Category: Uncategorized

by Franklin J. Parker, CFA

The Summary

• The Bottom Line. Despite the Fed’s best efforts to slow it down, the US economy remains ok, though Q3 earnings in a couple of weeks will be an important data point. Bonds are starting to look like good investments again, so some of the recent selloff may be investors moving back down the risk spectrum and picking up some yield, a reversal of the trend we have seen over the last decade where cash has flowed into ever-riskier assets. Unless consumer and business spending slow, or corporate earnings deteriorate in a meaningful way, it is my view that there is a bottom in these markets somewhere near here.
  
  
• This week we see data on jobs for September and factory orders for July, both important. Despite the Fed’s efforts to slow it down, the job market remains very tight, which is fueling demand in the economy. We expect factory orders to shrink, and we expect an addition of about 250,000 jobs with an unemployment rate holding steady at 3.7%. Ironically, if this data comes in better than expected, it will push the Fed to be more aggressive in their rate hikes, so we are in a good-news-is-bad-news situation here.
  
  
• Last week’s data was a continuation of the trend. Consumer confidence surprised to the upside and weekly jobless claims were fewer than expected, while durable goods orders shrank. Consumer spending is a key variable to watch in the coming quarter.
  
  

The Details

Let’s talk about the constraints on central banks.

Over the past week or so, the UK has seen enormous moves in its bond market and currency market. At a time when the Bank of England (the UK’s central bank, also called the BOE) has said they want to stop printing money and buying government bonds, the new prime minister proposed a significant tax cut. Obviously, when a government has less revenue and more expenses, someone has to finance that deficit by lending them money.

Over the past decade or so, the Bank of England has been fine with creating money and lending it to the UK government. With that program coming to an end, it is investors who are left to lend their money to the UK government to cover deficits. However, unlike central banks, investors care about getting paid back.

With the rate on UK government debt suddenly out of the hands of the BOE and in the hands of investors, the gap between what investors demand to be paid and what the central bank demands to be paid became immediately and painfully obvious.

In the end, the BOE stepped into the market and said they would start buying bonds to stabilize the market, which can be read as “to keep borrowing rates for parliament at reasonable levels.”

This is a bit of a lesson for central banks, globally. There are very real constraints on what central banks can do (and I have talked about this before), not the least of which is political. If the pain becomes too great, central bank heads (who are themselves political appointees) will be replaced. I expect central bankers know this, and are doing what they can quickly before those constraints are reached and/or noticed.

This is a slightly different view than most of the marketplace which seems to believe that central banks can operate as unconstrained as they wish.

Chart of the Week

There is an interesting relationship between earnings yield on stocks (which is the inverse of the price-to-earnings ratio), and 10-year US Treasury yields. In essence, investors have a choice between getting yield through stocks or getting yields through bonds. When bond yields fall, earnings yields tend to fall, as well. This means that stock valuations get higher.

Now that bond yields are marching upward in a meaningful way, valuations are coming back down. After seeing the gap between the two widen to historically high levels, it is now moving to be more normalized. Moreover, there are times when earnings yields are lower than bond yields, but those tend to be outliers (1980s and 1990s, or in recessions), but it is possible if we see a return to a stagflationary environment.

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 Bottom Line. The Federal Reserve meets this week. Markets expect a 0.75% rate hike, but it will be the chairman’s commentary and Q&A that is likely to push prices around the most. As I have said many times before, the key variables to watch are economic demand (consumer and business spending). If demand falters, a recession is likely not far behind. Until then, however, I expect modest expansion in profits and prices, though volatility is likely to remain elevated.
  
  
• Last week’s higher-than-expected 8.3% inflation figure caught many investors flat-footed. Producer prices (which is the inflation that businesses feel), also increased more than expected. That said, retail sales were better than expected, a sign that demand is still strong—an interpretation furthered by the University of Michigan’s Consumer Sentiment indicator, which ticked up over last month.
  
  
• This week is all about the Fed on Wednesday. We also get some insight into housing starts and existing home sales—both of which are important points as rates have shot up over the past months.
  
  

The Details

What is Risk?

There is a disconnect between how the financial industry defines risk and how individuals define risk.

Traditionally, risk is the volatility of your portfolio—the roller-coaster ride of ups and downs. When financial professionals discus risk, this is the definition they are using. By contrast, if you asked 100 individual investors to define risk I would expect that 95 of them would say risk is losing money.

But why is “losing money” our intuitive definition of risk? I think this is because we invest with some purpose in mind, with a goal we are trying to achieve. Losing money lowers the probability that we can achieve our goals, so, to our intuition, losing money is risk.

In the context of achieving goals, however, it would seem that risk, really, is the probability of failure, not losing money, per se.

And this is an important observation: your goals will define what is risky.

For goals that must be achieved within the next few years, a significant market loss is a big risk (because markets take time to recover). However, for goals that are 10+ years away, the bigger risk is staying in cash and missing 10+ years of market growth.

Contextualizing risk is a very very important component of proper investment management. It will dictate how we react to given market events and, just like everything else in investing, there is no one-size-fits-all solution!

For anyone interested in a deeper dive, redefining risk is a topic in my upcoming book Goals-Based Portfolio Theory. Adjusting our thinking really does adjust the portfolio management strategy, and that is also something we implement at Directional Advisors. As always, we’d welcome a conversation with you.

Chart of the Week

The main leverage Russia has over Europe is its natural gas. Many European countries, especially the industrial giant Germany, rely on Russian imports of natural gas. After beginning the year with natural gas storage well below the 2017-2021 average, European countries have caught up and have begun to surpass their 2017-2022 storage levels of natural gas.

Despite the aggressiveness of storage, Europeans are likely to see considerable pain in energy prices this winter.

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 Bottom Line. Overall, the economic data continues to be okay—not great, not bad, but just okay. Last week’s data was pretty light, but there is a lot of data posting this week that could easily move markets. The Federal Reserve meets next week to deliver a decision on rates, so all of this week’s data will be interpreted in that light. Fed members have given guidance that a 0.75% rate hike is likely, so that is priced in. A move of less would boost markets, more would push prices down. My view continues to be that there is some upside in these markets, though I do expect it will be rocky. However, once people stop buying stuff, I expect a recession won’t be too far behind.
  
  
• Last week, consumer credit data for July showed a decline from June’s figure, a good sign, but the general trend is still higher. Jobless claims were lower than expected and wholesale inventories were down. Overall, it was a pretty light data week, and the data continues to be mixed (though generally okay).
  
  
• In contrast to last week, this week is fairly heavy on data. Inflation figures for August post on Tuesday, producer prices (one of the Fed’s preferred gauges of inflation) post on Wednesday, retail sales for august post on Thursday along with industrial production (one of my favorite economic indicators). Finally, consumer sentiment posts on Friday. All of this data could easily push markets around: especially with the Fed’s rate decision coming next week.
  
  

The Details

The past few years have turned most professional investors into Fed watchers, and this begs the question: why does the Fed matter so much?

The Federal Reserve has the responsibility for controlling the money supply and influencing interest rates. This supports their dual mandate: to keep inflation low and employment at full capacity.

These two tools have the side effect of pushing market prices around, though some of that is intentional. By raising the rate they pay banks, the Fed is able to pull cash out of the general economy, making less credit available to businesses. This tends to constrain business activity. Of course, the inverse is also true—markets have benefitted from low rates over the past decade.

Increasing the amount of cash in the economy tends to push market prices up—both because investors themselves have more cash to put to work, but also because it increases the amount of credit available to businesses. The inverse here is also true.

Given the power of these forces, central banks can exert a lot of influence over market prices. During times like this, when the moves are very aggressive, prices will respond quite strongly. Of course, markets benefitted from aggressive moves in 2020, but those moves served to boost prices rather than pull them down.

In the end, however, prices will tend to follow the fundamentals of the economy. Profit growth is what drives prices, so while the Fed influences valuations in the short term, it is these bigger forces that will drive longer-term prices.

Chart of the Week

One way to measure the amount of cash in the economy is to look at the amount of assets on a central bank’s balance sheet, which is what this week’s chart shows. When a central bank “shrinks their balance sheet,” they are reducing the amount of cash in the economy, constraining credit, and generally slowing down the economy.

As this week’s chart shows, central banks globally are decreasing the size of their balance sheets, and at a quickening pace. Markets are reacting negatively to this change in policy.

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

• Last week’s economic data generally showed a strong underlying economy. The unemployment rate ticked up, but that was largely due to workers coming back into the labor force and looking for work. There are still 1.8 open jobs for every one unemployed person, and there were 315,000 jobs added in August. On the downside, factory orders ticked down for the month, but that data was offset by today’s service sector PMI showing that the services industry got a bit of a boost in August.
  
  
• This week we get a peek into consumer credit data. Spending has largely remained strong despite lower real wages because consumers have been willing to dip into their savings. The next and last step is dipping into credit. An expansion of payment burdens and/or credit outstanding could be a signal that consumers are beginning to feel the pinch and a slowdown in spending would not be too far behind. We also get wholesale inventories, a figure that has been swinging wildly post-Covid.
  
  
• I expect markets to be rocky for the next several months. Investors are pricing and repricing the Federal Reserve’s actions all the while trying to better understand the growth story for both the economy and corporate earnings. That said, it is my view that the general trend will be up, at least until consumers slow their purchasing and corporate profits start to weaken. Of course, the risks you should take are always informed by your goals. We cannot manage money in the abstract!
  
  

The Details

Investing with a mind toward ESG (environmental, social, and governance factors) has grown in both popularity and assets over the past decade. The Economist recently ran an entire special report on the topic, and there is more to unpack than we have space for. Even so, let’s look at it very briefly.

First, what is it? ESG investing involves looking at companies not just through the lens of risk and return, but also with a mind to their impact on the environment, their impact on the communities in which they operate (social concerns), as well as their overall governance, or any other non-financial factors an investor may be concerned with.

Unfortunately, the financial industry has taken the same tack they always have when it comes to this important topic: they have built products and have expected investors to buy them.

But ESG investing, along with its cousins impact investing and ethical investing, are all very personal endeavors. In my experience, every investor has a different take on exactly what this kind of investing means to them. Also overlooked by the industry as a whole: investors are often required to make tradeoffs when the E, S, and G might be in conflict. Tesla, for example, might be a net positive for the environment (the E in ESG), but its treatment of employees and its dictatorial governance structure generally give it low scores in the social and governance components (the S and G in ESG). An investor, then, must weigh the personal importance of each of those scores and decide whether such a company fits in their personal ESG mandate. Some may decide it fits, while others may decide it does not.

And that is the critical point: an ESG investing mandate is both important and very personal. There is no one-size-fits-all, so investors need an advisor who can talk through these important issues and implement individualized solutions.

This is an area we would be eager to help you navigate.

Chart of the Week

The Wall Street Journal reported a slight uptick in the defaults on low-credit-quality bonds this month. While it is a small corner of the market, there is worry that it may begin to spread as interest rates rise and profits come under pressure.

Delinquency rates on commercial loans is a metric that I follow closely. Typically, leading into a recession, delinquency rates start to rise. We haven’t seen a significant uptick on delinquency rates just yet, though this figure only posts quarterly (and the last data we have is from the first quarter of this year). If delinquency rates do begin to rise meaningfully, investors should grow more cautious.

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 offering investors a much-needed view on both the current economy and the expected future economy. Two-thirds of S&P 500 companies have reported earnings (including big banks and big tech), and we are seeing earnings growth in excess of what was expected. As it stands, quarterly earnings are about 6% higher today than they were last year, and revenue growth is posting at around 12%. While this is much lower than the double-digit profit growth of the past few quarters, forward guidance has given investors some hope: both Q3 and Q4 are now expected to post around 7% profit growth.
  
  
• Last week’s Fed decision pushed rates 0.75% higher. Investors latched on to Powell’s comments suggesting a slowing of further rate hikes, or possibly a pause to give time for the current moves to have their effect in the economy. Of course, the very next day we got GDP data showing that the US economy contracted for the second quarter in a row. While this is the usual, shorthand definition of a recession, investors will have to wait months to hear whether the NBER officially declares it as one (and by then the world will have moved on). This week we see data on jobs, manufacturing, and consumer credit—all of which is important.
  
  
• As I have said repeatedly, if we are in a recession it is a very strange one. Corporate profit growth alone is enough to give investors pause before allocating in a purely defensive manner. That is not to say that I expect smooth sailing, far from it, in fact. However, this environment does give nimble and thoughtful investors a chance to shine. As always, your goals and view of markets will dictate what risks you can and cannot afford to take.
  
  That is a conversation you should not be having alone.
  
  

The Details

There is a bit of a mystery developing in the US economy.

Relative to inflation, consumers have seen their wages fall over the past year. Despite this drop in income, consumers have more-or-less maintained their purchasing power. Now, enter the mystery: the amount of consumer credit outstanding has been falling over the past months. So where are people getting the money?

The answer is likely personal savings. Since the pandemic high, personal savings has dropped to a multi-year low, and appears to be continuing to fall. Since consumer credit has also fallen dramatically, we might conclude that households are tightening up their balance sheets—possibly in anticipation of some difficult times.

Of course, households will not spend down their savings forever. Once that limit is reached, consumer spending will have to be drawn from credit, or curtailed altogether. Investors would do well to keep a close eye on these figures over the coming months.

Chart of the Week

I’ve read many an article about how the Fed’s rate hikes are likely to cause a recession. While I do not necessarily disagree, the last 30+ years of history has shown us is that the Fed is actually pretty good at recognizing when a recession is on the horizon, and cutting rates to get ahead of it. In fact, the Fed has not once—in the last 30 years of history—increased rates immediately ahead of a recession. There are always exceptions, of course, and this unusual environment may well be one, but investors have some reasonable basis to follow the Fed’s actions on this.

At the moment, the Fed’s behavior suggests a recession is not immediate.

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

• LOTS of important data this week. For starters, earnings begin this week with the big banks. Investors will watch closely for guidance from bank CEOs on the expectation for loan losses as they are an important indication of the economic outlook. Inflation data posts Wednesday (8.8% expected), obviously this is an important data point (more on that in this week’s details). Thursday we get producer prices, another inflation indicator. Friday is retail sales and consumer sentiment. All of these data points could move markets.
  
  
• A not-widely-talked-about item of concern is the ongoing negotiations between the union representing dockworkers at US ports (ILWU), and the cargo companies and terminal operators. The ILWU’s contract expired on July 1, and though talks are still ongoing, there is worry among industry analysts that a strike or walkout could occur if negotiations turn sour. That would put some 40% of all inbound US cargo at risk. With supply chains already stressed, this is an event for which investors should prepare their portfolios.
  

The Details

Inflation continues to be a hot topic, and it is dividing analysts.

While headline inflation continues to tick higher—this month’s is expected at 8.8% while last month’s was 8.6%—core inflation (inflation minus volatile food and energy) has been falling. Some analysts say “so what?”, food and energy represent a significant portion of household spending, so to the extent that inflation affects consumers it is having its effect.

Other analysts point to falling core inflation as a signal that supply chain woes and other expenses are beginning to normalize and, once the war in Ukraine subsides (or is better absorbed), falling food and energy costs will pull down headline inflation, too.

In my view, inflation has three affects that investors should be concerned with. (1) The role inflation has in the Fed’s policy adjustments, (2) the role inflation has in absorbing spending that would otherwise drive economic growth, and (3) its negative affect on consumer sentiment (when people feel poorer, they tend to spend less).

The Fed appears to be committed to bringing down headline inflation, so interpreting those figures through that lens is important for investors, and it does appear that consumers have had to curtail other spending in order to absorb higher food and energy costs. They also appear to be taking on more debt to compensate (which cannot go on forever). And consumer sentiment is hitting pretty extreme lows.

All of that said, it does not appear that consumers have curtailed their spending in a significant way just yet. Although, retail sales (on Friday) along with retail earnings will give us better insight into all of that. Signals that the consumer is struggling would up my timeline for a recession considerably. Slack demand is the typical cause of recessions, and up to now demand has been robust. If that is changing, the economy will likely start to sputter.

Chart of the Week

Since we are on the topic, this week’s chart shows the relationship between inflation and personal incomes. As the chart demonstrates, other than a couple of blips, 2022 has been the first year in a decade that households have seen their real incomes fall due to inflation. Most of the past decade has seen personal incomes increase more than inflation. So, event though personal incomes have risen higher than average over the past year, inflation has risen even more.

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.