What I Care About This Week | 2022 May 16

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by Franklin J. Parker, CFA

The Summary

  • Inflation numbers continued higher last week, spooking markets. The S&P 500 dropped below the 4000 level, which had been a key technical support for some time. Interestingly, though prices have dropped, we have seen earnings growth continue with the S&P 500 on track to net a little over 11% growth in earnings (though most of that coming from the energy sector—factoring out the energy sector the growth figure stands around 5%).

  • This week we see data on retail sales, and several data points on US manufacturing. Today, the NY Fed Manufacturing Index posted at a shocking -11.60, which is about where is was in March of 2020 (and economists expected a +17—so this was a big surprise). One data point a trend does not make, but it certainly exacerbates concerns about a looming economic slowdown, concerns which were already heightened after last week’s weak consumer sentiment figures.

  • 20% drops in the S&P 500 are pretty rare outside of recessions. Outside of a recession, it has happened only five other times since 1950 (Fall of 2018 was the last time), and in every case stocks were fully recovered within six months. Of course, that assumes there is no recession. While I see a low probability of a recession this year, I admit that the chances are rising. Ultimately, the types of risk that you can afford to take on will be dictated by your goals.

The Details

As the Fed has begun to pull monetary support from the economy, public markets have been the most visual aspect of the shift in risk sentiment. However, the shift has hit private markets much more strongly.

And that makes sense when you think it out. With the valuation of many publicly-traded technology companies now cut in half, why would I risk my funds in a higher-risk startup company with a sky-high valuation when I could simply buy a similar company on the open market for less? Not to mention, many significant VC and Angel investors have seen their public-market portfolios take significant losses, leaving less money available for investment elsewhere.

One place we have yet to see this change in risk sentiment is in residential real estate. Rather than follow interest rates and pull back, real estate in many areas has continued to climb. Residential real estate is an interesting market, subject to many forces that have little to do with our intuition. For one, real estate serves a purpose beyond investment for most people (shelter). For another, it is very politically unpopular for real estate values to go down, so politicians have incentives to maintain real estate values.

At any rate, it appears the private markets are beginning to turn, and we may be soon entering a good buying opportunity for investors with cash and the ability to take on this type of risk. Though, as history has shown, it is often new funds that reap the benefits of a turn in the market like this.

Chart of the Week

This week we look at the sensitivity of home prices to changes in interest rates. Despite our intuition on the subject, home prices are not swayed much at all by changes in interest rates (first chart). Even looking at the absolute levels of rates (the second chart) shows that home prices tended to rise even when rates were historically high.

In other words, home prices are largely governed by factors other than interest rates, so, despite what we might initially think on the subject, rising rates alone do not predict lower home prices.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

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