Franklin J. Parker

What I Care About This Week | 2023 Aug 21

Posted by Franklin J. Parkeron August 21, 2023August 28, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

Investor moods shifted dramatically last week with an “everything selloff” hitting markets. US stocks sold off 2% of their value, long-term US Treasuries (usually a safe-haven) sold off along with gold, bitcoin, and international markets. It is difficult to pinpoint exactly what pushed investors over the edge, but the deteriorating economic news out of China appeared to be the main culprit. A slowdown in the world’s second-largest economy (and largest exporting economy) spells trouble for the global growth outlook, and may be an early indicator that the import-based economies (US, EU, Japan, etc) are themselves slowing down as well.
This is a light data week, although the Federal Reserve begins its annual Jackson Hole retreat on Thursday. Investors will be listening closely for clues from the Fed on both rate policy going forward, as well as their own economic outlook. Conflicting messages have come from FOMC members lately, some advocating for another hike before year-end and others calling for a “wait and see” approach. Both are relevant to markets and consumers who are now grappling with the highest borrowing costs in a generation.
While earnings season is almost entirely over, this Wednesday (after market hours) we see earnings from NVDA — a stock at the center of the AI-on-Wall-Street hype. After gaining 188% this year, this earnings call will be a test of its very lofty valuation (a topic I have written about before). A quick look a analyst estimates shows that investors expect a 300%+ growth in earnings this quarter… which will be tough to deliver. Given that much of the US stock rally has been driven by tech and AI hype, it seems likely to me that the market as a whole is somewhat fragile with respect to poor news on that front. Wednesday will be telling.

The Details

Diversification: I don’t think that word means what you think it means.

Diversification is one of those fundamental words that gets thrown around a lot in finance. We all know what it means conceptually: “don’t put all your eggs in one basket.” But, what does that mean in practice? That is, unfortunately, where many investors get squirmy.

For some, diversification means owning as many individual securities as possible: own everything you possibly can. The rationale, of course, is that if one security fails, the rest are there to cushion the fall and make up the difference. For others, diversification means owning different asset classes, like stocks, bonds, and commodities. The idea here is that each of these asset classes tend to move differently but all drift upward over time. When stocks sell off, for example, bonds can be expected to gain value.

My view of diversification is different in one very important and nuanced way. While the above ideas are true (and I subscribe to them), there is one added component that most investors miss.

Diversification means diversifying the factors driving your investments. Owning stocks and commodities is only diversified if the factors pushing the prices of stocks is different than the factors pushing the prices of commodities. If stocks and commodities are both driven by the same factors, then we aren’t actually diversified. World War II is an example of this: during the war, everything in the global economy was driven by one factor alone: war. Diversification was difficult, if not impossible, in that scenario.

Today we see something similar in central banks. Central banks, globally, have been the primary driver for the prices in just about every market. Housing, commodities, stocks, bonds, even the price of cars, can trace its cause back, in no small part, to central banks. This has made diversification difficult, and given us moments like last week, where everything sells off together.

As central banks normalize monetary policy, it will be important for investors to be cautious and not rely too firmly on diversification to save their portfolios. Given that everything is being driven by the same cause, we may need to rely on techniques other than diversification to keep portfolios on track to hit our goals.

Chart of the Week

Recovering the jobs lost during COVID was not limited to any particular industry (though hospitality, hardest hit in COVID, saw the largest gains). In the last year, by contrast, we have seen largest job growth in health & education. The pace of job creation has slowed, though that is to be expected after the COVID recovery.

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.

What I Care About This Week | 2023 Aug 14

Posted by Franklin J. Parkeron August 14, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

Earnings season has (mostly) come to a close, and companies have made about 4% less profit than this time a year ago. This is better than expected, but not good in general, as this is the 3rd quarter in a row of earnings contractions. With markets trending higher, we are seeing valuations get stretched in several sectors (looking at you technology!). On the upside, earnings are expected to turn slightly positive in Q3.
This week we see data on retail sales (expected to grow 0.4% month-over-month), business inventories, housing starts, and industrial production. As a preview to retail sales: Target is expected to post its first quarterly revenue drop in six years. As I have mentioned (repeatedly), the economic data is fairly tepid, and markets appear to be range-bound for the time being. A firm catalyst is needed to push markets higher or lower. That may come in the form of a credit event, as there are strains beginning to show, both domestically and globally.

The Details

Let’s talk about the “off label” uses of life insurance I see circulating on social media.

On social media I often see some really bad financial advice (TikTok and Instagram seem to be the the main culprits — is anyone surprised?). Often, the facts presented are just plain wrong and would result in big trouble with three-letter agencies, like the IRS and the SEC, if it were followed (please don’t take advice from those videos). More often, however, I see people marketing “off label” uses of life insurance — under headings like “infinite banking” and it’s “rich man’s Roth IRA.”

While there are some legitimate use cases for life insurance as something other than life insurance, there are some things you should know.

Incentives. Life insurance often pays a commission to the agent of around 80% to 100% of the first year’s annual premium. The agent, therefore, has a very strong incentive to sell high-premium life insurance (whether it is a good fit for you or not). If you are planning on funding a policy for $10,000/year, just remember the agent is about to make $8,000 to $10,000 on that sale. This drastically changes the quality of the advice you get from these folks. (Interestingly, most annuities are subject to the same perverse incentives).
Costs. Life insurance is expensive when compared to other investment vehicles. Typically, insurers charge both variable fees and fixed fees. You’ll have a set annual fee (typically in the $100s), a “mortality charge” which is the actual cost of the life insurance (typically in the $1000s/year, and it gets more expensive as you age), a “load” which is the commission the agent receives on every premium payment, and then there is usually a monthly assessment for the first 10-years. When you look at the actual amount of cash that gets invested after fees, it is probably much less than if you just invested the money normally and paid the taxes.
Marketing Claims. Let me also dispel some marketing claims these social-media types like to bandy about.
- “It’s a secret the wealthy use to get (or stay) wealthy.” No. Just no. I work (and have worked) with extremely wealthy people. Off-label life insurance is not a strategy they use for wealth creation or preservation. I have never seen it done because the numbers just don’t make sense.
- “Infinite banking.” Also no. Paying big fees to loan yourself your own money almost never makes sense. There are more efficient ways of accomplishing something similar, like investing your cash and then using a security-secured line of credit with a bank, for example.
- “It’s a rich-man’s Roth IRA”. This one is actually kind of true, but you still run into the cost issue. The idea here is that your investment gains are tax-deferred and when you go to make withdrawals, you actually take loans against your policy’s cash value instead — which are tax free “withdrawals.” Is it worth paying 3x to 5x the fees? Almost always not, but running the numbers might make sense.

In the end, I advise extreme caution when using life insurance for anything other than, well, life insurance. The misaligned incentives are enough to make me skeptical, but are also to fuel a massive marketing machine. While there are cases when “off-label” life insurance might make sense, those cases are much rarer than the social media “experts” make it sound.

Chart of the Week

When the Federal Reserve specifically mentions your concerts as an influence on the economy, and the Congress of the United States of America holds hearings on getting tickets to your concert, you know you’ve made it big. This week’s chart is a look at the resale value of Taylor Swift tickets versus other artists. As it turns out, tickets to a Swift concert were one of the best investments to make last year (that is, if you could get them!). Her current (and continually-extended) Eras tour is on its way to being the first $1 billion tour in history, and Swift is herself a breath away from joining the billionaire’s club — one of just a few musicians.

Whether you love her music or hate it, there is no denying that Taylor Swift has become an economic force.

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.

What I Care About This Week | 2023 Aug 7

Posted by Franklin J. Parkeron August 7, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

Most large US companies have reported earnings for the quarter. It appears that earnings have declined just over 5% — not as bad as expected, but still the 3rd quarter in a row of earnings declines. As an aside, about 1 in 3 companies have issued negative guidance on earnings for the year. We also got data on the services and manufacturing sectors last week, both were tepid. Manufacturing continues its contraction while services remained at about breakeven. Of course, the big news was unemployment, which ticked down from 3.6% to 3.5%. Overall, last week’s data deluge was mixed. Consumers remain strong and they are likely to keep the economy afloat a bit longer. Everything else, however, looks shaky.
Amazon delivered a big earnings surprise on the back of Amazon Web Services (AWS), demonstrating that they are carving out an important niche in the infrastructure of technology, especially the compute needed to fuel AI, but also in their consumer sales which was the main driver behind sales growth. Apple and Microsoft disappointed investors, although Apple’s new iPhone launches in September. With three quarters of price increases along side an earnings contraction, valuations appear to be stretched. Without a strong catalyst, I struggle to see how this market can push beyond its previous high.
This week we see data on inflation, which will be key to gauging the Federal Reserve’s ongoing rate policy. Investors see about a 30% chance of one more rate hike before year-end, and Friday’s data is likely to push that expectation around. Also of interest this week is a read on consumer credit, expected to increase from $7 billion to $13 billion (that is not an unusual move — anything below about $30 billion is pretty normal). As I have said every week for a while now, I am seeing the early warnings of a recession, but I have not gotten the “recession is here” signal. As always, your goals will dictate exactly what you do with this outlook, but caution seems prudent.

The Details

Why do we care about market drawdowns? Okay, stupid question, let’s rephrase: how much should we care about market drawdowns?

Most people don’t like to lose money — but why? If we are confident that our investments are high-quality enough to weather a storm and come rushing back, why do we care if they fall in price for a period of time? For over 50 years now, the standard advice in the industry has been somthing like Stay invested no matter what; Don’t worry, it’ll come back; Just buy and hold forever. It is a reasonable thing to say in general, because it is true that a long-term bet on the health of developed economies has been a good bet.

The problem, however, is when you find yourself approaching your financial goal. Once you find yourself needing the money within a short period of time, those market downswings can become a real problem. Of course the market will come back, but will it come back in time for you to accomplish your goal? If your portfolio loses 30% and only moves 15% higher before you need the cash, you have to change your plans. Or, worse yet, if you are taking withdrawals from your portfolio, your portfolio may not come back at all!

The key here is to base this understanding of losses on the math of what you need doing — on your goals — not to base it on feeling. Even though all losses feel excessive, only some losses are actually unrecoverable. Understanding when losses are too much is an analysis we do here at Directional Advisors. And, to help conceptualize the idea, we launched a free tool on the website that you can play with to get an idea of how it works.

Everything in investment management must be done with a mind to your objectives, to your goals. In the end, investments are just tools to get a job done. Let’s make sure we reach for the right one.

Chart of the Week

Population trends over the coming decades is now a major theme now being discussed. With China struggling to replace their aging population, and with the ongoing decoupling of the West from China, there are questions about where labor will be sourced in the future. With a working-age population that is expected to grow from about 750 million to around 1.5 billion over the next 25 years, Africa — though varied and certainly nowhere near as monolithic as China — is standing out as a contender. Might we see a similar scale of wealth-creation and standard of living increases over the next 25 years like we saw in China over the last 25 years?

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.

What I Care About This Week | 2023 July 31

Posted by Franklin J. Parkeron July 31, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

Of course, the big news last week was the Fed’s interest rate hike. Powel reiterated the point that the economy still needed to slow and the labor market weaken for the fight on inflation to be won. That, plus to his comment that September is a live meeting, seems to indicate that rates may yet go higher before they go lower.

There does appear to be strain building in the system. Employment remains positive, but if the Fed is aiming to reduce employment in the economy, there is not much left to support growth. Manufacturing is in contraction, services are at about breakeven, companies are making about 7% less money than last year, the index of leading economic indicators has been in contraction for a year and a half, and the yield curve is inverted (a classic recession signal). When we step back and look at the full economic picture, employment is the last domino to fall — and it is a domino the Fed is trying to make fall.
This is a busy week for earnings, with some big names reporting including Caterpillar, Starbucks, Pfizer, Occidental Petroleum, Apple, and Amazon. Overall, S&P 500 companies are expected to see a decline in earnings of about 7.5% from this time last year, making this the third quarter in a row of declining earnings. Interestingly, companies who have the majority of sales outside the US are seeing earnings declines of about 21%. We see important data this week including employment figures for last month, job openings, factory orders, and services/manufacturing PMIs.
Another important development occurred last week, though it is a bit technical. The central bank of Japan ended its long-standing program of strictly controlling its yield curve. Essentially, the BOJ was buying government bonds to keep rates at or below 0%. They announced an end to that program last week, allowing rates to now float up to 1%. For over a decade now, investors have ridden a so-called “carry trade,” wherein they borrow (at practically 0%) in Japanese Yen and use the cash to buy US or European stocks, bonds, and commodities. By borrowing at a low rate and investing at a higher rate, investors could pocket the difference. While that trade has not quite ended, it has certainly come under threat, and we saw western markets react strongly at the announcement. It is certainly something worth watching.

The Details

Should you buy a lottery ticket? The answer is more complicated than you think.

I fielded an answer to a question on Quora.com once: why don’t billionaires buy every possible lottery ticket combination and thereby guarantee they’d win the lottery? The answer to which is very simple: because the payout for the lottery is about 40% less than what gets made selling tickets. You’d be guaranteed to lose 40% of your “investment.”

But what about you? Should you buy (a few) lottery tickets?

Traditional economic theory tells us that gambling is always irrational — you should never buy lottery tickets. Any game where the odds are against you and the expected return on your investment is negative, you should avoid playing.

However…

New lines of thinking are giving us better models of what it is people are trying to do in the real world. In these new lines of thinking, we find something very interesting. Most people have many different goals they’d like to achieve, and each of those goals has a different priority. Retirement might be a very high priority, while buying a sailboat might be much lower. We fund those goals from high priority to low priority, so our low-priority goals tend to get a smaller chunk of our money.

Lot’s of people have aspirational goals, too. Things that they’d dream of achieving, but if those goals don’t come to fruition they’d lose no sleep over it.

And for those goals, it may be rational to gamble, though it is certainly not rational to gamble everything, nor all the time. While lottery tickets may not be the best vehicle for that, this could well explain why people buy meme-stocks, or Bitcoin.

They key is to ensure that your important objectives are funded with a high level of confidence. That, of course, involves cohesive financial planning.

Assuming that is true, then the next time you think about buying a lottery ticket or two… maybe go ahead and do it.

Chart of the Week

This week’s chart is an economic indicator I follow loosely. Bankruptcy filings are an important thing to check in on every now and again. While the absolute number of filings does not matter as much (though there is a whole story about why they are at all-time lows), the direction is what we watch for. Typically, bankruptcies start to tick upward as a recession approaches (or sets in). And, as you can see, bankruptcies have been moving upward in a meaningful way over the last 12 months.

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.

What I Care About This Week | 2023 July 24

Posted by Franklin J. Parkeron July 24, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

It is Fed week! Markets expect a 0.25% rate hike but see this as the last hike until cuts begin in December/January. Overall inflation has moderated quite a bit, although core inflation has remained stubbornly high, and Fed officials have indicated quite strongly that they do not feel the war on inflation is over just yet.
This week is a big week for earnings as we hear from numerous big companies including Google, Microsoft, General Motors, Verizon, Boeing, and MasterCard. Last week’s reports were disappointing, with Tesla and Netflix letting investors down. Overall, the expected earnings decline has increased from about 7% to about 9%. This week will be telling to see if earnings continue to shrink more than expected.
We got data on the US services sector this morning (which represents about two-thirds of the US economy) showing the sector is growing more slowly than before — barely growing at all, in fact. Of course this is not the only indicator that matters, but it is an important one. With the yield curve inverted, companies seeing contracting profits, and the Federal Reserve continuing to hike interest rates, I continue to be cautious. The possibility of a soft landing (no recession) is growing, but carries a small chance in my view.

The Details

Should I invest in _____?

This is, as you can imagine, a very common question that I answer. What you may not expect is that there are two versions of it. The first version comes from clients who see things on social media, or read things in the news, and want to discuss whether it fits in their portfolio.

The second version of this question, however, is more pernicious.

When I am in social situations and people find out that I am an investment advisor, it is not uncommon for them to ask about some hot investment topic. The question should I invest in _____? naturally comes up, and, admittedly, my response ranges depending on the situation. Sometimes I’ll discuss the pros and cons of the idea, sometimes I’ll simply say “I really can’t say without knowing more about you.”

The response I would like to give, however, is this: That question is an indication that you do not have a cohesive investment strategy. If you have a cohesive investment strategy, it will tell you the answer to that question! Should you buy or sell X? Your strategy will tell you. Should you invest in X? Your strategy will tell you.

Hand-wringing over whether you should or shouldn’t do something is a signal to get a cohesive investment strategy. Build one, borrow one, or buy one, but do not go into financial markets without one! That is like going to sea with no idea how to navigate. Don’t do it!

Our strategy at Directional Advisors has been tested, peer-reviewed, and even won an award. If you find yourself without a cohesive strategy, we would be happy to talk through ours with you.

Chart of the Week

This week we look at the market’s current expectations of the Fed’s activity over the coming months. A month ago, markets saw current rates as the peak, right now however, markets see rates moving higher and then beginning to decline into 2024. Since this is the expectation, a change from this path would easily move markets.

All eyes will be on Powell’s commentary Wednesday.

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.

What I Care About This Week | 2023 July 17

Posted by Franklin J. Parkeron July 17, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

Earnings season is in full swing. Last week, we saw earnings from the major banks, and the overall picture was mixed. Banks have begun to set aside more cash for potential loan losses, though not dramatically so. Overall, the S&P 500 is expected to report about 7% lower earnings than a year ago, making this the 3rd quarter in a row of declining profits. This week we see earnings from some more financials, IBM, and Netflix.
Big tech has roared back in the first half of this year, and these companies are now collectively trading at 40 times earnings. To put 40x in perspective: for investors to break even via earnings in the next 10-years, these companies would have to maintain a growth rate of 25% every year for the next 10 years. Valuations like that are very difficult to maintain — that isn’t to say they cannot go higher, of course, but it does urge investor caution.
Last week’s inflation figures were generally good news, though it did nothing to allay the expectation for another rate hike from the Federal Reserve. This week we see retail sales and industrial production, both important insights into the ongoing health of the economy. Overall, I am still cautious, and investors may do well to hedge away risks they cannot afford to take.

The Details

Should you sell your business, and if so, for how much?

Building a business from nothing takes a lot — lots of sleepless nights, lots of long hours, lots of sacrifice of all kinds. Getting to the point where it is up-and-running, not to mention profitable and big enough to sell, is an accomplishment in itself.

If you are considering cashing out and doing something else (retiring or pursuing another opportunity), there are a couple of things you should consider.

First of all, is your business the type of business someone would buy? I have a very simple test for this: does the business run without you? If it does not, then buyers will scarcer. That isn’t to say there is no value there, of course, but to get the maximum price, you should consider scaling the business so that it more-or-less runs without you.

Second of all, having your books together will be critical. Many business owners neglect this because it doesn’t produce revenue, and they have a good sense of what the numbers are in their heads. However, investors/buyers will want to see it on paper! Getting your books together is a great place to start if you are considering a sale.

Finally, how much do you sell the business for? Most business advisors/brokers can give a good estimate of what someone might pay for your business, but that is only half of the equation. What someone will pay for your business is a very important number to know, of course, but how much you need to net in the transaction is also very important. Understanding whether you can maintain your lifestyle is important, but an understanding of how the sale fits within a financial plan can also help your negotiating position.

A very general rule of thumb to help you: think about the amount of income you’ll need to replace after selling the business. For every $1000/month of income, you’ll need to get about $300,000 in sale price for the business. So, for example, if you need $9,000/month of income to maintain your lifestyle, then you’ll need to get 9 x $300,000 = $2,700,000 for the sale of your business. Again, this is a very very rough rule of thumb, but it is a nice mental shortcut when thinking through scenarios.

Obviously, the more fully you understand your financial plan, the more fully you can understand the requirements for the sale of your business. That is something we are happy to help with!

Chart of the Week

Last week’s inflation figures were very encouraging. Headline inflation has dropped to 3.0%, which is coming within the Federal Reserve’s tolerance. Core inflation, while falling, remained stubbornly high at 4.9%. This was enough to give markets confidence that the Fed would continue with at least one more interest rate hike, likely at its next meeting.

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.

What I Care About This Week | 2023 July 10

Posted by Franklin J. Parkeron July 10, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

It’s earnings season! Some major companies report this week and they are a good bellwether for the economy as a whole. JPMorgan, Wells Fargo, BlackRock, Citigroup, PepsiCo, and Delta Airlines are all on deck this week. At the moment, analysts expect a decline in corporate profits of about 7%. In addition to understanding the health of sales, investors will be listening closely to the outlook of management for the back half of the year.
This week we also see all-important inflation data. Economists expect inflation to be around 3.1%, down from 4.0%, which would be good news, generally. Core inflation, however, remains pretty sticky and is expected to come in around 5.0%, only down a bit from 5.1%. In addition to its effects on corporate profit margins, the concern is that consumers cannot hold up for much longer under the heavy inflation burden. Of course, inflation is also a central figure in the Fed’s interest rate decisions, and this will be the last inflation print before their meeting later this month. Markets now expect the Fed to raise rates at least once more before the end of the year.
Markets have been in a holding pattern for the last month. I am once again reiterating my view that a recession is on the horizon, though not here just yet. All of the classic signals are there, but the “recession is imminent” signals have not yet been triggered. Until then caution is warranted, and investors may do well to stay invested but include hedges or risk-controls against severe losses in their portfolio. As always, your goals will determine the types of risk you can and cannot afford to take.

The Details

Back in March, when Silicon Valley Bank (and others) failed, I spent quite a bit time looking at the balance sheets of regional banks in an attempt to sus-out how big the problem was. What I found was very concerning.

The problem with these banks is that they are not reporting the actual value of many of their bond and MBS holdings. Because regulations allow banks to hold these types of securities as “held to maturity,” they can lose considerable value but report the same value on the bank’s balance sheet. That makes it look like the bank has more in assets than there actually is.

Banks, of course, are not eager to report these figures, so some old-fashioned sleuthing work and estimation has to be done. As it turned out, almost every regional bank I looked at had negative equity (which is when liabilities are bigger than assets) when you adjusted for the estimated losses in their held-to-maturity portfolio.

Now, banks can run with negative equity for some time so this is not necessarily a death sentence. Plus, the Federal Reserve has implemented some programs to keep the banks solvent. When their balance sheets are in trouble, however, banks curtail lending considerably. That tightening of credit can slow down economic growth. And, of course, in a crisis, that problem of negative equity can sink a bank very quickly (as we have seen).

In any event, this is something to watch. If the Fed decides to raise rates again, and tighten the money supply, we may see more banks struggle to remain solvent.

Chart of the Week

Last week we got a look at the health of the services sector (services are 70%+ of the US economy). After a steady decline through 2022, it appears that services have ticked up in the last month (in this indicator, anything above 50 is expansion). Of course, one report does not a trend make, but this is one positive economic data point.

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.

What I Care About This Week | 2023 June 26

Posted by Franklin J. Parkeron June 26, 2023in Uncategorized

by Franklin J. Parker, CFA

The Summary

This week we get some important data on both the economy and inflation. New home sales, consumer confidence, durable goods orders, PMIs, and personal consumption expenditures (on of the Fed’s preferred measures of inflation) are all on tap. In general, expectations are low for these figures. Durable goods, new home sales, and consumer confidence are all expected to tick down with PMIs remaining in contraction territory.
With the Fed meeting out of the way, most eyes are turning to earnings season starting next month. At the moment, investors are expecting another quarter of shrinking earnings. While this could be short-lived, it is yet another signal that the economy is sputtering. My view is that a recession is likely within the next 6 months or so, but I have yet to get the “a recession is imminent” signals. This puts markets in a bit of a middle ground without a firm catalyst to move, either higher or lower. I continue to look for opportunities to reduce portfolio risks for those whose goals warrant such moves.

A Look at Recession Probabilities

Let’s cut to brass tacks and look at a few recession probability models.

I spend quite a bit of time talking about individual data points. That is important because each one is a piece of the mosaic that is our economy. Sometimes, however, it is easier to simply skim over those figures and wonder “So what?”. This week, let’s put that mosaic together in a more concrete way.

I have several models that I review to try and parse the business cycle. My simplest model is in the chart below. As you can see, it is indicating a 94% probability of a recession by January 2024, which is the highest this indicator has been since the early 2000s. Much of the intensity of this signal is coming from the yield curve, which has reached its most extreme inversion since 1981, but that is not the only input to this model.

In addition to my simpler model, I have a more advanced model that leans on more data and some AI techniques to combine. I trust it a little less because the only out-of-sample recession in the model was 2020 (which it did accurately predict, as did my simpler model). At any rate, this model is also showing increasing odds of a recession.

The NY Fed’s recession indicator, which is based solely on the yield curve, has a recession probability of 71%, which is the strongest it has been since the early 1980s (when the US experienced two back-to-back recessions).

The Conference Board’s recession probability model has the possibility of a recession by February 2024 at 99%. That is higher than their model indicated just before 2008. They see the downturn starting the third quarter of 2023.

And, of course, there are the various commercial models out there. Bloomberg’s recession probability model is at an elevated 65%. The point is, no matter who does the slicing, the data seems to point to a recessionary environment.

This is a good time to point out, however, that just because a recession is looming does not mean markets won’t move higher. First, there is the possibility that a recession does not form. Second, however, it is not unusual for markets to rally into the end of a business cycle, as we discussed in our May 1 update.

Of course, exactly how you implement this outlook in your investments will depend on your financial goals, but that is a conversation you should be having now.

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.

What I Care About This Week | 2023 June 19

Posted by Franklin J. Parkeron June 19, 2023June 26, 2023in Uncategorized2 Comments

by Franklin J. Parker, CFA

The Summary

The big news last week was the Fed’s decision to keep interest rates where they are. That was no surprise to markets (there was only about a 5% chance of a hike), but Fed officials continued to insist that they expect two more rate hikes before the end of the year. Of course markets cheered the pause but were negative on the “two more” part. There were two important things this Fed meeting demonstrated, however: (1) markets are becoming less sensitive to changes in Fed policy (other forces are taking over), and (2) the Fed is beginning to see negative developments in the economy that have them adjusting policy. The second point is important: once the Fed starts cutting rates, a recession is typically not far behind. Rate cuts, at this point, are bearish — not bullish — for markets.
This week is a light data week. Though the Fed meeting took center stage last week, we did see other important data on inflation, retail sales, and industrial production. Headline inflation dropped from 4.9% to 4.0%, but core inflation (which factors out food and energy prices) remained high at 5.3%. Retail sales continued its strong showing, with a surprise 0.3% increase over last month (a drop of 0.1% was expected). In short, consumers are still keeping everything afloat, despite inflation.
The next couple of weeks should be pretty quiet. I am reiterating my view that this is a good time for investors to hedge portfolios and/or reduce risk. This market rally does have me scratching my head a bit, but a rally into a recession is not unusual behavior for markets. As always, your goals will determine the types of risk you can afford to take, and the types of risk you cannot afford to take. Understanding that should be central to managing your portfolio.

The Details

Let’s talk about the AI hype, but specifically the market’s reaction to it. Have you seen Nvidia lately?!?

Artificial Intelligence (AI) is all the rage these days, and, to be fair, there is good reason. Recent developments promise to change the way business is done in a way not seen since the internet revolution in the 1990s. And the internet revolution offers some valuable historical lessons we can apply here.

During the 1990s, especially the late 1990s, the hype surrounding the internet reached a fever pitch — any business associated with this new way of doing business was seeing massive increases in stock price. As we learned quickly, however, those increases were not always justified. In fact, hype is often the enemy of reasonable behavior.

Take Nvidia as an example. They are currently trading at multiple of about 225… this means that investors are willing to pay $225 for every $1 they have earned in profit. It doesn’t take a finance genius to wonder how that makes sense. If you do run the math, however, you will find that, at its current price, Nvidia would need to grow earnings by 62% every year for the next 10 years for an investor to just break even!

The basic question is, then: do you think developments AI will give Nvidia the ability to do that? I am no expert in AI, but I would struggle to believe that were possible.

None of that is to say that Nvidia stock won’t continue to climb (and I’m not picking on Nvidia here, they are just an example). If we have learned anything from market behavior in a bubble it is that extreme valuations can persist for quite some time. Investors can make money in these moments, but the key is to not be left holding the bag when the music stops.

In that vein, I will close with a quote from Scott McNealy, former CEO of Sun Microsystems, that sums up these ideas:

“[In the year 2000, Sun Microsystems was] selling at ten times revenues…

At ten times revenues, to give you a ten-year payback, I have to pay you 100% of revenues for ten straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes that, with zero R&D for the next ten years, I can maintain the current revenue run rate….

Do you realize how ridiculous those basic assumptions are? You don’t need transparency. You don’t need footnotes. What were you thinking?”
Bloomberg Businessweek, emphasis added.

Nvidia is currently trading at 11 times revenue, so be careful out there.

Chart of the Week

One of the recession indicators that I watch is business inventories. Usually (but not always), you see inventories peak just before a recession. Since this happens concurrent with a recession, we have to use this as more of a confirmatory signal rather than a predictive one.

As this week’s chart shows, inventories do appear to be peaking. When combined with the other data on my recession dashboard, this adds some confidence to my view that a recession is likely to form within the next six months. At this point, however, the key figure to watch (as I mentioned in my last note) is employment.

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.

What I Care About This Week | 2023 June 5

Posted by Franklin J. Parkeron June 5, 2023June 5, 2023in Uncategorized1 Comment

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:

Economic Fundamentals,
Central Bank Policy,
Governmental Policy (things like laws, gov’t spending, etc), and
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.