back?”
Well, take a look at this from UBS.
Since 1945, stocks are pretty much at record highs one-third of the time and within 10% of record highs two-thirds of the time.
But what about this time, right? Valuations are absolutely crazy.
Well, take a look here.
(Source: Charle Bilello)
Since 1928, we have, within 12 months, the average gain from record highs at 13%.
Okay, but what about valuations? I am Mr. Valuation.
Haven’t I been saying for weeks it is 18% overvalued?
Well, I found some new information, which is that the most accurate metric to use for valuation is cash-adjusted earnings.
It's not just earnings, it's cash-adjusted.
Because remember, if a company is a $1 trillion company, but they have $500 billion in cash, the market cap, effectively, is $500 billion, not $1 trillion.
So, what is the historical cash-adjusted PE for the S&P? It's 13.1.
Well, what is it now? It's 13.5, just 3% premium.
Now you might be thinking, “Okay, well, what about the Magnificent Seven? That's 30% of the market. That is a crazy bubble that's going to crash. The market is going to collapse and everything is going to fall.”
Actually, the Magnificent Seven largely rallied from last year, driven by fundamentals. It had an earnings growth of 50% according to FactSet Consensus, 24% this year, 18% next year, and 18% the year after that.
What is the cash-adjusted PE for the Magnificent Seven?
It's 17 for 18% growth from the most wide moat world beaters in the world.
Guess what? Ben Graham and Peter Lynch would both call that growth at a reasonable price.
So that doesn't mean the market is cheap. It means it's fairly valued. And now we have tailwinds for the economy and earnings. So that means a lot better outlook.
Now I know what you're thinking, “What about Fortress?”
Well, remember, at Fortress we play a different game.
We want to earn the same 13–14% long-term returns as the Nasdaq.
But we want to do it the smart and safe way, swimming in dividends. And that is why we have a portfolio yielding of 6.5%, generating about 12% income growth over time.
And today, I want to share with you the single best value in the entire Fortress Portfolio.
That is Altria. So let me show you why this is such an incredible opportunity.
I'm showing you this picture of inflation. Now you might be wondering why inflation affects Altria.
(Source: Truflation)
Well, Altria has been beaten down because in this high period of inflation, the worst inflation in 42 years, some of their customers have been trading down to discount cigarettes.
So, volumes have been steadily negative for decades. It's been able to adapt.
Well, negative declines in volumes spiked to around -10%. They weren't able to keep up.
They did keep up with price hikes, but sales growth stalled and the market got very worried about whether or not their traditional business model was broken and if they had time to get to reduced risk products.
Well, as you can see, inflation has, in fact, come down. And in fact, core PCE, the Fed's official metric, if these numbers hold, would fall to 1.3% and the Fed would cut to about 1.7%.
But for Altria, here's what matters.
This means that the biggest headwind that it's been facing is about to disappear. So let me show you here from the actual FactSet Terminal, just to confirm that this thesis is intact.
So first, let's check with the balance sheet, because remember, if bond investors don't get paid, neither do dividend investors.
(Source: FactSet Research Terminal)
Credit default swap spreads are the most important thing to look for in the short term.
These are real time insurance policies that the bond market takes out against defaults on bonds from a company.
Effectively, what is the bankruptcy risk? They want to be insured against that.
Well, it's been declining. So, the prices have fallen, but so has the fundamental risk.
Now, let's talk about the actual debt. There is $25 billion in debt. That seems scary. But remember, debt doesn't matter. It's debt relative to cash flow and your ability to service it.
A debt to cash flow ratio of three or less is safe according to rating agencies. Altria’s is at two.
Next year's is also at two. They have almost $5 billion in liquidity.
So, there are no short-term needs for cash. And you can see well-staggered bond maturities.
So, there's no giant debt cliff to worry about. All of the debt is unsecured. So, if they needed to borrow against their assets, they have maximum financial flexibility.
And finally, let's talk about the yield curve for Altria. The bond market and the smart money on Wall Street are so confident in Altria that they're willing to buy bonds that mature in almost 40 years.
They are saying that 40 years from now, Altria will still be around paying its bills.
What about the growth outlook? Well, the growth outlook is certainly not that great at 3.5%.
But we can sales are expected to be relatively stable.
So, volume declines are met by price increases.
And free cash flow is growing very slowly, but still moving higher.
But here's the key: buybacks. More and more buybacks. That is how they're expected to drive that steady 3–4% growth. Dividends are expected to keep growing steadily at around 3–4%.
Now, what if the price just stays the same?
For example, in 2027, it's down to 7x earnings. Meanwhile, the yield by 2027 would rise to 11%. It's currently at 9.7%.
But here's why I'm confident that Altria is such an incredible bargain.
The only time it was cheaper was after the master settlement period.
Remember, there was a big $240 billion settlement with all the states. People thought tobacco was about to go out of business.
Well, other than that, the market has never been more pessimistic, pricing in at -1% growth.
But we can see positive growth, slow but steady, for the dividends and earnings.
(Source: FAST Graphs)
Now, this is 14x historical PE. That requires just 2% growth to justify this, according to Ben Graham.
So, what are we looking at now? We're looking at the potential if Altria grows as expected, returning to historical fair value.
There will be a 120% upside in the next three years, which is 30% annually. Let's see the Nasdaq match that. It is probably not going to be able to even come close.
So, analysts are optimistic. How often does this company grow as expected?
The answer over the last 20 years is within a reasonable margin of error of just a few percent, 100% of the time. This is a very steady business.
Management's guidance is almost always perfect as they know this business. That's why they've been raising the dividend for 54 consecutive years. And as you just saw, there are incredible opportunities.
What about in the long term?
Well, you're talking about a yield of nearly 10% and 3–4% growth. So that's 13–14% long-term returns, even if the PE never returns to historical fair value.
If the PE stays at eight forever, pricing in no growth, you're still looking at Nasdaq-like returns from a near 10% very safe yield.
Now, of course, in the future, the fundamentals could turn and that's why we use 30% hard stops just in case the wheels do fall off the bus.
But right now, Altria had a 33% historical discount, representing a profit-like fat pitch and an opportunity to literally make Buffett-like returns from a blue-chip bargain hiding in plain sight.
So, you can see, even though some stocks are in a bubble, and while the market is certainly at record highs, there is fair value, and lots of downside risk in the short term, you have always and forever a market of stocks, not a stock market.
And you have wonderful world-class companies with 10% very safe yields, trading at incredible opportunities. And that is how we make our money at Fortress.
Helping you sleep well at night no matter what the market is doing. Thank you so much for joining us.
Please remember to send questions and comments. Just remember, I can't provide personalized investment advice.
Until next time, this is Adam Galas wishing you and your family a safe, healthy, and relaxing weekend and a joyous New Year.
