Tag: Market Update

What I Care About This Week | 2023 Jan 3

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • Happy New Year! 2022 was a difficult one in markets, to be sure. Whether a recession actually formed in 2022 has yet to be announced, but there is no question that the economic data deteriorated considerably. Risky assets closed the year down 20% or so, and the very risky corners of the market were either wiped out or closed down considerably worse (looking at you cryptocurrency!). More and more analysts are expecting a significant recession in 2023, as am I.

  • Some important data posts this week. Unemployment will be the big item with a headline rate of 3.7% expected, but factory orders and the look at manufacturing will be important, as well. Investors have placed a 65% chance that the Fed will hike rates by only 0.25% at their meeting this month, which could set markets up for a downside surprise. Fed actions had the most influence on markets last year, and this year is likely to be similar.

  • Caution is ever-more warranted, and now that yields have come back, holding cash-like assets makes more sense. I see a recession as likely this year, and investors with goals to achieve should weigh what risks are appropriate given their time horizon. Having a recession playbook seems sensible in this environment, and if you don’t have that, let’s talk it through.

The Details

I see a recession as likely this year.

In the end, this forecast is driven by the underlying economic data. No matter how you slice it, the economic data indicates an economy that has slowed considerably. Manufacturing, services, consumer spending, even many of the classic recession indicators, are all flashing yellow and red. Not to mention, the Fed is still restricting monetary policy and that is likely to push markets down even further.

Of course, it is notoriously difficult to predict exactly when the recession will hit. Even so, taking precautions now might make some sense.

But how should investors prepare? The trouble with the question is that the answer genuinely depends on your situation. For investors with a decade or more until their goal, staying invested and taking the lumps may well be the most appropriate answer. For investors who are a few years from their goals, building up cash and getting defensive may be the better option.

In any case, this is a topic you should be addressing now. Once the storm is here, it is much more difficult to prepare—or repair.

Chart of the Week

This week’s chart is a look at the index of leading economic indicators. As this chart shows, this index tends to peak and then begin falling ahead of recessions. It can be some time before the actual recession hits, however. As you can see, a year to 18 months is not uncommon. In February 2022, this index peaked, and has been falling ever since. This is one of the several recessionary indicators we are getting.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Dec 12

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. All eyes will (yet again) be on the Federal Reserve this week. Inflation is still running hotter than expected, but investors are hopeful the Fed will slow down its pace of rate hikes. That said, the economic data has deteriorated significantly over the past few weeks, and many of my recessionary signals are flashing caution. While there may be some upside from here, investors might do well to be careful.

  • This week we get inflation data for November, a key data point before the results of the Fed’s meeting on Wednesday. Markets expect a post of around 7.3% (which would be down from October’s 7.7%). Much higher than this and markets would see a more aggressive posture from the Federal Reserve. On Thursday, data on retail sales and industrial production post. Industrial production is a figure I watch closely, and it has slowed over the past few months. A negative posting here would add to the recessionary signals.

  • As a minor note, the US Congress faces a deadline Friday to pass a spending bill to continue funding the government. According to Reuters, Democrat and Republican negotiators are about $25 billion apart—not much considering the $1.5 trillion in funding that is required. While I see a low probability for a government shutdown (brinksmanship has become part of the job these days), it is something investors should keep an eye on just in case.

The Details

As we close out the year, there are some “to-dos” that tend to pop up. On the investments side, one of them is tax-loss harvesting.

Tax-loss harvesting is a helpful tool. In short, you sell investments that have lost value before year end. This gives you a tax credit that you can use either now or in the future to offset gains when you sell an investment at a profit.

This year’s market volatility has given some investors an opportunity to capture that tax benefit. Now that my outlook has shifted to the negative, booking losses today gives us two immediate benefits in the face of potentially more losses next year. First, we get the tax benefit. Second, we get the cash to deploy at lower prices in the future. Of course, the latter reason carries some risk that markets move higher instead of lower. But, in a volatile market, cash gives us the luxury of future choices.

Considering these tax advantages is important—especially in this environment! And, it can be an incentive to go ahead and dump some of those stocks you’ve been waiting on to recover, but suspect never will.

Taxes can be boring to talk about, but incorporating taxes in your investment strategy is a must! Tax-loss harvesting is an important component in managing your investments efficiently.

Chart of the Week

Industrial Production is a figure that is on my recession dashboard. While not perfect, we do tend to see a contraction in production over the 6-months leading into a recession (sometimes more), but certainly not always. At the moment, we are not seeing a contraction in industrial production, but it is getting close. A drop of 0.5% or more in November would be a recessionary signal.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2020 Nov 28

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. My outlook on the US economy has shifted significantly over the past couple of weeks. A recession, while not imminent, does appear to be forming. Of course, pre-recessionary markets can still deliver solid returns, but I am watching the fundamental economic data closely, and this week we get a lot of it!

  • We get several important data points this week. Consumer confidence, job openings, headline unemployment, personal consumption expenditures, factory orders, and PMI all post this week. I am watching very closely for signs of a recession. An uptick in headline unemployment and a downtick in PMI and factory orders would confirm my suspicions that the economy is weakening, but we need to wait and see what the data says.

  • Protests in China’s largest manufacturing hubs have sparked concerns among investors that supply chains may again be disrupted. Speaking of supply chains, there is growing worry that the largest railroad unions will strike, and the union representing all dockworkers on the west coast has yet to agree to a contract with ports. All three of these represent critical infrastructure for the movement of goods, and a failure at any point would significantly slow an already-sputtering US economy.

The Details

It is no secret that recessions cause damage to investment portfolios. There are, however, several considerations investors should keep in mind.

First, markets tend to price about six months ahead of the news. So, the drawdown in markets tends to begin around six months before the recession begins, and the recovery begins six months before the end of the recession. Understanding when a recession might begin or end is a critical component to managing risk.

Second, your goals—not just the overall market environment—should inform the risks you can take in your portfolio. There are drawdowns, for example, which are too great to recover from, and understanding the limits of your portfolio is a critical element to managing your risk (a topic I address in my latest book).

Finally, recessions do not treat all investment types equally. Bonds, gold, and even small-cap stocks tend to outperform other sectors through recessions (though the cause of the recession is an important component in that calculation). There are places to make money, even when things start to look dire.

If you don’t have a playbook for the next recession, now would be the time to begin discussing one. Let’s open a conversation.

Chart of the Week

Another indicator on my recession dashboard is the Purchasing Manufacturer’s Index (or PMI), which is a gauge of the health of manufacturing, and in this indicator anything over 50 is expansion, anything under 50 is contraction. It can be a bit noisy, so it must be viewed in the context of other indicators, however, figures at or below 50 tend to create amenable conditions for a recession.

This week, we get the latest view of PMI, and a post below 50 would make this another a warning sign.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Nov 21

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. After an initial bounce, markets have faded just a bit with questions about whether the Fed will acknowledge the lower-than-expected inflation data. Hawkishness seems to pervade, and Powell has repeatedly said that he would rather over do it than under. By my read of the economic data, there is a storm brewing on the horizon, but the economy has yet to enter a dangerous recession. Caution is warranted, but it appears pessimism is dominating, which may offer some opportunities.

  • OPEC is considering increasing their oil production significantly, sending oil prices lower. This would alleviate a lot of pain in prices, both in the US and especially in Europe. Lowered energy costs also gives consumers a bit of a boost, and just in time for the Christmas shopping season. Moreover, lower energy prices should help push down inflation figures, adding some fuel to the “central banks can slow down” narrative.

  • Expect a light trading week this week, and a return to business with reports on Black Friday shopping and retailers taking the spotlight next week. This week, durable goods orders will post and global manufacturing PMIs. Both will be watched, but they are unlikely to move markets much.

The Details & Chart of the Week

One of the most reliable indicators of a pending recession is the yield curve.

I specifically look at the difference between yields on 10-year US Treasury bonds and 3-month US Treasury bonds. In a normal environment, you get paid more to tie up your money for 10-years than you do for 3-months, but leading into a recession that relationship inverts. This week’s chart plots the difference between the two.

As you can see, over the past week, the yield curve has inverted and inverted quite strongly. When coupled with everything else, this is a signal that a recession may be beginning to develop.

However, a careful observer will note that it is not the inversion per se that signals the recession. Rather, it is the recovery from that inversion that signals a recession is imminent. In past recessions, the curve reverts about 3 to 10 months prior to the official start of the recession, meaning we have some time to sit and wait.

The point is: caution is warranted, but the current level of pessimism may be overdone.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Nov 14

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. With slightly lower inflation, investors caught hope that the Fed will slow rate hikes. Earnings are meh, but certainly not recessionary, and this week we get some important data on the fundamentals of the economy. I could see this as the beginning of a meaningful recovery rally. However, I would temper any enthusiasm with the longer-term outlook, which appears tepid at best.

  • The big news last week was a lower-than-expected inflation print (7.7% versus 8.0% expected). This lent investors hope that the Fed will slow down their rate increases. Earnings are mostly finished with over 90% of S&P 500 having reported. Earnings growth across all sectors is just over 2% for the quarter, which is not great but not terrible. With revenues up over 10% (and earnings up only 2%), investors are seeing inflation take its bite.

  • This week we get data on industrial production, retail sales, and producer prices (a measure of inflation). Each of these are important for insight on the economy. Investors will also listen to management outlooks from retail bellwethers Target and Walmart, especially with the Christmas shopping season rapidly approaching. Consumer spending has remained strong and has lifted the economy, but a slowdown in this would be bearish.

The Details

“It’s only when the tide goes out that you learn who has been swimming naked.”

Warren Buffett

Well… crypto markets have imploded over the past couple of weeks.

After sudden price plunges, one of the largest cryptocurrency exchanges, FTX, went suddenly and dramatically insolvent. Reuters reported that $1 billion to $2 billion was missing from client accounts and, apparently, executives at the exchange had surreptitiously moved about $10 billion to their trading firm to fund risky bets on other crypto businesses and market trades.

First of all, this has all happened before, which is why investors should be students of history as much as of markets. In the 1920s, banks and brokerage houses regularly used client money to fund risky market bets. It turns out this strategy still doesn’t work, but it is good to be reminded of that every century or so.

Second, it was amidst the fallout of those trades in the 1920s that lawmakers formed the FDIC, SEC, and the now-famous Securities Acts of 1933 and 1934, all of which still govern financial businesses and transactions. Crypto markets, of course, haven’t had such regulatory oversight and law, but I strongly suspect this is about to change.

Finally, crypto’s meltdown is a stark reminder of the difference between professionals and amateurs. Amateurs are obsessed with making money. Professionals are obsessed with managing risk. This event is likely to wash amateurs out of the business, making room for professionals to step in.

In the end, I see crypto laws and regulation coming quickly (politicians have already started making some noise about this), and I would expect a more professional class to begin managing these financial businesses. Both of these represent a real maturation of the sector and are very healthy, long-term.

Crypto isn’t dead, in my view, it is just growing up.

Chart of the Week

This week’s chart comes to us from Bloomberg News, and is notable for its historicity. The founder of the exchange FTX, Sam Bankman-Fried’s change in net worth may well be the fastest in the history of mankind—going from $16 billion to $0 in the space of about 36 hours.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Nov 7

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. With the Fed maintaining its aggressive posture, investors are forced to continue bidding down company valuations. This is likely to put the P/E ratio for public (and private) companies under continued pressure. This, all while inflation takes its bite from corporate profits. Despite all of this, demand remains strong and the labor market remains tight. Until the fundamentals of the economy start to erode in a meaningful way, investors may do well to simply sit tight and let this transition develop.

  • Earnings reports were largely sidelined in the news last week, overshadowed by the Fed and other big economic data. As it stands, 85% of S&P 500 companies have reported results, and it appears that earnings will be about 2.2% higher than they were at this time last year. Overall, this shows that earnings are beginning to wane in a meaningful way, and analysts now expect negative earnings growth in Q4 of this year (-1%). There is probably no more illustrative point about the damaging power of inflation on corporate profits than seeing revenues up by 10% and profits down 1%.

  • Last week saw considerable data, but none more important than the Fed’s interest rate hike and press conference. The Fed firmly declined to pivot, and seemed to warn investors that rates will keep going up, and may stay at higher levels for some time. Of course, markets sold away the hope of that dovish change in expectation of an aggressive Fed.

  • This week, we see the all-important inflation figure (8%, year-over-year is expected), and we also get consumer sentiment data. Of course, the US midterm elections are also this week (though market reaction is expected to be muted). Consumer credit posted today with a slight decline (down $5 billion, which was a pleasant surprise). Overall, this week is much quieter on the data front than last.

The Details

One thing that really struck me at the Fed’s press conference last week were several questions from reporters on how the Fed knows when rates are just right. In other words: what does the Fed believe causes or halts inflation? Understanding the Fed’s model helps investors understand how to interpret the data through the Fed’s lens.

And this is a topic that has been rather hot lately, especially in the political sphere (there is an election tomorrow, after all). And it is an important question: what causes inflation?

Sen. Elizabeth Warren has suggested that inflation is the result of higher energy costs from the war in Ukraine, and even corporate greed. Sen. Mitch McConnell has blamed excessive spending. Others have blamed bottlenecked supply chains.

Discerning the cause(s) of inflation is important because different causes call for different solutions and different tools.

Economists, generally, have three formal models of inflation of which I am aware:

  • Inflation is always and everywhere a monetary phenomenon. This was Nobel-laureate Milton Friedman’s view. He believed that central banks are the sole responsible parties for inflation. Creating currency from nothing debases your currency. Therefore, inflation is a monetary policy issue.
  • Inflation is the result of deficit spending on things that do not create economic growth. This is a much more recent view, one espoused by what is generally called Modern Monetary Theory. In short, creating currency from nothing is not necessarily bad, so long as it is spent on productive projects. It is inflationary when those projects are not productive.
  • Inflation is the result of the interplay between monetary policy, government spending, taxes, and economic growth. This is known as the Fiscal Theory of Price Level. Inflation is the result people losing faith in a government’s ability to repay its debts.

Each, of course, carries its own recommended solutions (and models). What became clear to me last week, however, is that the Fed does not subscribe to any particular view or model. In short, the Fed seems to believe that inflation exists, they have tools, so they’ll use them until they work.

And so we wait for them to work.

Chart of the Week

This week’s chart is a look at household savings rates in the US, UK, and Eurozone. The Covid stimulus across these areas is clearly seen as the spike on the chart. However, individuals in each economic zone have not responded the same over the past couple of years. The Eurozone and UK have both maintained higher savings rates than before the pandemic (and saw less of a spike). The US, by contrast, has seen savings rates plummet to 20-year lows, only lower in 2005.

In short, while people are still saving, it is clear that current spending in the US is coming from money that would have been saved in the previous economic cycle. While this is keeping consumer demand up, there is a limit. At some point consumers are forced to slow down and again resort to saving.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Oct 31

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. Last week’s GDP print was encouraging, and may have struck the right balance: economic growth, but with flagging consumer and business spending. The Fed meets this week, and all ears are listening for whether they plan to adjust the path of interest rate hikes. If we get some dovish commentary (which is my expectation), we could then expect to see a market rally. Overall, my view is cautious, but not pessimistic. There are some buying opportunities in this market, in my view, but consumer spending will be a key variable to watch.

  • In addition to being Fed week, investors get lots of data. We see data on manufacturing, job openings, the unemployment rate, productivity, and consumer credit. Any of this data could move markets, but it will be the Fed meeting that will dominate both the news and market gyrations.

  • Grains and foodstuffs are back in the news as Russia has pulled out of a pact to continue grain exports citing danger to merchant shipping. This in addition to rising energy prices, globally. In addition to the humanitarian concerns, food and energy are basic inputs into economies. With higher energy and food costs, economic growth is expected to slow in addition to the upward pressure this puts on already-high inflation figures.

The Details

This week we’re going to discuss a pet peeve of mine.

It is not uncommon to see charts like the one below both online and in presentations. The narrative usually runs something like this: markets have grown exponentially, and, over time, long-term investors are rewarded by simply staying invested. So, the conclusion runs, you should just stay invested!

What irks me about this narrative is that it is both true and not true.

It is true in the factual sense: yes, over a 60-year period, markets have tended to deliver exponential returns (see chart below), and there is a reasonable basis to believe the next 60-years will look similarly.

It is untrue in the sense that almost no one has a 60-year time horizon!

Real people who have real goals to achieve will become short-term investors at some point, which, unfortunately, makes all of us market timers. It is not enough to simply say “don’t worry, it’ll come back!” Of course markets will come back, but that isn’t the relevant concern. Whether markets recover in time for you to accomplish your goals is the relevant concern.

Proper investment and risk management must begin with an understanding of your goals. For some objectives, you may have a 30-year time horizon, while you may have a 3-year time horizon for others. Managing risk looks entirely different in each of those accounts.

Chart of the Week

Last week’s GDP release was both encouraging and discouraging.

Headline GDP growth was better than expected at 2.6%. However, private investment continued to contract and consumer spending, though still positive, was less than expected. In short, exports boosted GDP growth much more than normal, but that is unlikely to continue much longer.

The key variables to watch, in my view, are consumer spending (personal consumption, in the chart below) and private investment. If we see both of those turning negative, a recession is likely not far behind.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Oct 24

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. It is my view that investors could see an upside surprise from the Fed next week. While markets have priced-in a 0.75% rate hike (which I think is likely), I believe the central bank is also likely to offer more dovish guidance on the path of future hikes. Furthermore, the economy has remained fairly robust to these hikes and earnings growth is likely to continue through the end of the year. I would caution investors against being overly pessimistic at this moment.

  • About 20% of the S&P 500 has reported earnings for Q3, and it looks like companies will report around 3% profit growth over last year. Profit margins have started to show signs of pressure as companies are having more difficulty passing along cost increases from inflation. 3% profit growth is not great, but it is also not recessionary, and analysts continue to expect profit growth through year-end.

  • This week is a pretty busy one for data. Global PMI’s posted today—offering some insight into the health of global manufacturing and services—both posted a slight decline. Consumer confidence and new home sales both post this week, as do durable goods orders, and an advance reading on Q3 GDP. We also get personal consumption expenditures, which is the Fed’s preferred measure of inflation. Since the Fed meeting is next week, investors will be interpreting this data through the lens of Fed actions—which means that bad news is good news.

The Details

In my upcoming book, I recount a story from early in my career. The firm I was with rolled out some new financial planning software. Responding to my question, the trainer indicated that I could just put in long-run averages for my inflation assumptions, that “it really doesn’t matter too much anyway.” As I played around with the tool, however, I found that this was flat wrong—inflation assumptions mattered quite a lot!

Indeed, over the course of 20 years, the difference between a 3% inflation rate and a 5% inflation rate is the difference between achieving your goal and having only about two-thirds of the money you need! Said another way: you need almost 50% more money in the 5% inflationary scenario than in the 3% inflationary scenario.

The details of this are covered in my book, so I won’t recount them here. The point is, the damage done by high inflation cannot be understated. Furthermore, getting assumptions like this as right as possible when running financial planning scenarios is critically important. It is not enough to say “yeah, 3% is close enough.” Time and effort spent getting those expectations as right as possible is time and effort well spent!

So, while investors are rightfully reeling at the recent market selloff, inflation does considerably more damage, long-term, than do these short-term market downswings. Getting inflation back down is critical for investors with goals to achieve. And it is especially important for investors and practitioners who underestimated inflation over the coming decade.

Chart of the Week

There is a strange dichotomy in markets at the moment. On the one hand, talk of a recession is everywhere. On the other hand, analysts don’t see a recession in their earnings forecasts. European earnings estimates 1-year ahead of now indicate expectations for almost 5% earnings growth. Certainly not great, but also not recessionary. We see something similar in the US earnings growth outlook. Analysts expect mid to low single-digit earnings growth through next year. Again, not great, but not recessionary.

It can be easy to get caught up in a narrative. As investors, we should always let the data drive our narrative. At the moment, the data does not indicate that fear is warranted. Caution, certainly, but recessionary fears may be overblown—at least for the moment.

Of course, as the data changes, so do our minds.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Oct 10

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. This week starts earnings season, which will be important, but not nearly as important as the ongoing economic data as interpreted through Federal Reserve’s actions. In sum, investors expect about 3% earnings growth for this quarter, and outlooks will be watched closely for signs that inflation is eating into profits and/or consumers have slowed their buying.

  • Major banks, Walgreens, and Delta Airlines report earnings this week. Investors are listening closely to calls with executives to hear their outlooks for the economy, inflation, and spending. In sum, earnings are expected to grow about 3% for the quarter, but that is not equally distributed. Energy, Industrials, and Consumer Discretionary sectors are expected to see the highest growth this quarter, whereas Telecom, Financials, and Materials are expected to see the biggest drop.

    We also see data on inflation, retail sales, and consumer sentiment this week. Inflation is expected to post around 8.1%. Lower inflation would likely boost markets, whereas higher inflation would likely see markets sell off again.

  • Last week’s unemployment rate was generally positive: a drop from 3.6% to 3.5%, and more jobs than expected were created. This sent markets into a tailspin as investors moved away from a “the Fed is almost done” attitude toward a “the Fed is going to keep hiking rates.” As I have mentioned before, the underlying economy has remained fairly robust to the Fed’s actions so far. In my view, it is ultimately the economic data and corporate profits which drive prices.

The Details

I have tried to avoid it, but we have to talk about the war in Ukraine.

Of course, most people are rooting for Ukraine to prevail. However, exactly what the response of Europe and the United States should be to Putin’s aggressive invasion of his neighbor has become a politically-charged topic. It is not my intent to weigh in on the politics of the conflict, rather, I want to consider some high-level risks facing investors from the ongoing conflict.

First, as we have seen, the conflict has exacerbated inflation. Energy costs have ballooned, and grain costs have also jumped considerably. We have also seen many large companies work to divest their Russia-based holdings, partly in response to sanctions, but partly as a show of solidarity with Ukraine.

There is a deeper risk, however. Ukraine has become a proxy war between the US, her allies, and Russia. Which brings back many cold war era geopolitical risks. World War I showed us that regional proxy wars can ignite wider and more damaging confrontations, for example. Those wider confrontations change the nature of economies and therefore the investment landscape—especially when the largest economies in the world are involved.

From a consequence perspective (though not a probability perspective), the biggest risk is that nuclear-armed states are pulled into a hot war with one another. Since the dawn of the nuclear age, a direct war between nuclear-armed states has been avoided (because no one is sure how it would end), but past behavior is no guarantee of future results. And this risk, while unlikely, seems worth paying a high price to hedge away because the consequences are so large.

As this war becomes drawn out, these geopolitical risks grow. Investors should be mindful of the role they play in their portfolio allocation and risk-management. Again, I see these risks as small, and I do not claim the sky is falling. However, it would be equally foolish to claim that all is well on the eastern front.

Chart of the Week

This week’s chart is very simple: it shows the percentage of revenue earned internationally and domestically by companies in the S&P 500. What becomes obvious is that the 500 largest US companies are quite geographically diversified, which is both good and bad.

The good side means that these companies continue to expand into new markets, and that a blip in one area of the world has less of an impact on the overall movement of S&P 500 prices.

On the bad side: as the US dollar grows stronger relative to other currencies, the revenues coming from those international holdings becomes worth less when converted back to the US dollar. There are some tricks for offsetting that risk, but, ultimately, currency risks are something that companies just have to bear.

With the dollar growing stronger, existing international holdings become more of a drag on performance for US-based investors. For non-US-based investors, this exchange-rate move makes US markets considerably more attractive than they have been in a while.

source: FactSet Research Systems

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from Directional Advisors to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

What I Care About This Week | 2022 Oct 3

Posted by on in 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.

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