What I Care About This Week | 2023 Mar 20

dawn sunset clouds weather
Photo by Tamás Lichter on Pexels.com

by Franklin J. Parker, CFA

The Summary

  • And all of a sudden, banks are in trouble. After the failure of Silicon Valley Bank, this week saw trouble in other regional banks, but also at one of the worlds largest: Credit Suisse. Regulators and central bankers have worked to hold off panic and major failures in the banking system, with the FDIC and Federal Reserve offering unlimited deposit insurance (holding off a bank run) and the Swiss authorities offering an unlimited line of credit to Credit Suisse.

  • This week is Fed week! Markets have priced in a 60% chance of a 0.25% rate hike and a 40% chance of no hike at all, which is a massive change from a week and a half ago. Based on the Fed’s own commentary a 0.25% hike is possible, but a 0.50% hike is certainly on the table. Inflation figures came in last week at 6%, still much higher than Fed officials would be happy with. Retail sales also came in last week with 0.4% fewer sales than last month.

  • Things break slowly, and then all at once (to bend Hemingway’s phrase a bit). While it is still too early to tell if this is the moment, there does appear to be fissures forming in financial markets, even if not yet in the real economy. Though contagion risk has been mitigated by authorities, banks that are in survival mode are not expanding credit to customers, but are likely contracting it. Credit contraction is a main cause of recessions. The macro economic data is not yet showing this, but that does take time to appear. In my view, caution is warranted here.

The Details

So a recession might be coming… what’s the plan?

The first thing you have to do is assess what risks you can afford to take. There are, fundamentally, two types of risks for goals-based investors.

The first type of risk is downside risk — we are all familiar with that. Downside risk is the risk that you are invested and markets fall, then fail to recover in time for you to achieve your goal.

The second type of risk is upside risk. Upside risk is the risk that you are not invested and markets rise, leaving you without the benefit of those gains, now making it less likely to achieve your goal.

Balancing the two is a quantitative question (meaning, there is some math for it), but the essence of it is this: as your time horizon shortens, downside risks tend to hurt you more than upside risks. With longer time horizons it is the opposite: upside risks hurt you more than downside risks.

Finding a balance between the two is a big part of why I spend so much time trying to understand the business cycle. In markets where downside risks loom large (like right now), it is especially important to take steps to mitigate those risks for accounts that carry short time horizons. That can be done in a variety of ways from building cash, to hedging, to shorting, and so on. How should it be done for you?

Your goals are a key input to answering all of these questions. And if these are answers you don’t have, let’s open a conversation.

Chart of the Week

Another signal of economic health is how many small businesses are planning big investments in the coming three to six months — these are called capital expenditures, or CAPEX for short. Because small businesses account for about 44% of economic activity in the United States, but do not have the same access to financial markets, they can be a canary in the coal mine of the economy.

Typically, before a recession, small business owners report planning fewer capital expenditures in their business in the coming 3 – 6 months. Rebounding after COVID, this indicator has turned negative, showing that fewer are now planning CAPEX. This is, to me, a negative signal, though this can trend downward for some time before a recession actually hits.

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.

%d bloggers like this: