Three's A Company Or A Crowd?

Scott Poore

3 days ago

6 min read

Another week in the markets full of its fair share of drama. Equity markets had been fading early in the week leading up to the FOMC meeting on Wednesday. However, equities were trading higher Wednesday morning until the Fed's Dot-plot was issued.

Between the Fed, AI concerns, and the price of oil, markets are trying to decide if three is a company or a crowd. This week we gather inspiration from the '80s TV show "Three's Company." Here is some trivia about the show:

This show ran for 8 seasons (1976-1984). It was nominated for 6 Emmy's, but only won once. The first season was a success, with the show reaching #11 in the Nielsen ratings. Moreover, seasons 2-4 saw the show fighting for the top spot in the nation consistently. It stayed in the top 10 every season except for the first and final seasons.
John Ritter, who played Jack Tripper, was the sole Emmy winner for Best Lead Actor in a Comedy in 1984, while also being nominated two other times. Ritter had been a steady B movie actor and had some bit parts on television shows until he landed the role of Tripper, which set his career track on fire.
Ritter was the only actor to appear in every episode of the show. Suzanne Somers, who played Chrissy, would be replaced with two other actors/characters, and Joyce DeWitt did not appear in all of the episodes of the final season.
Suzanne Somers led to some of the initial tension behind the scenes on the show. After the 4th season, Somers demanded a huge salary increase and part ownership of the show. When she was turned down, she would often not show up for work, causing Ritter & DeWitt to decline to work with her. After leaving the show, Somers had little success in television and a few failures on the silver screen. However, she was redeemed in 1991 with a recurring role on the show "Step by Step," which ran for 7 seasons. Of course, everyone from that era remembers her infamous infomercials for the ThighMaster.
By the way, the spin-off series that was planned was called "Three's A Crowd" and lasted only 1 season.

Here's what we've seen so far this week...

Caught In The Middle. The character of Jack Tripper in "Three's Company" is typically caught in the middle of pleasing his roommates and not poking the suspicions of the landlord, Mr. Roper. It could be argued that the trouble in the Middle East causing

elevated oil prices, mid-term elections, the Yen "carry trade", and elevated AI valuations has the Fed feeling a bit caught in the middle. The market had largely priced in a 25 basis point rate hike by the Fed on Wednesday. What the market did not expect was a Dot-plot that indicated a 2nd rate hike in 2026 and at least one rate hike in 2027, as equities went from positive to negative with the Dot-plot reveal on Wednesday. The vote was unanimous with all 12 voting members approving the rate hike. On the plus side, Fed Chairman Warsh stated that the U.S. economy was "strengthening" and that the Fed was predominantly focused on price stability.1

Equities recovered on Thursday, but the focus for investors now seems to have shifted from will the Fed hike to how many times will the Fed hike interest rates. While the Dot-

plot suggests two more rate hikes, Fed futures are suggesting three more rate hikes - one in 2026 and two in 2027.2 We highlighted the different effects on equities depending upon how fast or slow the Fed hikes interest rates in last week's post.3 So, if the market is pricing in a total of 4 rate hikes in 8 months, is that considered "fast" or "slow"? According to Liz Ann Sonders and Kevin Gordon at Schwab, a "fast" rate hiking cycle would be akin to the Fed hiking at every single meeting.4 However, as beauty is in the eye of the beholder, a fast, aggressive Fed might be in the eye of the investor. Will a market that has not seen rate hikes in over 3 years consider 4 hikes in 8 months "fast"? Time will tell.

Who Pays The Bills? The role of Janet Wood in the TV show is the steady roommate who is responsible for paying the bills and keeping the apartment from getting into trouble with the landlords. However, when chaos ensues, which it normally did with

Jack's exploits, Janet could get quite explosive. Markets are still grappling with daily headlines on the Middle East and oil remains elevated. Oil reached a 3-month high of $102/barrel this week.5 A key Saudi Arabian pipeline in the Hanish Islands was seized by Houthi rebels this week and damaged the pipeline, which will require weeks to repair.6 In addition to oil, the price of diesel fuel continues to rip higher7 as Exxon Mobil's Joliet, Illinois fuel refinery, a major Midwest diesel supplier, was taken offline due to floodwaters overwhelming the pumps.8

There is little on the oil front from an fundamental standpoint to suggest oil prices will fade in the near term. While oil flows from the Middle East have improved, they are not

close enough to pre-war exports to move the needle. At the height of the military conflict in the Middle East this year, the exports from that region reached approximately 10 million barrels per day. Currently, as displayed in the graphic, flows from the Strait of Hormuz and outside the Strait account for about 15 million barrels/day. Until the conflict sees some sort of resolution and exports near pre-war levels of 24 million barrels/day, consumers and investors alike could expect oil prices to stay elevated. This could exert more pressure on inflation and the Fed.

Beauty At A Cost. Last, but certainly not least, the role of Chrissy on the show was the attention-getter. She would appease Mr. Roper with flirtations and help keep the

audience's attention, hence her salary demands. Like Chrissy, we may be entering the phase where AI, though shiny and powerful, may be losing some of its luster. The issue we have been raising of late is revenue growth versus debt for AI. The non-accrual rates for BDC companies that have partially funded much of the AI buildout with private credit has begun to reach a problematic zone. According to the graphic, the rise in non-accrual rates means these BDCs are not recognizing interest income on those loans because they are considered "non-performing" or in danger of default.9 According to Fitch, default rates have moved higher as well, reaching 6.3%.10

As if decay in the engine behind much of the AI buildout were not enough to be concerned about, the other side of the ledger may be as concerning. The expensing of

capital expenditures on AI may not be fully revealing. Because some of the capex on AI is not fully expensed in the period it is incurred, earnings per share of AI companies may be overstated as the expense timing gap is sitting on balance sheets and will be charged later.11 As the graph shows, should that capex be fully expensed today, and also due to the nature of concentration of AI companies at the top of the index, the S&P 500 earnings per share could be meaningfully lower than is currently reflected.12 Should that be the case, AI-related earnings (and valuations that rely on them) could look less attractive than they do today, and a reversion toward longer-term averages would be more plausible. As we have been urging for weeks now, it might be appropriate investors to revisit whether their long-term risk tolerance still matches how their portfolios are positioned.

Click here to watch Jack's trouble with a hammock.....

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Disclosures

The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.

Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general.

Past Performance does not guarantee future results.

Three's A Company Or A Crowd?

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