Tag: Market Update

What I Care About This Week | 2023 July 10

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • It’s earnings season! Some major companies report this week and they are a good bellwether for the economy as a whole. JPMorgan, Wells Fargo, BlackRock, Citigroup, PepsiCo, and Delta Airlines are all on deck this week. At the moment, analysts expect a decline in corporate profits of about 7%. In addition to understanding the health of sales, investors will be listening closely to the outlook of management for the back half of the year.

  • This week we also see all-important inflation data. Economists expect inflation to be around 3.1%, down from 4.0%, which would be good news, generally. Core inflation, however, remains pretty sticky and is expected to come in around 5.0%, only down a bit from 5.1%. In addition to its effects on corporate profit margins, the concern is that consumers cannot hold up for much longer under the heavy inflation burden. Of course, inflation is also a central figure in the Fed’s interest rate decisions, and this will be the last inflation print before their meeting later this month. Markets now expect the Fed to raise rates at least once more before the end of the year.

  • Markets have been in a holding pattern for the last month. I am once again reiterating my view that a recession is on the horizon, though not here just yet. All of the classic signals are there, but the “recession is imminent” signals have not yet been triggered. Until then caution is warranted, and investors may do well to stay invested but include hedges or risk-controls against severe losses in their portfolio. As always, your goals will determine the types of risk you can and cannot afford to take.

The Details

Back in March, when Silicon Valley Bank (and others) failed, I spent quite a bit time looking at the balance sheets of regional banks in an attempt to sus-out how big the problem was. What I found was very concerning.

The problem with these banks is that they are not reporting the actual value of many of their bond and MBS holdings. Because regulations allow banks to hold these types of securities as “held to maturity,” they can lose considerable value but report the same value on the bank’s balance sheet. That makes it look like the bank has more in assets than there actually is.

Banks, of course, are not eager to report these figures, so some old-fashioned sleuthing work and estimation has to be done. As it turned out, almost every regional bank I looked at had negative equity (which is when liabilities are bigger than assets) when you adjusted for the estimated losses in their held-to-maturity portfolio.

Now, banks can run with negative equity for some time so this is not necessarily a death sentence. Plus, the Federal Reserve has implemented some programs to keep the banks solvent. When their balance sheets are in trouble, however, banks curtail lending considerably. That tightening of credit can slow down economic growth. And, of course, in a crisis, that problem of negative equity can sink a bank very quickly (as we have seen).

In any event, this is something to watch. If the Fed decides to raise rates again, and tighten the money supply, we may see more banks struggle to remain solvent.

Chart of the Week

Last week we got a look at the health of the services sector (services are 70%+ of the US economy). After a steady decline through 2022, it appears that services have ticked up in the last month (in this indicator, anything above 50 is expansion). Of course, one report does not a trend make, but this is one positive economic data point.

source: Refinitiv datastream

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 | 2023 June 26

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • This week we get some important data on both the economy and inflation. New home sales, consumer confidence, durable goods orders, PMIs, and personal consumption expenditures (on of the Fed’s preferred measures of inflation) are all on tap. In general, expectations are low for these figures. Durable goods, new home sales, and consumer confidence are all expected to tick down with PMIs remaining in contraction territory.

  • With the Fed meeting out of the way, most eyes are turning to earnings season starting next month. At the moment, investors are expecting another quarter of shrinking earnings. While this could be short-lived, it is yet another signal that the economy is sputtering. My view is that a recession is likely within the next 6 months or so, but I have yet to get the “a recession is imminent” signals. This puts markets in a bit of a middle ground without a firm catalyst to move, either higher or lower. I continue to look for opportunities to reduce portfolio risks for those whose goals warrant such moves.

A Look at Recession Probabilities

Let’s cut to brass tacks and look at a few recession probability models.

I spend quite a bit of time talking about individual data points. That is important because each one is a piece of the mosaic that is our economy. Sometimes, however, it is easier to simply skim over those figures and wonder “So what?”. This week, let’s put that mosaic together in a more concrete way.

I have several models that I review to try and parse the business cycle. My simplest model is in the chart below. As you can see, it is indicating a 94% probability of a recession by January 2024, which is the highest this indicator has been since the early 2000s. Much of the intensity of this signal is coming from the yield curve, which has reached its most extreme inversion since 1981, but that is not the only input to this model.

In addition to my simpler model, I have a more advanced model that leans on more data and some AI techniques to combine. I trust it a little less because the only out-of-sample recession in the model was 2020 (which it did accurately predict, as did my simpler model). At any rate, this model is also showing increasing odds of a recession.

The NY Fed’s recession indicator, which is based solely on the yield curve, has a recession probability of 71%, which is the strongest it has been since the early 1980s (when the US experienced two back-to-back recessions).

source: NY Federal Reserve

The Conference Board’s recession probability model has the possibility of a recession by February 2024 at 99%. That is higher than their model indicated just before 2008. They see the downturn starting the third quarter of 2023.

source: The Conference Board

And, of course, there are the various commercial models out there. Bloomberg’s recession probability model is at an elevated 65%. The point is, no matter who does the slicing, the data seems to point to a recessionary environment.

This is a good time to point out, however, that just because a recession is looming does not mean markets won’t move higher. First, there is the possibility that a recession does not form. Second, however, it is not unusual for markets to rally into the end of a business cycle, as we discussed in our May 1 update.

Of course, exactly how you implement this outlook in your investments will depend on your financial goals, but that is a conversation you should be having now.

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 | 2023 June 19

Posted by on in Uncategorized2 Comments

by Franklin J. Parker, CFA

The Summary

  • The big news last week was the Fed’s decision to keep interest rates where they are. That was no surprise to markets (there was only about a 5% chance of a hike), but Fed officials continued to insist that they expect two more rate hikes before the end of the year. Of course markets cheered the pause but were negative on the “two more” part. There were two important things this Fed meeting demonstrated, however: (1) markets are becoming less sensitive to changes in Fed policy (other forces are taking over), and (2) the Fed is beginning to see negative developments in the economy that have them adjusting policy. The second point is important: once the Fed starts cutting rates, a recession is typically not far behind. Rate cuts, at this point, are bearish — not bullish — for markets.

  • This week is a light data week. Though the Fed meeting took center stage last week, we did see other important data on inflation, retail sales, and industrial production. Headline inflation dropped from 4.9% to 4.0%, but core inflation (which factors out food and energy prices) remained high at 5.3%. Retail sales continued its strong showing, with a surprise 0.3% increase over last month (a drop of 0.1% was expected). In short, consumers are still keeping everything afloat, despite inflation.

  • The next couple of weeks should be pretty quiet. I am reiterating my view that this is a good time for investors to hedge portfolios and/or reduce risk. This market rally does have me scratching my head a bit, but a rally into a recession is not unusual behavior for markets. As always, your goals will determine the types of risk you can afford to take, and the types of risk you cannot afford to take. Understanding that should be central to managing your portfolio.

The Details

Let’s talk about the AI hype, but specifically the market’s reaction to it. Have you seen Nvidia lately?!?

Artificial Intelligence (AI) is all the rage these days, and, to be fair, there is good reason. Recent developments promise to change the way business is done in a way not seen since the internet revolution in the 1990s. And the internet revolution offers some valuable historical lessons we can apply here.

During the 1990s, especially the late 1990s, the hype surrounding the internet reached a fever pitch — any business associated with this new way of doing business was seeing massive increases in stock price. As we learned quickly, however, those increases were not always justified. In fact, hype is often the enemy of reasonable behavior.

Take Nvidia as an example. They are currently trading at multiple of about 225… this means that investors are willing to pay $225 for every $1 they have earned in profit. It doesn’t take a finance genius to wonder how that makes sense. If you do run the math, however, you will find that, at its current price, Nvidia would need to grow earnings by 62% every year for the next 10 years for an investor to just break even!

The basic question is, then: do you think developments AI will give Nvidia the ability to do that? I am no expert in AI, but I would struggle to believe that were possible.

None of that is to say that Nvidia stock won’t continue to climb (and I’m not picking on Nvidia here, they are just an example). If we have learned anything from market behavior in a bubble it is that extreme valuations can persist for quite some time. Investors can make money in these moments, but the key is to not be left holding the bag when the music stops.

In that vein, I will close with a quote from Scott McNealy, former CEO of Sun Microsystems, that sums up these ideas:

“[In the year 2000, Sun Microsystems was] selling at ten times revenues…

At ten times revenues, to give you a ten-year payback, I have to pay you 100% of revenues for ten straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes that, with zero R&D for the next ten years, I can maintain the current revenue run rate….

Do you realize how ridiculous those basic assumptions are? You don’t need transparency. You don’t need footnotes. What were you thinking?”

Bloomberg Businessweek, emphasis added.

Nvidia is currently trading at 11 times revenue, so be careful out there.

Chart of the Week

One of the recession indicators that I watch is business inventories. Usually (but not always), you see inventories peak just before a recession. Since this happens concurrent with a recession, we have to use this as more of a confirmatory signal rather than a predictive one.

As this week’s chart shows, inventories do appear to be peaking. When combined with the other data on my recession dashboard, this adds some confidence to my view that a recession is likely to form within the next six months. At this point, however, the key figure to watch (as I mentioned in my last note) is employment.

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

What I Care About This Week | 2023 June 5

Posted by on in Uncategorized1 Comment

by Franklin J. Parker, CFA

The Summary

  • A debt ceiling deal was passed last week, and markets have breathed a sigh of relief. Lots of comprising was done, so both sides have things they are unhappy about — I have little doubt this will be an issue revisited in the election next year. For now, however, investors’ worst fears have been averted. Markets rallied higher on the news, which was to be expected. However, I would not take that as a sign that all is clear. It won’t be long before the focus returns to the fundamental economic data, which is not particularly good.

  • Last week we got a read on the health of the labor market. Job openings remained strong, with just over 10 million, and new jobs created came in at a whopping 283,000 (165,000 were expected). Despite those very good numbers, the unemployment rate ticked up from 3.5% to 3.7%. This was enough to trigger one of my recessionary indicators (more on that below), though it does take several months for that indicator to be confirmed.

  • This week is a fairly light data week, factory orders posted today (slightly lower than expected), and later this week we see data on consumer credit. Investors are watching Fed officials for clues about the path of rates. At the moment, it seems officials are leaning toward a pause in hikes. Markets currently see about a 1 in 4 chance of a hike at the Fed’s meeting later this month. In all, I am not optimistic about the direction of the economy. This rally is a wonderful opportunity to hedge and take some risk off the table. As always, however, your goals will determine the types of risk that make sense for you.

The Details

Morgan Stanley thinks corporate earnings will fall by 16% this year, and will kill the stock rally. It has been a while since anyone has discussed something like earnings affecting stock prices, so how does that even work?

First, here the “four winds” of market prices:

  1. Economic Fundamentals,
  2. Central Bank Policy,
  3. Governmental Policy (things like laws, gov’t spending, etc), and
  4. Business Fundamentals (things like earnings, growth, etc);

These forces are not linear, and they interact in unexpected ways, but ultimately an investor has to determine the strength and direction of each wind to come up with some sense of how to navigate the market environment. Of course, these four “winds” only set the environment — nothing is certain — and sometimes we are forced to sail through a hurricane.

At any rate, for the past decade, the dominant force has been central bank policy. Zero interest rates and unlimited money printing were the dominant wind in the marketplace and, though the other winds may have been blowing in a different direction at times, they were not strong enough to overcome central bank policy.

But that now changed, as the Morgan Stanley report demonstrates. Economic fundamentals and business fundamentals have become the dominant forces, overpowering central bank policy. Indeed, central bank policy has begun to follow economic fundamentals.

The point is, new winds are blowing. The next five to ten years won’t be like the last, and the lessons investors learned over the past decade (buy the dip, trust the Fed, quality doesn’t matter) may not be as applicable in the next decade.

Chart of the Week

This week’s chart is from my recession dashboard and it looks at the direction of unemployment. Typically, leading into a recession, unemployment begins to tick upward in a meaningful way (2020 was the exception, but that was because COVID hit first). May’s unemployment number triggered this indicator, though several months in a row are really needed to offer confirmation.

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

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

What I Care About This Week | 2023 May 22

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • So… the debt ceiling debate is still going on. Janet Yellen, US Treasury secretary, has warned that cash could run out as soon as June 1; Goldman Sachs suggests the drop-dead date is June 8. Predicting exactly when is tricky since the income/outflow of Treasury is lumpy. Progress is being made, and investors will continue to watch the negotiations with baited breath. As it stands, traders have bid up insurance policies that protect investors against bond defaults. The US is now more expensive to insure against a default than any other G7 country.

  • This is a light data week (other than the debt ceiling negotiations). We see data on personal consumption expenditures, which is an important figure, both economically and to the Federal Reserve. We see orders for durable goods, which are expected to decline by 1% month-over-month, and consumer sentiment which is expected to continue declining.

  • As I have repeatedly talked about, the economic news has been deteriorating — all except employment. Employment, and by extension the US consumer, has remained strong and is pretty much keeping the economy out of recession. Unemployment is typically the last domino to fall, however. There are a couple of other signals that tend to indicate when a recession is imminent, and those have not triggered just yet. With current market complacency, there is a great opportunity to lighten a portfolio’s risk load and/or hedge. Of course, your goals will determine what is an appropriate course of action.

The Details

Let’s talk AI, specifically how it may reshape our economy.

AI has been in the news quite a lot lately, with the roll-out of ChatGPT and Google’s Bard. While they have captured most of the attention, AI has also entered other historically human domains, such as art. Back in September, an AI-generated piece won first prize at the Colorado State Fair.

With AI tools becoming ubiquitous, and whether you love them or hate them, it is hard to deny that they are likely to make an impact on our economy. But how? And how can investors profit from this trend?

First of all, AI is, to me at least, a foundational technology, not too dissimilar from the internet. No one invests in “the internet,” we invest in companies that make use of the internet. So it is with AI — companies will emerge that leverage AI into new products/services and create efficiencies in old products/services. And, just like the internet revolution, it is very hard to see which company will be the big winner.

Second, there is no magic. Just like anything else, saying “AI” doesn’t magically make a company more valuable. How the company adds value to people’s lives is the relevant question with regard to AI, just as it has always been the relevant question in investing.

Finally, the disruption AI may bring will probably be offset by increasing standards of living — just as all technological tools have tended to do. The difference this time around is that many white-collar jobs are to be disrupted. The consequences for attorneys, accountants, copywriters, and (gasp) financial advisors is sure to be significant, and, thus, carry some political repercussions.

For investors to profit from the trend, the same critical questions need to be asked. And, finding the ultimate winners will be difficult, especially as the gold rush begins. In the end, there is plenty of money to be made, but a keen eye and a focus on investing basics will help keep investors away from the Pets.com of the AI age.

Chart of the Week

This week, the US officially began to spend more on interest payments than on the military — a milestone, to be sure. In that vein, this week’s chart looks at interest costs, but adjusted for GDP over time. As we can see, despite interest costs increasing considerably, the US actually spent more in the 1980s, at least as a percentage of her economy.

This is both good news and bad news. On the upside, we have been in this situation before and made it through okay. On the downside, we are clearly breaking from the norm, and that likely comes with consequences that we do not fully understand. The early 1980s were a painful time for lots of people. The next few years are going to require careful thought and diligence.

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 | 2023 May 15

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • Earnings season is coming to a close, with almost all companies having reported earnings. The news isn’t great, but it isn’t terrible either. We started the quarter expecting a 6% decline in earnings, and it appears that we will close the quarter with a 3% decline in earnings — better than expected, but still a contraction. Inflation is a common theme in earnings calls, with companies starting to have difficulty raising price to offset increased costs. Additionally, earnings outlooks for the rest of the year have softened considerably, with many companies indicating ongoing trouble through 2023.

  • Inflation and the Fed are still top-of-mind for investors, but the big story right now is the debt ceiling debate. Treasury has indicated that timing exactly when they will run out of cash is tricky, but late June is starting to look like a danger zone. With negotiations moving slowly, investors are getting worried. As I have talked about here before, a default on US treasury bonds would be catastrophic to the financial system and broader economy. Everything would be affected, from mortgage rates, credit cards, bonds, stocks, the value of the dollar (and thus inflation), and so on. Who Treasury pays in a shortage of cash scenario is an open question, and one investors are not eager to see answered.

  • This week is a light data week, though we do get a read on manufacturing and retail sales. Overall, the signs are pretty clear that the US economy is stumbling. That said, employment remains very strong, though it is typically the last domino to fall. Given the risks in the marketplace (earnings contractions, the debt ceiling debate, manufacturing contraction, etc), I am holding my view that there is more downside risk in this market than upside. Caution is warranted, although your goals and time horizon will dictate which risks you can afford to take.

The Details

How much do you need to accomplish your goal?

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

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

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

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

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

Chart of the Week

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

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

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

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

What I Care About This Week | 2023 May 1

Posted by on in Uncategorized1 Comment

by Franklin J. Parker, CFA

The Summary

  • This is a big data week for markets. The Federal Reserve meeting concludes on Wednesday with a rate decision and commentary. While a 0.25% hike is baked-in, investors will listen very closely to Powell’s remarks about the path of rates for the rest of the year, as well as the Fed’s economic outlook (a recession: will there/won’t there).

  • About half of the S&P 500 companies have reported earnings. As it stands companies are making about 4% less money than they did this time last year. The big story is Amazon’s blowout quarter — if Amazon’s earnings were excluded from the S&P 500 results, the average decline in profit would be 5%! Overall, the earnings contraction is mild, but CEOs are also cutting outlooks for the rest of the year — not a good sign.

  • This week we also see employment data, which is an important economic signal, along with Factory orders. Today’s Purchasing Manufacturer’s Index showed further declines last month, which is an ongoing concern. Last week we got a read of US GDP, which grew just over 1% in Q1. Digging into the forces driving that GDP print, it is clear that consumers are the main drivers of GDP growth. Should consumers begin to stumble, an economic contraction would likely not be far behind.

The Details

First Republic Bank became the second-largest bank failure in US history over the weekend.

I have surveyed the balance sheets of many regional banks, and this problem is more widespread than regulators would like us to believe. Many banks are suffering from serious losses that are unreported, due largely to their holdings of long-dated US Treasury bonds as well as US agency bonds.

This isn’t necessarily an immediate problem, but it significantly curtails lending and puts many of these banks at a disadvantage to weather an economic storm.

Looking at the earnings contraction, the contraction in manufacturing, and the credit/banking contraction, this has all the hallmarks of a prelude to recession with one caveat. The US consumer has remained quite strong. Unemployment would be the next domino to fall, then we should expect to see consumer spending slow.

Of course, you wouldn’t think much was wrong at all looking at the recent run-up in markets. I would caution against chasing that return, however. It is not uncommon for markets to run higher leading into a recession (as this week’s chart of the week shows).

Chart of the Week

This week’s chart shows the behavior of stocks leading into the last four recessions. As we can see, markets do not tend to sell off until a month or two ahead of the actual start date of the recession. 2008 is a notable exception, when markets topped out, then topped out again, just 60 days before the start of the recession. The point is, markets are not great at pricing-in recessionary signals until just before it hits. That is both good news and bad news. It takes some psychological wherewithal to trust the data when markets are running higher. On the upside, it gives alert investors plenty of time to position themselves for the coming storm.

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 | 2023 Apr 17

Posted by on in Uncategorized1 Comment

by Franklin J. Parker, CFA

The Summary

  • Earnings season has begun! Overall, investors expect an earnings contraction of 5% to 6%. On Friday, we saw earnings from banks, including Wells Fargo, JPMorgan, and numerous regional banks. What became clear was that the top five banks benefitted greatly from the turmoil in regional banks last month. Shares of regional banks fell sharply after their earnings. Banks have also begun building up rainy-day funds to weather a coming storm. It is another reminder that the economic outlook continues to deteriorate.

  • Unemployment figures for March were a bit stronger than expected, although job openings fell below 10 million for the first time in years. We also saw inflation data, which cooled slightly (5.6% year-over-year). Investors took this as a signal that the Fed will begin slowing rate hikes, with their next meeting delivering the final rate hike for the year (of 0.25%). Markets rallied on the news, although it is not particularly good. The Fed tends to cut rates just before recessions, so watching their behavior is a good signal that the economic cycle is ending.

  • The recent everything-goes-up rally is a bit of a head-scratcher. There are few reasons why risky assets should be climbing as much as they have year-to-date. That said, it is not uncommon for stocks to rally into a recession. Nothing is certain, of course, but this rally is not supported by the economic data. It does, however, provide opportunities to adjust portfolios and grow more conservative. As I have been saying for a few months now, this is the time to batten down the hatches — there is a storm on the horizon.

The Details

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

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

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

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

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

Chart of the Week

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

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

What I Care About This Week | 2023 Apr 3

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • Markets ran higher last week, with tech stocks leading the charge. Some analysts have pushed back suggesting that the recent rally is unsustainable. With earnings declining and the Fed continuing to hike rates in the face of a slowing economy, it is my view that there is more downside than upside risk in play. That said, it is not uncommon for markets to hit new highs just before a recession takes hold (that happened in 2007, just before the great financial crisis).

  • Manufacturing fell to new lows last week. This week is important because we get data on employment. The unemployment rate is expected to hold steady at 3.6% with about 215,000 jobs created last month. Obviously, a big deviation from these figures would push markets to update expectations for the Fed, as well as the economic outlook. Again, it is my view that a recession is not far away, though the macro-economic signals I watch have yet to flash “the recession is imminent” signals. Though this week’s data will update our recession dashboard.

The Details

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

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

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

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

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

Chart of the Week

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

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

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

What I Care About This Week | 2023 Mar 27

Posted by on in Uncategorized

by Franklin J. Parker, CFA

The Summary

  • In the face of a crisis among banks, the Fed raised rates by 0.25% and indicated this could be the last hike for a while (read as: in this economic cycle). Investors have now priced-in rate cuts to begin later in the summer. Of course, the Fed cutting rates would be in response to recessionary signals, so that would not be positive for stocks, at least based on today’s data.

  • While the immediacy of the crisis in banking has subsided, more policymakers are sounding the alarm that this is likely to cause a credit crunch which could lead to a recession (we discussed that here last week). Banks in crisis aren’t expanding credit, so individuals and businesses will need to curtail their spending. In that vein, March 9 – 17 was the first week since 2013 that no investment-grade corporate bonds were issued. The drying up of credit is a strong recessionary signal.

  • This week we get some more data on the economy, from manufacturing to services to consumer spending. My view is that a recession is becoming more imminent, though the macroeconomic signals have not flashed red just yet. While the economy could still land softly, I see that outcome as less likely. In any event, investors with short time horizons would do well to lighten their risk exposure and batten down the hatches. Downside risk looms much larger than upside risk in this environment.

The Details

How much do you need to retire?

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

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

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

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

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

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

Chart of the Week

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

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

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

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