Category: Uncategorized

by Franklin J. Parker, CFA

The Summary

• Through some last-minute wrangling, congress managed to extend funding for the US government by 45 days. It appears that Speaker McCarthy’s political position is now vulnerable, but that is of less concern to investors. While a shutdown itself is not particularly noteworthy economically, it does add to investors’ waning confidence in policymakers to steer the ship.
  
  
• The United Auto Workers expanded their strike last week, calling out 25,000 workers. While this may seem to be an event isolated to a small corner of the economy, there are knock-on effects. In 1998, for example, a 54-day strike at GM of 9200 workers led to the loss of 150,000 jobs nationwide. Of course, that was 25 years ago and the world is a bit different today, but the point is that these effects are not linear. When coupled with the increased demands on consumers — student loan payments restarting, higher oil prices, and higher borrowing costs — there is an argument to be made that even small shocks can have larger-than-expected impacts.
  
  
• We see important data this week: job openings, a look at the health of the services sector, factory orders, and unemployment. While I still have not gotten the “recession is imminent” signals, I still see more downside risk than upside in this market. Caution is warranted, especially for investors with goals to achieve in the nearer-term. If the data starts to turn positive (unemployment dropping or holding steady for months, and corporate earnings improving), then I will adjust that view.
  

The Details

Imagine you get invited to a dinner party, and all the best minds in finance are there. Nobel-winning economists, big hedge fund managers, guys who have been profitably trading for 30 years. Now, imagine you get to ask the dinner guests questions.

In essence, that is what markets give us. Every day, we are invited to a dinner party, and, while we don’t get to ask individual guests what they think, we do get to poll the audience with almost any question we have. Where will the price of oil be in 6 months? How much risk is in gold? Is the S&P 500 going up or down next week?

For those who know how to read markets, we have the dinner party’s answers to these questions every single day. Of course, the dinner party crowd isn’t always right, but — and this is the key — they are more right more often than you or I would be. That makes the dinner party a resource that we can mine for our benefit!

Indeed, this is my view of markets. By gathering the data of the dinner party crowd, we can use their collective insight to help us forecast what is happening next. In many ways, this is the core of our recession dashboard and these weekly commentaries about what is going on (and what might be next). It is simply the collection of the “dinner party wisdom.”

That said, there are certainly times the dinner party guests seem more distracted than usual, and we may disagree with their answers. Those times are rare, but when they occur there are exciting opportunities for those able to take the risk.

Chart of the Week

This week’s chart demonstrates what has been keeping this economy afloat. Most of the time, consumption of goods and services follows disposable income pretty closely. Covid, and the stimulus associated with it, disrupted the pattern considerably. As the chart shows, disposable income jumped while consumption dropped. Incomes have more-or-less stabilized, but the consumption of goods has grown in an abnormal and outsized way. Eventually, one would expect goods consumption to normalize and begin to track with incomes again. So far, however, that has not happened.

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.

by Franklin J. Parker, CFA

The Summary

• A government shutdown is back on the radar. Current funding ends at the end of this month and without a spending agreement, many pieces of the government begin to shut down. While not nearly as dramatic as the debt ceiling showdown earlier this year, the government shutdown would likely dent economic activity and increase market volatility — on average, the S&P 500 falls about 0.4% in the weeks leading up to a government shutdown, and remain about flat until it ends.
  
  
• The economic data from last week was somewhat mixed. The services sector appears to be slightly stronger than otherwise thought, but still isn’t very strong. Pay for new hires has fallen quite dramatically in what may be an early indication that the labor market is weakening. This week we see all-important inflation data. Investors appear to be getting behind the idea that the Fed has successfully managed to create a soft landing. I remain skeptical — the historical record does not favor such a scenario, and the economic data has deteriorated. That said, if corporate earnings improve in this quarter and unemployment does not tick meaningfully higher, there is a case that history is being made.
  

The Details

I still see more risk than opportunity in this market.

Commercial real estate, to take one example, continues to show worse figures month after month. Occupancies are down, rents are down, prices are down, and many developers and investors are unable to refinance loans at rates comparable to a few years ago. Ultimately, banks are the ones left holding these failed properties, and we are seeing non-performing loans on the rise (though banks are very reluctant to foreclose). Not to mention, many of these banks have their own troubles with their bond portfolios — the dynamics that sunk Silicon Valley Bank and First Republic are still in play.

Evidence is also mounting that consumers, the lifeblood of the economy up to now, are beginning to hit some speedbumps. Labor market conditions have loosened, leaving employees with less leverage to negotiate higher wages. The considerable savings built through pandemic-era programs has mostly run out, and the student loan and rent payment moratoriums are coming to an end. Consumer behavior through the end of the year will likely determine how much life this economic cycle has.

There are counterpoints, of course. Consumers, despite almost everyone’s expectations, have kept spending. Jobs have remained plentiful (and still are), and the services sector is expanding (albeit slowly). Consumer and corporate Debts are still generally being paid and, as I have said before, the “recession is imminent” signals have not started blinking their warnings.

For markets to move higher, however, we really need a catalyst: strong earnings in Q3 could do it. 2015 – 2016 was a period when earnings contracted outside of a recession, only to recover and push markets higher for the next five years. Strong consumer spending would keep the economy afloat, and a recovery of the manufacturing sector would be a signal that things are landing okay.

At the moment, with current data, I see more downside risk than upside motion. Markets appear to be stuck in a sideways churn, with little to push them higher or lower. Given this economic data, however, I see downside risks looming large coming into the end of 2023. Investors should be cautious, though, as always, your individual objectives will govern which risks are more important to you.

Chart of the Week

Following on the article I wrote in Enterprising Investor, I have fielded several conversations surrounding cryptocurrency, and Bitcoin in particular. There is a great chart put out by LSEG group that shows the size of various bubbles in the past, from gold in the early 1980s to the Tech bubble of the 1990s. As this chart shows, all of them pale in comparison to the meteoric rise in Bitcoin price over the past decade. Will the massive rise in price hold? Or will the bubble pop? Really, only time will tell. There is no denying, however, that this has been among the most dramatic price movements in history.

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.

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.

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.

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.

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.

by Franklin J. Parker, CFA

The Summary

• Earnings season is coming to a close, with almost all companies having reported earnings. The news isn’t great, but it isn’t terrible either. We started the quarter expecting a 6% decline in earnings, and it appears that we will close the quarter with a 3% decline in earnings — better than expected, but still a contraction. Inflation is a common theme in earnings calls, with companies starting to have difficulty raising price to offset increased costs. Additionally, earnings outlooks for the rest of the year have softened considerably, with many companies indicating ongoing trouble through 2023.
  
  
• Inflation and the Fed are still top-of-mind for investors, but the big story right now is the debt ceiling debate. Treasury has indicated that timing exactly when they will run out of cash is tricky, but late June is starting to look like a danger zone. With negotiations moving slowly, investors are getting worried. As I have talked about here before, a default on US treasury bonds would be catastrophic to the financial system and broader economy. Everything would be affected, from mortgage rates, credit cards, bonds, stocks, the value of the dollar (and thus inflation), and so on. Who Treasury pays in a shortage of cash scenario is an open question, and one investors are not eager to see answered.
  
  
• This week is a light data week, though we do get a read on manufacturing and retail sales. Overall, the signs are pretty clear that the US economy is stumbling. That said, employment remains very strong, though it is typically the last domino to fall. Given the risks in the marketplace (earnings contractions, the debt ceiling debate, manufacturing contraction, etc), I am holding my view that there is more downside risk in this market than upside. Caution is warranted, although your goals and time horizon will dictate which risks you can afford to take.

The Details

How much do you need to accomplish your goal?

I’ve seen several news articles in my various social media feeds about how much you need to retire. The figures vary wildly from $500,000 to over $5,000,000, with everything in between. Why such a disparity in figures? And how much do you really need to accomplish a goal?

There are some financial planning rules of thumb that we can use for goals require ongoing cashflows, like retirement.

The first rule of thumb is that for every $1000 per month you need in income, you need $300,000 invested. This carries several important assumptions which is why it is only a rule-of-thumb. Even so, it is helpful for some back-of-the-envelope planning. If, for example, you figure that you need $9,000 per month of income from your investments, then you can ballpark that you need about 9 x $300,000 = $2,700,000 to sustain that income forever.

Again, this is just a rule of thumb, but it gives you somewhat of a starting point. Digging deeper is important to understand more specific figures, and the financial planning process is critical for that.

In the end, the planning process helps to not only develop a plan, but also to solidify your own goals. Not to mention, it informs the risks you can and cannot take with your investment portfolio.

Chart of the Week

The cost to insure US Treasury bonds against default has spiked to the highest level in at least 20 years, surpassing the previous debt-ceiling standoffs. While the market-implied probability of a default is still very low (in the neighborhood of 0.22%), the concern has gotten very acute for investors eager to see progress.

In the event of a default, I would expect a suspension of interest payments and maturities (investors won’t get any more cash). Once Congress authorizes additional borrowing, I would expect to see investors made whole (investors would then get their interest and maturity payments). In the meantime, there would be lots of volatility and scrambling to find a safe haven (which would normally be treasuries). In the end, however, investors would most likely get the money they are owed.

Of course, it is the aftermath that is most concerning. The “full faith and credit” of the US would, from here on out, be highly suspect.

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.

by Franklin J. Parker, CFA

The Summary

• Earnings season has begun! Overall, investors expect an earnings contraction of 5% to 6%. On Friday, we saw earnings from banks, including Wells Fargo, JPMorgan, and numerous regional banks. What became clear was that the top five banks benefitted greatly from the turmoil in regional banks last month. Shares of regional banks fell sharply after their earnings. Banks have also begun building up rainy-day funds to weather a coming storm. It is another reminder that the economic outlook continues to deteriorate.
  
  
• Unemployment figures for March were a bit stronger than expected, although job openings fell below 10 million for the first time in years. We also saw inflation data, which cooled slightly (5.6% year-over-year). Investors took this as a signal that the Fed will begin slowing rate hikes, with their next meeting delivering the final rate hike for the year (of 0.25%). Markets rallied on the news, although it is not particularly good. The Fed tends to cut rates just before recessions, so watching their behavior is a good signal that the economic cycle is ending.
  
  
• The recent everything-goes-up rally is a bit of a head-scratcher. There are few reasons why risky assets should be climbing as much as they have year-to-date. That said, it is not uncommon for stocks to rally into a recession. Nothing is certain, of course, but this rally is not supported by the economic data. It does, however, provide opportunities to adjust portfolios and grow more conservative. As I have been saying for a few months now, this is the time to batten down the hatches — there is a storm on the horizon.

The Details

The US debt ceiling is still looming. What’s the big deal?

It is an open question whether the US Treasury can still pay interest payments on debt if the debt ceiling is not raised. Treasury secretaries from both parties have argued against testing it as there are legal questions as well as financial ones.

US Treasury securities are the keel of the international financial system. A default would be a severe crack in the very foundations of the financial system, and many of the consequences are unknown.

Of course, the US defaulting on her debt is a low probability event — investors have priced a 0.22% probability of that happening. Yet, the consequences are so severe (and unknown) that investors should still pay close attention and take steps to insulate portfolios.

And now is the time to be doing that. If it becomes clear that no deal will get done, everyone will be rushing for the exits at the same time. That, of course, makes it very difficult to get to safety.

Chart of the Week

With earnings season in full gear, it is helpful to review what investors think is going to happen. Remember — it is significant deviations from expectations that move markets. While some sectors are expected to do well this quarter (Consumer Discretionary and Industrials, in particular), overall the market is expected to deliver a contraction of 5% to 6% in earnings. If that happens, it would be two quarters in a row of earnings contractions. Not a good sign, overall.

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.

by Franklin J. Parker, CFA

The Summary

• Markets ran higher last week, with tech stocks leading the charge. Some analysts have pushed back suggesting that the recent rally is unsustainable. With earnings declining and the Fed continuing to hike rates in the face of a slowing economy, it is my view that there is more downside than upside risk in play. That said, it is not uncommon for markets to hit new highs just before a recession takes hold (that happened in 2007, just before the great financial crisis).
  
  
• Manufacturing fell to new lows last week. This week is important because we get data on employment. The unemployment rate is expected to hold steady at 3.6% with about 215,000 jobs created last month. Obviously, a big deviation from these figures would push markets to update expectations for the Fed, as well as the economic outlook. Again, it is my view that a recession is not far away, though the macro-economic signals I watch have yet to flash “the recession is imminent” signals. Though this week’s data will update our recession dashboard.
  

The Details

I am surprised just how often I advise people to spend money.

Typically it is folks entering or nearing retirement and this usually comes after a financial assessment. It makes some sense: many people have spent a lifetime disciplining themselves to save or to build a business, which is wonderful — it gives choice and comfort through their most vulnerable years.

There does come a time, however, when it is okay to enjoy the fruits of that discipline and sacrifice. That enjoyment will look different to everyone, of course, and that is perfectly okay. Some people like to travel, some like to enjoy good food, and still others like to give. Often people enjoy all of these things and more.

The point is that finding what it is you enjoy, and then making a conscious effort to appropriately proportion that into your life, is a very important and often under-discussed aspect of your lifestyle. More often than I would expect, people withhold permission from themselves for such things. Naturally, I am not advocating unnecessary largesse. However, after a full financial workup, if we find that you have the resources to do so, don’t be surprised if I tell you “its okay to spend some more.”

And, as I often point out, if you don’t enjoy it, then your heirs certainly will!

Chart of the Week

The thing that sunk Silicon Valley Bank and Signature Bank were unreported investment losses (I covered the reasons for this in more depth in a previous update). This week’s chart looks at the health of US, EU, and UK banks after adjusting for these unrealized investment losses. Bubbles that are below the dotted line are banks that are in worse shape than their balance sheet would suggest.

In general, we can see that EU and UK banks are in much better shape than US banks, and there are still some banks that may have inadequate capital ratios should the investment losses need to be realized. As I have mentioned before, banks in crisis mode may not fail, but are unlikely to be doing much lending. That credit crunch is likely to lead to less business expansion, and, in turn, a recession.

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.

by Franklin J. Parker, CFA

The Summary

• In the face of a crisis among banks, the Fed raised rates by 0.25% and indicated this could be the last hike for a while (read as: in this economic cycle). Investors have now priced-in rate cuts to begin later in the summer. Of course, the Fed cutting rates would be in response to recessionary signals, so that would not be positive for stocks, at least based on today’s data.
  
  
• While the immediacy of the crisis in banking has subsided, more policymakers are sounding the alarm that this is likely to cause a credit crunch which could lead to a recession (we discussed that here last week). Banks in crisis aren’t expanding credit, so individuals and businesses will need to curtail their spending. In that vein, March 9 – 17 was the first week since 2013 that no investment-grade corporate bonds were issued. The drying up of credit is a strong recessionary signal.
  
  
• This week we get some more data on the economy, from manufacturing to services to consumer spending. My view is that a recession is becoming more imminent, though the macroeconomic signals have not flashed red just yet. While the economy could still land softly, I see that outcome as less likely. In any event, investors with short time horizons would do well to lighten their risk exposure and batten down the hatches. Downside risk looms much larger than upside risk in this environment.

The Details

How much do you need to retire?

Of course, before we can even attempt to answer this question we have to understand what you would like retirement to look like. This is a harder question to answer, but it is a critical part of the process! Only once we understand what you’d like to be doing can we assign a monthly income requirement to it.

In truth, this can be the hardest part of the process, and it very often requires some dreaming. I like to start with some imaginary questions: it is Tuesday morning and you are having your coffee. What do you see our of your window? What are you doing today? What are you looking forward to later in the week?

These kinds of questions can at least get the wheels turning! Even so, I have found that it is rare for people to have a perfectly clear picture of what retirement looks like, and that is okay.

It can also be helpful to think of your retirement in layers. The foundational layer are your basic necessities: your food budget, where you live, your utilities, etc. From there, we can build spending that is more flexible: “fun” money, things you’d like to do, trips, family vacations, etc.

This layering also helps us plan for the inherent uncertainties that come with planning across decades. Adverse events (like a medical issue) cannot always be planned for, but the layering of expenses gives you flexibility for dealing with these moments.

Retirement planning is not a cut-and-dry activity. It takes some dreaming, some scheming, and some on-the-fly free-wheeling!

Chart of the Week

Bubbles are an interesting phenomenon in financial markets. Pretty much everyone agrees they happen and yet no one can agree on a definition of them. Indeed, very often, whether someone believes something is a bubble or not depends on whether they invested in it or not (if you are invested then it is not a bubble, if you are not invested then it is a bubble).

This week’s chart looks at some bubbles over the years, starting with gold in the early 1980s and ending with FANG+ stocks and bitcoin (which haven’t popped just yet). Of course, whether FANG+ and bitcoin are indeed bubbles remains to be seen, and whether you agree that these are indeed bubbles may have a lot to do with whether you are invested in them or not. Even so, it is difficult to deny the massive price run-up in these assets over the past years. I do wonder how they will behave through the next recession.

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.