Tag: Market Update

by Franklin J. Parker, CFA

The Summary

Investors have been buying over the last week — large-cap US stocks have hit all-time highs. That said, there are underlying weaknesses. It is not earnings that have pushed prices higher. With about three-quarters of the S&P 500 companies reporting earnings, we have only seen around 3% earnings growth over this time last year (and last year saw earnings contract by around 7%). This means that valuations on stocks are becoming stretched. In fact, the price-to-earnings ratio (a measure of stock valuation) is now above both its 5- and 10-year averages.

This week we see data on inflation, retail sales, industrial production, and consumer sentiment. All of this gives us a helpful read on the economy, retail sales and consumer sentiment are playing a bigger role than usual. Of course, at the moment, investors are watching the Fed very closely. Markets still expect a rate cut in the May/June timeframe, and Tuesday’s inflation may give investors reason to adjust their thinking (and thereby move markets).

I admit, markets hitting all-time highs somewhat baffles me. That said, until the underlying economic data improves, I am generally cautious. History has shown us that markets are fragile when they move higher without support from the economic data. In all (and as this week’s chart shows), I don’t think it is time to celebrate just yet.

Chart of the Week

An interesting chart from Fathom Consulting this week who point out that the new highs in stocks is, in fact, not a new high when we factor-in inflation. When accounting for inflation, earnings are also below where they were when markets hit their previous all-time high, and it has only gotten worse from there. In a sense, this helps us to normalize equity markets in an otherwise strange environment.

So, despite the headlines, stock investors have moved backward over the last 3ish years!

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

by Franklin J. Parker, CFA

The Summary

• We are still in a holding pattern. Economic data continues to be mixed, and investors are now focused on consumer spending through the holiday season. Consumers have largely kept the US economy afloat and investors are expecting that trend to continue through the last month of the year.
  
  
• The US and EU central banks are expected to be done raising interest rates and markets now predict rates to begin coming down over the coming year. That expectation has resulted in prices moving higher for risky assets (stocks, bitcoin, etc). Interestingly, GDP growth in the US has started to diverge from other global economies — the Eurozone and Chinese economies have seen GDP growth slow, while the US has seen GDP growth tick upward (see Chart of the Week). The big question is whether the US can sail on her own without growth support from the rest of the world.
  
  
• I want to reiterate the challenge of this environment. US stocks have been volatile and traded mostly sideways since April of 2022, and long-dated bonds have had some of the worst returns on record. To be clear, this is a difficult environment to invest through. Even this recent rally has only pushed stocks back to where they were this summer. I am watching for a catalyst to break markets free from this sideways trading, whether that be higher or lower. Again, with such mixed data caution is warranted, and I am reluctant to recommend committing strongly to one direction or the other.

The Details

I watched a docuseries on Netflix this past weekend called Live to 100: Secrets of the Blue Zones.

The series follows bestselling author Dan Buettner as he travels to various blue zones around the world and discusses what they can teach us about living longer and also living better (a blue zone is an area where people live much much longer than the global average).

Buettner finds that there are four basic things that the longest-lived humans have in common, and these are things that can help us not just increase our lifespan, but also lower our healthcare costs through retirement.

First, they live in a way that exercise comes naturally. In some places, a village is nestled into a hillside or mountain making a simple walk to church or friend’s house an exertion. In other places, food from gardens is an important component of their food supply. In all places, however, constant natural movement is an important part of their lifestyle.

Second, they eat well. Long-lived folks tend to have a diet heavy in complex carbohydrates (things like yams, potatoes, sourdough breads) and vegetables. Wine seems to play an important role, as well. In all cases, moderation is the name of the game: only eating until you are about 80% full seems to make a big difference.

While diet and exercise are not surprising, what I found most interesting were the final two:

Having a relaxed and positive outlook on life appears to have a significant effect on living longer. Additionally, long-lived people tend to have a purpose that drives them, a real and expressible reason to live. This is something I can confirm in my own experience, a point I have discussed here before.

Last, the longest-lived people tend to have meaningful friendships, faith, and family connections. Having people around you who care about you, and for whom you care, is a very important component in both quantity and quality of life. Volunteering, faith, part-time work, even exercise leagues, can be simple but profoundly important ways to build and maintain your connection to other people.

For those of us who find our lives out of alignment with these principles, simple and small changes are probably our best bet for getting on a different track. Change one small thing, then another, then another. Before too long you’ll find that your life is different in a very positive way.

Chart of the Week

This week we see data on US GDP, and analysts expect it to post around 5% (annualized) for Q3. That would be a fantastic figure, to be sure especially when one considers that China and the Eurozone are both in a downward GDP growth trend. Can the US continue its stellar performance without other major economies? Markets are celebrating a successful soft landing by the Federal Reserve. However, history is not on our side here. Typically, recessions are global phenomena, and central banks have yet to engineer a soft landing. Yet I must admit that there is a first time for everything. Will this be it?

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

by Franklin J. Parker, CFA

The Summary

• Inflation posted lower than expected last week, and markets now believe the Fed is done raising rates. In fact, markets expect the Fed to begin lowering rates sometime around May of next year. We also saw data last week on retail sales and industrial production, both of which were pretty mediocre. Despite being a short week, we see important data on home sales, durable goods orders, and consumer sentiment.
  
  
• Investors have taken the Fed’s commentary suggesting an end to rate hikes and slower inflation figures as an “all clear” signal. I am, however, still cautious. The economic data is still mixed — there hasn’t been a firm signal to suggest taking a strong stance in either direction. Besides, the market’s expectation that the Fed begin cutting rates in May of 2024 is itself a recessionary signal. The Fed tends to cut rates just before a recession. In the end, we need to see a firm change in the economic data: expanding corporate profits and employment, or a strong signal that things are weakening. Until then, unfortunately, we are stuck in what one client called “the longest recession watch in history.”
  
  
  

The Details

With Thanksgiving approaching, family is on our minds. And with family gathering, it is a good time to review your estate plan.

Estate planning is not something that most people want to think about regularly: What happens after I die? can be a morbid question to dwell on. Estate planning, however is about more than just that, and with family gathering, this is a good time to discuss your plans and expectations with them.

First, an important part of estate planning is detailing what you want to happen while you are still alive. Putting some basics in place, like medical and financial powers of attorney, are important to do because they are useful in moments where you are unable to make decisions.

It is also worth noting that much estate planning today involves adjusting the ownership of your assets while you are still alive in order to take advantage of tax rules and liability issues that center around how you own an asset. This kind of planning also aids in a smooth transition of those assets after your death.

The technical components of an estate plan are obviously critical (and should be handled by a good estate planning attorney), but it is also important that you communicate your plans and expectations to your family. Not to mention the value of simply showing family members where the documents are and who to call if something happens!

These little details can also help put family members at ease. And, if you need to start a conversation about putting something together, please reach out. While Directional Advisors does not provide tax or legal advice, we can certainly discuss what to expect and help you connect with the right professional for you.

Chart of the Week

Industrial production is one of the data points that I watch on my recession dashboard. Production tends to decline ahead of recessions (though not always). As the chart shows, we have had an extended period of weakness in US production, and this week’s data is not expected to change that trend. While not itself definitive (take 2015 – 2016 for example — production contracted, but there was no recession), it is a sign of weakness.

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

by Franklin J. Parker, CFA

The Summary

• Earnings season is coming to a close and it is better than expected. S&P 500 companies grew earnings by about 4%, which was much better than the expected no-growth scenario. This is important because this is the first earnings increase in a year. Guidance has also generally been good, and analysts are now expecting growth in earnings for Q4 and Q1 of next year.
  
  
• Several important data releases are this week, including industrial production, retail sales, and the all-important inflation figure. Inflation is expected to post at 4.1%, and this is a figure that can move markets if it is much higher or lower because it has a direct effect on Fed rate expectations. At the moment, investors see a potential rate hike in early 2024, but the probability of that has dropped over the last few months, and many investors have started pricing-in peak rates, with a drop in rates as 2024 wears on.
  
  
• Earnings have given investors a reason to be optimistic — if companies can indeed pull off profit growth for the next two quarters, this past year may have just been a blip and the risks of recession would fade into the background. Other economic data is still negative so it is not yet time to declare victory, but the ambiguity is likely to resolve in one way or another (either more expansion, or a recession). I still see the risks to the downside, but the data is very muddy and markets need something to happen to move them higher or lower.
  

The Details

Let’s talk about risk control strategies.

I have regularly suggested that goals-based investors consider controlling their downside risk given the ambiguous economic data (and the danger that this ambiguity breaks by sending markets strongly lower). But how do we go about managing that downside risk? There are three basic steps we must follow.

1. Quantify the Risk

Before we can take steps to control something, we have to first understand it! This begins by understanding your financial goals, and from there extrapolating a return that we need from your investments. When coupled with your time horizon, we can do some math and understand the downside risk you can afford to weather before you’ve lost too much in your portfolio.

In fact, a few months ago, we released a simple tool to help investors assess how much they can afford to lose in their investments before they’ve lost too much (if you haven’t checked out our MAL tool, you should!).

2. Mitigate the Risk

Once we understand the downside that we can afford to weather, we can take steps to mitigate those risks. It is important to note that risks can never be completely eliminated, only minimized!

This can be done in different ways. Sometimes, simply allocating to different investments (or cash) does the trick. Sometimes, we can add a trade to your portfolio that automatically sells certain investments if they cross below a given price. Or, we could use some options strategies to hedge against certain market drops. The exact strategy will — you guessed it — depend on your goals and objectives!

3. Monitor the Risk

It is not enough to simply set it and forget it. We have to constantly monitor markets, your objectives, and your portfolio to ensure we are properly offsetting risks.

All of that said, the types of market drawdowns that can blow up a financial plan are rare. While it is important to understand them and take steps to mitigate them, there are many things going on at once in managing your investments, all of which are important. In this environment, however, downside risk strikes me as one item that is moving up the list of concerns. We’d love to chat with you if this is something on your mind, too.

Chart of the Week

The US has been the world’s largest economy for 100 years now. Over the last decade — and especially since COVID — the US has pulled much farther ahead when looking at GDP per person, and the difference is pretty dramatic. Much of that difference since COVID may be due to the drastic and sizeable measures taken by the US government relative to Europe and Asia. Understanding the “whys” of the differences in growth is important to extrapolate what may or may not be true into the future.

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

by Franklin J. Parker, CFA

The Summary

• The big news last week was the stellar GDP growth for last quarter: 4.9%. This was much higher than most analysts expected and adds to the conflicting data this economy is putting out. Of course, it is not unusual to have a strong economic growth just before it contracts. I think of this like a car engine that is sputtering: you get jolts of power here and there until it finally stops. Similarly, the conflicting data in the economy may be because the economy sputtering out. This quarter’s figures will be key, and I am watching unemployment, consumer spending, and consumer debt. The US consumer is holding the economy afloat, and weakness there is likely to lead to a wider problem.
  
  
• Corporate earnings have been among the conflicting data we have seen. For three quarters in a row, companies have reported a decline in earnings relative to the year before. With about half of the S&P 500 companies having reported earnings, it appears this quarter may see a break in the trend, with large US companies reporting an increase in earnings of 2.7% over the same time last year.
  
  
• This week is Fed week. Markets do not expect a change in the Federal Reserve’s policy rate, but Powell’s press conference will be a key moment to watch. Investors are very keen to understand when the Fed will declare victory over the inflation battle, and indicate a “peak rate.” Interestingly, bond markets have completely repriced expectations, with yields on the 30-year US treasury racing from 3.5% just a few months ago to over 5%. This has cascaded into higher borrowing costs throughout the economy (notably in mortgages), and has led to a considerably more restrictive credit environment. Not to mention, putting considerable strain on banks. As I have done most every week since this summer, I am reiterating my view that caution is warranted. Until the data shifts, markets are in a no-man’s land of sorts, with no firm catalyst to move higher or lower, but the dominant risk is to the downside.
  

The Details

The Wall Street Journal had an article in their Sunday edition: “Can ChatGPT Replace Your Financial Advisor? Not Yet. But Wait.” Here’s my take. (I also asked ChatGPT to summarize the article, see below).

“ChatGPT, Please Summarize This Article”

“The article discusses the potential of AI in replacing human financial advisers. It outlines five essential qualities for effective financial advice and evaluates how AI currently performs in each aspect:

1. Debiasing: Human advisers excel at helping clients avoid costly mistakes caused by behavioral tendencies. AI, however, exhibits similar biases and tendencies, which could lead to costly mistakes. To improve AI performance, metarules (rules governing other rules) need to be created to help the software override these biases.
2. Empathy: AI, like ChatGPT, excels at empathy, which is crucial for reassuring and supporting investors during market turmoil. Studies have shown that AI can provide empathetic responses comparable to or better than human advisers.
3. Accuracy: AI currently struggles with accuracy, sometimes providing incorrect information. This issue can be mitigated by integrating AI with reliable financial databases and plug-ins to ensure accurate recommendations.
4. Best interest: Advisers must act in the best interest of their clients, and AI, in theory, should be less likely to have conflicts of interest. However, there’s uncertainty about how well AI will perform in this aspect, and it’s important for AI architects to audit the recommendations of digital advisers.
5. Consistency: Good financial advice should be consistent across different advisers. Research suggests that human advisers often struggle with this, but AI has the potential to achieve consistency by providing the same advice to clients with similar financial needs and preferences.

The article suggests that while improvements are needed, AI will play an important role in the future of financial advice. A potential model is a hybrid approach where humans collaborate effectively with AI, similar to how doctors work with smart software in the medical field. This hybrid model could increase access to financial advice. The author believes that human advisers can use AI to enhance their services rather than worry about job replacement.”

There is lots of discussion around AI and what it may or may not do for humans in the future. I am certainly not qualified to wade into the big picture discussion, however I do know the financial advisory business, so this is one AI topic I feel qualified to discuss.

I agree with Dr. Benartzi, the author of the WSJ article, in almost all respects. Because AI is trained on past data (and past financial data is riddled with human biases), AI has human bias “hard-coded,” so it is not particularly helpful with overcoming them. AI also lacks empathy and understanding, and, of course, it often simply makes things up (and its fictions tend to be indistinguishable from fact). Not to mention, current AI models tend to give almost comedically simplistic advice. For example, as an experiment I have repeatedly attempted to use ChatGPT to help me write one of these weekly updates, but its treatment of the topics is so trite and shallow that I would be embarrassed to associate my name with such work.

What Dr. Benartzi does not account for, however, is the rapid improvement of AI (and specifically language models). There are empathetic AIs now in development. Also in development are hallucination-free AIs that can ensure correct and consistent information on various topics. These developments will go a long way to seeing AI more rapidly adopted by the financial sector, and specifically financial advisors.

All that said, I am not yet convinced that AIs will have any ability for creative solutions. I cannot count how many times normal, everyday human conversation and connection led to an solution to a client problem that was nowhere near “textbook”. Will AI have such insights? Even if we grant the creativity component, will people interact in a human-enough way to even trust AI with the problem in the first place?

Time will tell. But I do agree that AI will be an important tool in the financial advisor’s toolbox very soon.

Chart of the Week

This week’s chart is a breakdown of US economic growth. First, it is worth noting that a high growth quarter can precede a contraction, which is what happened in Q4 of 2021. This quarter’s growth was higher than even the most optimistic of predictions, and was driven mostly by consumer spending (and business inventories helped, as well). It is an odd fact that companies have been making less money for a year now, despite the economy expanding — we would typically expect the opposite to occur. That lends to the general sense that something has to give: either the economy stalls out (and earnings were a precursor to that), or companies begin to grow again.

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.