The American financial landscape is locked in a tug of war. This presents both danger and opportunity.

At one end of the spectrum, the economy remains quite good — even vital. Economic activity remains brisk which increases corporate profit.

At the other end of the spectrum, interest rates are rising rapidly. Higher interest rates — if increased enough — will slow economic activity and dampen or lower corporate profit. Higher interest rates also lower the price earnings multiple investors are willing to pay for stocks.

These two trends — unfolding in real time at the same time — will eventually collide. In fact, they are colliding as we speak.

When the stock market runs into a rough patch — worry not.

When the bond and credit markets falter — watch out.

Interest rates rose dramatically in the third quarter. Interest rates have now risen to the point that any further meaningful increase in rates will cause real pain in the stock market.

Bottom line — the Federal Reserve will probably continue to increase interest rates because the Fed must stamp out inflation and return price stability to our economy. This would hurt.

The root of the inflation problem is that the United States is a rapidly aging society and we have a shortage of workers in our country. It is no coincidence that there are now numerous strikes in the United States — labor has the advantage. Therefore, businesses are having to “pay up” for employees. The higher wages being paid to employees increase the cost of a good or service. In addition, the larger employee paychecks mean that people will pay more for goods and services.

The United States currently has 9.1 million job openings — workers have choices.

This is called the wage/price inflation spiral — last seen in the 1970s. It was a difficult period for the stock market.

So, what do we want? A strong economy with inflation and the cost of living rising faster than our paychecks?

Or, do we want our economy to roll over into recession, soften demand and job openings, and kill inflation and achieve price stability? The result — a bad economy.

Tough choice.

Stocks and bonds took a meaningful hit in the third quarter as the above scenario played out.

For the first nine months of the year (1/1/23-9/30/23), the Concentrated Equity Alpha (CEA) composite returned +12.4% net of fees vs. a return of +12.4% for the Russell 3000 Total Return Index. Our equity positions took a meaningful hit in the third quarter due to meaningfully higher interest rates.

For the first nine months of the year (1/1/23-9/30/23), the Corporate Bond composite returned +2.2% net of fees vs. a return of +1.9% for the Bank of America Merrill Lynch 3-5 Year Corporate Bond Index. In a year when interest rates have increased dramatically, we are very pleased with this performance. I remain very bullish on the bond market for 2024 and 2025.

For the first nine months of the year (1/1/23-9/30/23), the Large Cap Yield composite returned -1.4% net of fees vs. a return of +1.1% for the Dow Jones Industrial Average.

For the first nine months of the year (1/1/23-9/30/23), our Preferred Equity composite returned +2.2% net of fees vs. a return of +1.9% for the Bank of America Merrill Lynch Corporate Bond Index. The goal of the Preferred product is to beat its corporate bond benchmark (based on a similar duration) and deliver the return with a lower tax rate. The trade-off is that the Preferred product will be more volatile. The bedrock of both corporate bonds and preferred equities are the underlying credits (companies) that issue the securities.

For the first nine months of the year (1/1/23-9/30/23), the Private REIT we distribute returned +4.1% net of fees. The return from this product is all dividends and we will be 75% tax-protected this year.

The current danger is that interest rates go meaningfully higher. Our economy and capital flowers can handle a lot — but we are getting close to the breaking point. The Federal funds rate was at 0% eighteen months ago. The Fed funds rate is now 5.25%. I believe an increase in the Fed funds rate to 6% or higher will cause serious problems for the stock market. I don’t know if we will get there. The economy has cooled off a bit — but, in my opinion, not enough.

Growth stocks are getting attractive again. They are not a bargain but are starting to get interesting. As always, we play the long game. We like dislocation and opportunity when others are fearful.

I have been salivating over opportunities in the fixed income markets for a couple of months. I don’t know if yields have peaked, but there are some fabulous investments out there.

I am a buyer of quality credits with longer maturities. I want to lock in today’s high yields for longer periods. This is a mouthwatering opportunity for people in their 50s, 60s, and 70s who want to lock in income for the next 10 to 20 years. This opportunity has not been available for years and I don’t know how long it will last.

Here’s an example. I bought a 19-year triple A rated New York State municipal bond yesterday with a 4.3% yield to maturity. No federal tax. No state tax. For someone living in New York state at the higher end of the tax bracket, that’s a tax equivalent yield of 7.81%. Good stuff!

We are currently buying five-year non-callable corporate bonds with yield to maturities of approximately 5.75%. Great for tax-deferred accounts. Those kinds of yields for such a short duration are good bets.

Our Preferred product has held up remarkably well and now offers a current yield of 5.47%, a yield to worst of 7.76%, and a 20% federal tax rate on the income.

While rates may well push higher, we have entered an attractive window to structure your retirement cash flow needs.

As always, success in the fixed income markets is about timing and credit quality.

I view this as a golden opportunity.

On a tax equivalent basis, municipal bonds are now more attractive than U.S. Treasuries and corporate bonds. We have been studying this for a couple of months and are close to product launch. More to come.

We now offer a very well-developed fixed income platform. The products are U.S. Treasuries and T Bills, corporate bonds, preferred equities, municipal bonds (coming soon), and the private REIT that Sandhill distributes.

This platform is designed so that you — the client — can make the right investment at the right time to meet your needs and goals after consulting with your advisor.

There are certain times and market conditions to use each of these products. I now believe we have a product platform that can address almost any investment environment.

Despite all my excitement about opportunities in fixed income, a well-run stock portfolio will far outperform fixed income investments over time.

It is important to consider this when our clients construct their choice of assets in their investment portfolios.

Assets under management and advisement were $1.96 billion on 9/30/23. This is an increase of $120 million since the beginning of the year.

We are thrilled to welcome John Canty to our team as an Investment Advisor. John spent the last 14 years at Roosevelt & Cross in Buffalo, NY as a municipal bond dealer. John carries a well-developed knowledge and experience skill set across the capital markets. John’s addition will add talent and depth to the Sandhill team.

The environment is tricky out there. When things are tricky it is important to stick to the basics and execute across our ongoing investment game plan. We continue to build Sandhill out as a world-class investment manager in the public markets. We are investing heavily in people and products to meet our client needs.

I am optimistic about where our investment portfolios sit — and as always — we will be driven by quality, patience, and opportunity.

My best to everyone for a terrific fall season.

With warm regards,

Edwin M. “Tim” Johnston III
Founder, Partner

Annualized Performance Summary (Net of Fees) As of 9/30/2023

CEA (Master): 1 Year: 25.7% | 3 Year: 4.9% | 5 Year: 5.7% | 10 Year: 10.5%

Russell 3000 TR: 1 Year: 20.5% | 3 Year: 9.4% | 5 Year: 9.1% | 10 Year: 11.3%

Corporate Bond: 1 Year: 5.9% | 3 Year: -0.9% | 5 Year: 1.5% | 10 Year: 2.4%

B of A ML 3-5 Year: 1 Year: 4.4% | 3 Year: -1.9% | 5 Year: 1.9% | 10 Year: 2.1% | Inception: 2.0%

Large Cap Yield: 1 Year: 12.4% | 3 Year: 8.2% | 5 Year: 6.0% | 10 Year: 7.4%

DJIA: 1 Year: 16.7% | 3 Year: 6.5% | 5 Year: 4.8% | 10 Year: 8.3%

Preferred Equity (Cumulative): 3.0%* [since inception]

Invesco Variable Rate Preferred ETF (Cumulative): YTD: 4.6% | Inception: 5.0%*

*Please note: Inception date of Preferred Equity product is 11/30/2022

This report has been prepared for informational purposes only and is neither a solicitation to buy or sell securities. Third-party information in this report has been obtained from sources believed to be accurate; however, Sandhill makes no guarantee as to the accuracy or completeness of the information. Sandhill Investment Management (“Sandhill”) is a registered investment adviser with the Securities and Exchange Commission that is not affiliated with any parent company. Individual results may vary. Investments may not be suitable for all investors. Performance may be materially affected by market and economic conditions. Investment strategies have the potential for profit or loss. The U.S. dollar is the currency used to express performance. Performance presented net-of-fees is reduced by investment management fees, trading expenses, and administrative fees. Interest, dividends and capital gains in these Composites are not immediately reinvested. The Concentrated Equity Alpha Composite includes all discretionary non-wrap fee paying accounts in the all-cap core strategy which may hold large, mid, and small capitalization U.S. common stocks, American Depositary Receipts (A.D.R.’s), domestic ETF’s, sector ETF’s, and cash. The Russell 3000 TR Index is a market cap-weighted index of 3000 of the largest US common stocks which represents 96% of the US equity market. The Large Cap Yield Composite consists of all discretionary non-wrap fee accounts invested in U.S. common stocks, American Depositary Receipts (A.D.R.’s), domestic ETF’s, sector ETF’s, and cash in solely large capitalization companies. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ. The Corporate Bond Composite consists of all discretionary non-wrap fee paying accounts invested solely in individual Corporate Bonds and cash equivalents. The Corporate Bonds will generally be rated single B to single A and will have maturities of three to nine years. The Bank of America Merrill Lynch 3-5 year Corporate Bond Index is a subset of the Bank of America Merrill Lynch US Corporate Master Index tracking the performance of US dollar denominated corporate debt publicly issued in the US domestic market. The Preferred Income product’s primary goal is to provide current income with secondary objectives of total return and tax efficiency. The Preferred Income product will primarily buy Preferred Equity but maintains the flexibility to hold other hybrid instruments such as Convertible or Baby Bonds. Holdings may be either investment grade or high yield. The Primary benchmark is the Invesco Variable Rate Preferred ETF (VRP).  VRP seeks to track the investment results of the ICE Variable Rate Preferred & Hybrid Securities Index. The fund will invest at least 90% of its total assets in the components of the index, as well as ADRs that represent securities in the index. The index provider compiles and calculates the index, a market capitalization weighted index designed to track the performance of floating and variable rate investment grade and below investment grade U.S. dollar denominated preferred stock, as well as certain types of hybrid securities. It is non-diversified. VRP performance is reported net of the 50bps expense ratio based on closing market prices.  VRP is the only above referenced benchmark available for direct investment. For a full performance presentation and/or the Firm’s list of composite descriptions, please call 716-852-0279.

Private REIT Disclosure: Accredited investors only: Non-Traded Private REIT is only offered and sold to individual investors and certain entities which are “accredited investors” under the Securities Act and the rules of the SEC, and who provide us with information we require to verify their status as accredited investors. Individuals are accredited investors only if they meet certain minimum net worth or sustained annual income thresholds. Entities are accredited investors only if they hold sufficient assets or are completely owned by accredited investors. Limited Liquidity: Investors may need to hold their shares for an indefinite period. REIT’s dividend is comprised of ordinary income (taxable) and return of capital (tax deferred). For income tax reporting via form 1099, real estate investments benefit from certain non-cash tax deductible expenses (i.e. depreciation). You should obtain financial and tax advice and conduct diligent investigation of information material to you before making any investment decision.