by Franklin J. Parker, CFA
- The Bottom Line. The Federal Reserve meets this week. Markets expect a 0.75% rate hike, but it will be the chairman’s commentary and Q&A that is likely to push prices around the most. As I have said many times before, the key variables to watch are economic demand (consumer and business spending). If demand falters, a recession is likely not far behind. Until then, however, I expect modest expansion in profits and prices, though volatility is likely to remain elevated.
- Last week’s higher-than-expected 8.3% inflation figure caught many investors flat-footed. Producer prices (which is the inflation that businesses feel), also increased more than expected. That said, retail sales were better than expected, a sign that demand is still strong—an interpretation furthered by the University of Michigan’s Consumer Sentiment indicator, which ticked up over last month.
- This week is all about the Fed on Wednesday. We also get some insight into housing starts and existing home sales—both of which are important points as rates have shot up over the past months.
What is Risk?
There is a disconnect between how the financial industry defines risk and how individuals define risk.
Traditionally, risk is the volatility of your portfolio—the roller-coaster ride of ups and downs. When financial professionals discus risk, this is the definition they are using. By contrast, if you asked 100 individual investors to define risk I would expect that 95 of them would say risk is losing money.
But why is “losing money” our intuitive definition of risk? I think this is because we invest with some purpose in mind, with a goal we are trying to achieve. Losing money lowers the probability that we can achieve our goals, so, to our intuition, losing money is risk.
In the context of achieving goals, however, it would seem that risk, really, is the probability of failure, not losing money, per se.
And this is an important observation: your goals will define what is risky.
For goals that must be achieved within the next few years, a significant market loss is a big risk (because markets take time to recover). However, for goals that are 10+ years away, the bigger risk is staying in cash and missing 10+ years of market growth.
Contextualizing risk is a very very important component of proper investment management. It will dictate how we react to given market events and, just like everything else in investing, there is no one-size-fits-all solution!
For anyone interested in a deeper dive, redefining risk is a topic in my upcoming book Goals-Based Portfolio Theory. Adjusting our thinking really does adjust the portfolio management strategy, and that is also something we implement at Directional Advisors. As always, we’d welcome a conversation with you.
Chart of the Week
The main leverage Russia has over Europe is its natural gas. Many European countries, especially the industrial giant Germany, rely on Russian imports of natural gas. After beginning the year with natural gas storage well below the 2017-2021 average, European countries have caught up and have begun to surpass their 2017-2022 storage levels of natural gas.
Despite the aggressiveness of storage, Europeans are likely to see considerable pain in energy prices this winter.
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