As the summer ends and fall rolls around, it’s natural to expect a surge in market volatility. This is even more relevant this year given that stocks have enjoyed a period of low volatility and gently rising prices throughout most of the summer despite a variety of challenges such as rising rates, stubborn inflation, and pockets of weakness in the economy.

Further, history shows that periods of sharp increase in rates can often trigger stress in parts of the financial system that can have knock-on effects in the real economy. The most recent example is the crisis in regional banks due to an inverted yield curve which could have negative effects on the flow of credit in the economy.

For ETFTrends, Ben Hernandez discusses how direct indexing benefits from these surges in volatility. Direct indexing differs from traditional investing in funds as it allows investors to re-create an index in their portfolio. 

This allows tax losses to be harvested as losing positions can be sold with the proceeds re-invested into stocks with similar factor scores. Then, these losses can be used to offset gains in other parts of the portfolio, leading to a lower tax bill. 

Finsum: Direct indexing has many benefits but the most impactful in terms of alpha is its ability to generate tax savings for clients during volatile markets. 

REIT stocks are slightly down YTD. On the bright side, yields are at their highest level in decades, defaults have not materially risen and occupancy rates have been stable. However, this has not been substantial enough to offset the headwind from rising rates.

This headwind is only getting more potent with yields on longer-term Treasuries breaking out to new highs which is bearish for the asset class given its embedded leverage and exposure to rates. Higher rates also are impacting demand and leading to lower affordability. 

The most damage is evident in commercial real estate, where REITs are trading close to their lows while REITs with exposure to healthcare, industrial, or residential sectors are performing much better. This is mostly a reflection of a structural change following the pandemic as companies cut back on office space. 

In the event that rates remain at these lofty levels, REIT stocks are likely to underperform. However, the current weakness in the sector could present a long-term opportunity to accumulate REITs that continue to grow their earnings and use the weakness in the sector to add high-quality holdings at attractive prices.

Finsum: REITs are moving lower as Treasury yields break out to new highs. While higher yields are a major headwind, the current selloff is likely to create some attractive opportunities.

Entering 2023, many were expecting a big year for gold due to high inflation, rising recession risk, and considerable amounts of geopolitical turmoil. Yet, this hasn’t come to fruition. Gold prices enjoyed a decent rally in the first-half of the year but has given back the majority of these gains in recent weeks.

The most likely culprit is that real interest rates continue to rise as inflation moderates, but the Federal Reserve continues to hike rates. When real rates are rising, gold becomes less attractive as an investment because it offers no return to inventors. However when real rates are negative and/or falling, gold becomes more attractive to own. Thus, the best combination for gold prices would be a weak economy coupled with high inflation. As long as the economy continues to defy skeptics, a breakout for gold prices is unlikely.

The metal hit an all-time high of $2,078 in March 2022 following Russia’s invasion of Ukraine when geopolitical tensions culminated. It re-tested these levels in March of this year following the crisis in regional banks when many thought the Fed would have to intervene and possibly cut rates to support the banking system. Since then, prices have declined by about 6%. 

Finsum: Gold prices have stagnated following strong performance in the first-half of the year. Currently, prices are likely going to move lower as long as Treasury yields keep chugging higher.

The first-half of the year was defined by stock market strength and bond market wobbliness. In the second-half of the year, we are seeing an inversion of sorts as the bond market has weakened, while the stock market has been giving back recent gains.

This is a natural consequence of the market consensus being upended as it’s clear that the Fed is not going to budge from its ultra-hawkish stance for at least the rest of the year, inflation is stickier than expected, and that the economy is resilient enough to continue evading a recession. Treasury yields are also responding with the 2-year note yield reaching 5%, and the 10-year yield breaking out above 4.2%. 

Previous instances of Treasuries reaching these levels have resulted in equity weakness as it portends greater stress for banks, housing, and other parts of the economy. However according to Yardeni Research, bond weakness is more driven by a widening federal deficit and a better than expected economy. Another factor is the ‘pricing out’ of pivot in Fed policy from the second-half of this year to later in 2024. 

The firm sees the market continuing to rise despite yields remaining elevated and believes the S&P 500 will make new highs next year. 

Finsum: US Treasury yields are rising and leading to a pullback in the stock market. Some of the factors are the resilience of inflation, a stronger than expected economy, and a wider than expected federal deficit.

Energy stocks have underperformed in 2023 following a year of massive outperformance. YTD, the sector is up 5%, while the S&P 500 is up 15%. However, the sector continues to attract interest from value investors due to its low valuations and high dividend payments. The Energy Select SPDR (XLE) has a P/E of 8.2 and a dividend yield of 3.7% vs a P/E of 25 and yield of 1.5%.

Recent 13-F filings show that prominent value investors continue to build a position in the sector. Warren Buffett’s Berkshire Hathaway boosted its stake in Occidental Petroleum by 5% and now owns 25% of the company. Despite his appetite for the stock and approval from the SEC to buy up to 50% of the company, Buffett has dismissed speculation that he is looking to buy the whole company, remarking that “We’re not going to buy control. We wouldn’t know what to do with it.” 

Carl Icahn also owns Occidental albeit a much smaller stake at 1.5%. He also owns positions in Southwestern Oil & Gas and CVR Energy. Like Buffett, his career has been defined by buying into industries that are unloved with compelling valuations that are being ignored by the broader market in favor of ‘hotter’ sectors. 

Many see a looming catalyst for energy in that oil producers have reduced production in the second-half of the year which should provide a healthy tailwind for prices the rest of the year.  

Finsum: The energy sector is one of the cheaper parts of the market. So, it’s not surprising to see that many value investors are making big bets on the sector.