What I Care About This Week | 2023 June 5

by Franklin J. Parker, CFA

The Summary

• A debt ceiling deal was passed last week, and markets have breathed a sigh of relief. Lots of comprising was done, so both sides have things they are unhappy about — I have little doubt this will be an issue revisited in the election next year. For now, however, investors’ worst fears have been averted. Markets rallied higher on the news, which was to be expected. However, I would not take that as a sign that all is clear. It won’t be long before the focus returns to the fundamental economic data, which is not particularly good.
  
  
• Last week we got a read on the health of the labor market. Job openings remained strong, with just over 10 million, and new jobs created came in at a whopping 283,000 (165,000 were expected). Despite those very good numbers, the unemployment rate ticked up from 3.5% to 3.7%. This was enough to trigger one of my recessionary indicators (more on that below), though it does take several months for that indicator to be confirmed.
  
  
• This week is a fairly light data week, factory orders posted today (slightly lower than expected), and later this week we see data on consumer credit. Investors are watching Fed officials for clues about the path of rates. At the moment, it seems officials are leaning toward a pause in hikes. Markets currently see about a 1 in 4 chance of a hike at the Fed’s meeting later this month. In all, I am not optimistic about the direction of the economy. This rally is a wonderful opportunity to hedge and take some risk off the table. As always, however, your goals will determine the types of risk that make sense for you.
  

The Details

Morgan Stanley thinks corporate earnings will fall by 16% this year, and will kill the stock rally. It has been a while since anyone has discussed something like earnings affecting stock prices, so how does that even work?

First, here the “four winds” of market prices:

1. Economic Fundamentals,
2. Central Bank Policy,
3. Governmental Policy (things like laws, gov’t spending, etc), and
4. Business Fundamentals (things like earnings, growth, etc);

These forces are not linear, and they interact in unexpected ways, but ultimately an investor has to determine the strength and direction of each wind to come up with some sense of how to navigate the market environment. Of course, these four “winds” only set the environment — nothing is certain — and sometimes we are forced to sail through a hurricane.

At any rate, for the past decade, the dominant force has been central bank policy. Zero interest rates and unlimited money printing were the dominant wind in the marketplace and, though the other winds may have been blowing in a different direction at times, they were not strong enough to overcome central bank policy.

But that now changed, as the Morgan Stanley report demonstrates. Economic fundamentals and business fundamentals have become the dominant forces, overpowering central bank policy. Indeed, central bank policy has begun to follow economic fundamentals.

The point is, new winds are blowing. The next five to ten years won’t be like the last, and the lessons investors learned over the past decade (buy the dip, trust the Fed, quality doesn’t matter) may not be as applicable in the next decade.

Chart of the Week

This week’s chart is from my recession dashboard and it looks at the direction of unemployment. Typically, leading into a recession, unemployment begins to tick upward in a meaningful way (2020 was the exception, but that was because COVID hit first). May’s unemployment number triggered this indicator, though several months in a row are really needed to offer confirmation.

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.

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.