Tag: Market Update

What I Care About This Week | 2022 Sep 19

Posted by on in Uncategorized

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.

source: Reuters / Refinitiv

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 Sep 12

Posted by on in Uncategorized

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.

What I Care About This Week | 2022 Sep 6

Posted by on in Uncategorized

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.

What I Care About This Week | 2022 Aug 29

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • The Federal Reserve’s annual retreat at Jackson Hole, WY was last week. Historically, this has been a time when Fed speeches are used to provide a defense of policy as well as some nuance and outlook for that policy. This meeting was no different. Chairman Powell reiterated the FOMC’s commitment to bringing down inflation even if that meant enduring “some economic pain.” This was one of the few times that the chairman acknowledged the Fed’s willingness to push the economy into a recession if it meant bringing down inflation.

  • This week we get unemployment data (3.5% expected), factory orders for August (0.2% increase), consumer confidence (slight rise), and job openings (slight decline). Investors are watching all of this through the lens of Federal Reserve activity, and also with an eye to a potential slowdown in the drivers of this economy. Those two are the main forces pulling prices around.

  • As I have often discussed here, investors are struggling to balance the influence of the Fed with the influence of corporate profit growth. Earnings season was generally ok, and outlooks are positive — most analysts expect ongoing profit growth through the end of the year. Yet the Fed’s ongoing guidance that rates are likely to trend higher has spooked many investors. This tug-of-war between generally ok economic data and the Federal Reserve is likely to continue for the near future. However, it is the economic data that will drive the general direction of market prices, at least in my view. As long as consumer demand is strong and corporate profit growth continues, I expect prices to drift higher.

The Details

When operating in a high-inflation environment, companies typically go through three stages.

Stage 1. Usually corporate executives see higher costs coming. To get ahead of those higher costs, they will raise prices as quickly as possible. This shows up as expanded profit margins and higher-than-normal earnings growth. Of course, that also means higher stock prices.

Stage 2. Thankfully, companies cannot raise prices forever so they are eventually forced to begin eating these higher costs. This shows up as lower margins and decreasing profits. As we would expect, this also means lower stock prices.

Stage 3. For as long as high inflation remains, this tug-of-war exists. Companies will raise prices when/if they can, and inflation will work to eat away their profits. Generally speaking, when viewed over a long period of time, companies tend to keep up with inflation, but it is certainly not a straight line. Inflation injects lots of volatility into profits and, by extension, market prices.

Fathom Consulting put out a chart this morning that shows we are firmly in Stage 2. After increasing profit margins over the past year, US companies are now unable to continue passing those increased costs on to consumers. This bodes well for future inflation figures, but creates a challenge for future profits.

Chart of the Week

This week’s chart is my favorite recession indicator: the 3-month US Treasury yield minus the 10-year US Treasury yield. When this figure turns negative, a recession is typically not too far behind. While financial news focuses on other yield curve indicators, I find that none of the others are as reliable as this one. While the indicator has moved very quickly toward zero over the past few months, it has not yet turned negative. Once it does, my “recession clock” begins in earnest — we typically get anywhere from 6 to 18 months before the recession hits. Interestingly, the indicator tends to become positive again just before the recession actually hits.

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 Aug 15

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • Last week, inflation posted lower than expected and came off of its previous highs. Both consumer prices (which is what you hear about in the news) and producer prices (which is what the Fed watches more closely) abated a little in June. That said, consumer prices still rose 8.5% year-over-year, which is still very high, and the Fed has so far kept their guidance for aggressive rate hikes.

  • This week, investors will get a sense of the health of US consumers with retail sales data posting on Wednesday. In that theme, Walmart and Target report earnings this week, and investors are very likely to see these two as a bellwether. Some information on manufacturing hits as well with industrial production and the NY Fed’s Manufacturing index.

  • Overall, investors appear to be pricing away the Fed a bit faster than may be warranted. On the upside, companies have grown earnings and the US consumer remains strong. If those two factors begin to falter, investors may do well to adopt a more defensive posture.

The Details

What is risk?

In the traditional economic sense, risk is the volatility of your portfolio. A more extreme rollercoaster is generally less preferred than a less extreme rollercoaster. In this context, diversified portfolios, held forever, are preferable to non-diversified portfolios with limited holding periods.

A new line of thinking is emerging, however. Risk, at least to me, is the probability that you fail to achieve your goals. Most of the time that means trying to lower the volatility of a portfolio, but not always. There are some circumstances when concentrated and very volatile positions are appropriate.

Also in this context, the timing of market drops matters because goals usually have a limited time horizon. A 2008 in your portfolio is considerably worse right before you retire than it is when you are 20 years from retirement.

Ultimately, this means that we must view potential market moves and investment selection through the lens of the goals you are trying to achieve. That is why financial planning is so important. We have to understand you and your objectives just as well as we have to understand the wider world of investment opportunities.

Chart of the Week

Another recession indicator that I follow is the Conference Board’s Index of Leading Economic Indicators. It is a quick summary of many different economic indicators (the S&P 500 index is one of them).

This index has been on the decline recently, which is usually a recessionary signal. However, as past recessions have shown us, there can be quite a time gap between when the index peaks and when the recession actually hits. Taking the COVID recession out of the data puts the average time around 16 months. With the recent peak in February of 2022, based on this index alone, we might expect a recession sometime in June of 2023.

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 Aug 1

Posted by on in Uncategorized

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.

What I Care About This Week | 2022 July 18

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • All investor focus has turned to earnings, with big-name companies reporting this week (like IBM, Johnson & Johnson, Netflix, Abbott Labs, Comerica, etc). As it stands, analysts expect 4% growth in earnings for the quarter. While low this is still growth, and it would be unusual to have a recession while corporate profits are growing. Of course, how investors react will also be heavily driven by guidance and how executives discuss inflation. Plenty to watch over the next few weeks!

  • Last week’s data was a mixed bag. Inflation is bad—worse than expected. At 9.1%, inflation is bumping up against double-digits and is at the highest levels since the early 1980s. This is pushing the Fed to act aggressively with raising rates, and investors now expect a 0.75% rate hike at the Fed’s meeting at the end of the month.

    However, some data was positive. Turns out there are more open jobs than previously thought, and the headline unemployment rate continues to indicate a very tight labor market. Retail sales were higher than expected, indicating consumers are—so far, at least—still spending money even though prices are higher.

  • As I discussed a few weeks ago, if we are in a recession it would be the strangest recession on record. That isn’t to say I expect smooth sailing, but it does indicate that we may have generally more upside than downside from here. For investors with cash to deploy, this may be a good entry point, and for investors whose goals are years away, this is likely to be a passing concern. As always, your goals, risk tolerance, and time horizon will govern what you should do in this economic environment.

The Details

There is a somewhat arcane metric in economics called “total factor productivity” (often called TFP for short). In essence, if you add up all of the labor in the economy and all of the capital in the economy, you have some growth left over, and that growth is attributed to TFP.

Economists think of this as the role of technology in an economy. As technology advances, both labor and capital tend to get more productive. So, technological advances add a multiplier to economic growth that would otherwise be constrained (because there are only so many people in the world and there is only so much capital in the world). For example, TFP accounts for the difference between one worker making a pair of shoes by hand in a day, and one worker running a machine that makes 1000s of shoes in a day. 1000s of shoes took the same input of labor (1 day of work), but they took more capital (the machine), and more technology. TFP measures this technology component.

Historically, TFP tends to grow at about 0.68% per year, but there are periods of stagnation. The period from the early 1970s to the early 1980s, for example, was a period when technological adoption through the economy appeared to stagnate (at least, as measured by TFP).

The bottom line is that, as investors, we cannot underestimate the role of innovation in the economy. Without it, the economy can stagnate and run sideways, even amidst population and capital growth. With it, growth can easily outstrip what should be possible with labor and capital investments alone.

Innovation has been—and is very likely to continue to be—the key to increasing our standards of living via economic growth. Especially as the economic waters grow murkier, investors would do well to focus on the basics: companies adding real value to real people in the real world.

Chart of the Week

This week’s chart shows the divergence between expected earnings growth for US vs European companies. In both cases earnings are expected to grow, but analysts have gotten more pessimistic about the growth story in Europe and more optimistic about the growth story in the United States.

Of course, earnings growth is only part of the story. For investors to harvest differences in return also requires exposure to currency risks. With the Euro falling strongly against the dollar, dollar-based investors may be better poised to harvest these differences in return than Euro-based investors.

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 July 11

Posted by on in Uncategorized

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.

What I Care About This Week | 2022 July 5

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • It is jobs week! We got factory orders today, which surprised to the upside (1.6% growth vs 0.5% expected). JOLTS job openings report tomorrow, we get the unemployment rate and average earnings on Friday. Employment is the key figure in ongoing economic growth, so it could move markets.

  • Last week’s data was a mixed bag: consumers spent more than they earned for the first time since December. In addition, personal consumption expenditures increased at an uncomfortably higher level, though if we factor out food and energy costs, it does appear that PCEs are slowing, although it may also be that consumers are having to stop buying other things to keep up with rising food and energy costs. PCEs are the Fed’s preferred measure of inflation, so higher figures here drew pessimism from market participants about the outlook for Fed policy.

  • Next week kicks off earnings season. Maybe more than anytime before, this earnings season will be critical. Because this economic environment is so ambiguous (if we are in a recession, for example, it is the strangest recession on record), investors will be watching corporate results and their outlook for direction. At the end of the day, earnings growth is what drives market prices. If earnings growth is expected to wane, prices are likely to fall further. Despite the doom and gloom, this quarter is expected to see positive earnings growth for the market as a whole.

The Details

There is a controversy silently brewing between the investment management industry and regulators. “Greenwashing” has become a real, and not often talked about, problem.

With ESG investing (Environmental, social, and governance investing) becoming more popular, regulators have begun to take notice of funds and investment managers that make claims to the investing style, but do not back up their actions with the claims. “Greenwashing” is the term that describes an investment strategy that claims to have an ESG mandate, but whose holdings are indistinguishable from a non-ESG mandate. It can also refer to an investment process that has a marketing banner of ESG, but does not, in fact, consider any ESG factors in the security selection process.

The challenge, of course, is that there is no standard definition for ESG investing. Because ESG investing is very personal, I doubt a standard definition ever could exist. For example, one investor might include Tesla in an ESG strategy because of its positive environmental impact, while another might exclude Tesla because of its poor social or governance components. The point is: every investor values each ESG component separately, belying any attempt to codify the practice across the industry.

Recently, regulators in Germany outright raided Deutsche Bank’s asset management unit on allegations of greenwashing. The SEC recently proposed two new rules to combat it.

More than anything, securities regulators do not like lying. If a firm says they are running an ESG strategy, they had better be able to prove in court that they are running an ESG strategy. Regulators are even more apt to ensure investors are getting what they pay for since the average ESG fund is almost 50% more expensive than the average investment fund.

I believe that investors should consider their ethical investment goals just as carefully as their financial goals. Just as with all goals, these are very personal undertakings, and when tradeoffs exist, those tradeoffs should be carefully considered. In the end, it is incumbent on us, investors and advisors, to navigate these waters and to do our due diligence!

Chart of the Week

Capacity utilization is, in theory, a measure of how much of its potential economic capacity the US is using. A little-talked about figure, it can give some insight into the underlying fundamentals of the economy. Other than 2008 (which was a financial-driven recession), this figure tends to decline leading into recessions. At the moment, it is at its highest levels in over 15 years.

This is an odd economic environment, to be sure. I am cautious to rely too heavily on indicators that worked pre-2020 as I believe post-2020 is a different paradigm. Even so, the underlying economy appears to be fairly robust, despite the headlines.

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 June 27

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • This morning we saw data on the pending sales of homes, which surprised to the upside: +0.7% vs. -3.7% expected. This is the first positive figure since October 2021. Looking ahead, we get data on home prices, consumer confidence (another drop expected), personal incomes and consumption, and a couple of indices on manufacturing. Overall a pretty busy week in data. With data we have seen this quarter, the narrative of slower growth is gaining traction. And, although the word is thrown around a lot lately, the evidence of a looming recession is scant (of course, that isn’t to say a recession cannot happen anyway).

  • Ever-more isolated by sanctions, for the first time in 100 years Russia officially defaulted on her debt this weekend. Thanks to ongoing oil and gas payments, Russia does have the cash to pay the overdue interest payments, but is not able to transfer payments to bondholders due to sanctions. Technically this is a default, though Russian officials have pushed back on that word. The significance of a major economy failing to make interest payments on its sovereign debt cannot be understated. Despite the situation, it does hurt the general confidence of market participants, and it is a stark reminder of very real (and often forgotten) political risk.

  • Markets have rallied strongly over the past week, yet the S&P 500 still remains almost 20% off of its highs. If the US economy is or is about to be in a recession, last week’s rally will be one of many bear market rallies on the way down. If, however, a recession is not forthcoming, I would expect markets to continue higher. How you view the current economy will inform how you interpret recent market rallies (and selloffs). As always, understanding these events through the lens of the data is of paramount importance. While our feelings get loud during times like this, they are not a good guide for strategy in their raw form.

The Details

Let’s talk about what is going on with cryptocurrencies.

Bitcoin, a good proxy for the crypto market as a whole, is down almost 70% from last year’s high. Using traditional lines of thinking, this should not be the market reaction to higher inflation. Inflation is, at heart, a loss of value in your domestic currency. Meaning other currencies should gain in value. Were bitcoin a traditional currency, this line of thinking might apply.

However, bitcoin (and other crypto assets) are not traditional currencies. Rather, as their recent price action has shown, they are very risky assets. As such, they are governed more by liquidity flows than traditional valuation models. Let’s dig into that a bit.

Cash flows across markets in fairly predictable ways. During times of cash inflows, investors allocate to safer assets first, then they allocate cash to risky assets (like stocks or high yield bonds), then they allocate to more speculative markets (like angel investments, hedge funds, or cryptocurrencies). When cash flows away from investors, it is pulled from the last market first. So, speculative investments get liquidated first, then risky investments, then safer investments.

In many ways, this makes crypto a sort of “canary in the coal mine.” The selloff began there first because it is a liquid and speculative investment. As cash flowed away from investors, they began to re-allocate away from these markets and into others (pushing stocks higher and crypto down). Of course, cash kept flowing away from investors (in the form of quantitative tightening and inflation) so that selloff continued into risky markets. Now with less cash available to it than before, prices in this market may struggle to regain their previous levels (at least until cash begins to move back toward investors).

And, of course, as good times turn to bad times, we find out which organizations have the fortitude and foresight to survive. This is a good thing, long term, for that marketplace. After this, the crypto market should be a somewhat less speculative place to be.

Chart of the Week

The Federal Reserve has repeatedly talked about inflation expectations as a source of policy frustration. Along with very real policy tools, the Fed actively attempts to influence sentiment among both market participants and the general public. A public that believes inflation will continue marching higher is a public that will actively push inflation higher through the aggregation of their individual actions.

So, charts like this week’s are not good news to the Fed. As consumer sentiment has plunged, expectations for inflation—across both 1-year and 5-year windows—have increased substantially. As a keen observer will note, as inflation expectations increase, the general mood among consumers tends to decrease.

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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