Posts tagged ‘interest rates’
Motel 6 or Four Seasons? Preparing, Not Panicking, for Retirement
Stock prices go up more often than down, and that was the case again last month. The S&P 500, Dow Jones Industrial Average, and the NASDAQ were all up in April. For the year, the S&P has gained +8.6%, Dow +2.9%, and NASDAQ +16.8%. What’s more, these increases are built upon the appreciation experienced in the fourth quarter of last year – the S&P 500 index has rebounded more than +19% since the last lows seen in the middle of last October.
Even when the unemployment rate currently stands at 3.5%, and GDP continues to grow for the third consecutive quarter, there is never a shortage of concerns (see also A Series of Unfortunate Events) as evidenced by worrying questions like these:
- Is the Federal Reserve going to increase interest rates again?
- Has inflation peaked?
- Are we going into a recession?
- Is Silicon Valley Bank and First Republic Bank the beginning or the end of bank failures?
- Will Vladimir Putin use nuclear weapons in Ukraine?
- What is going to happen with the Debt Ceiling deadline and will the U.S. default on its debt?
- How will elections affect the economy?
- Will AI (artificial intelligence) take all our jobs?
Hope is Not a Strategy
We have lived through an endless number of scary headlines in some shape or fashion throughout our lifetimes. These are all interesting and important questions, but preparation for retirement is much more important than panicking over issues you have no control over. For many investors, however, the more important questions to ask and answer relate to your retirement strategy. The answers to your questions should not contain the word hope – hope is not a strategy. Just guessing and waiting out of fear is unlikely to produce optimal results.
Many Americans spend more time planning a vacation than they do preparing for retirement or planning their finances. Rather than constantly scrolling through headlines on your mobile phone news app, here are some areas of focus and questions you should be asking yourself:
· Investment Strategy: What type of investment strategy should you be utilizing to reach your retirement goals? A passive investment strategy with low-cost index funds and ETFs (Exchange Traded Funds)? Or an active investment strategy with individual stocks, bonds, and mutual funds?
· Diversification: How diversified are your investments? Are you overly concentrated in one asset class, sector, or individual security? If you are over-tilted on one side of your financial boat, it could tip over.
· Risk Tolerance: What is your asset allocation? If you are close to retirement, and you have too much exposure to equities, a retrenchment in the stock market could delay your retirement plans by years. This concept highlights the importance of rebalancing your portfolio as you get closer to retirement.
· Fees: What are you paying in advisor fees and/or product fees? Fees are like a leaky faucet. You may not notice a leak over a day or week, but over a period of a month or longer, you are likely to receive huge water bills. Over the long-run, even a small pin-hole leak can cause extreme water damage to floors, ceilings, and walls just like fees could delay retirement or dramatically reduce your nest egg.
· Tax Planning: Are you maximizing your tax-deferred investment accounts? Whether you are contributing the limit to your IRA (Individual Retirement Account), 401(k) retirement plan at work, or pension (for larger business owner contributions), these are tremendous tax-deferral savings vehicles. By squirreling away savings during your prime earnings years, your investments can enjoy the snowballing effect of compounding over the long-term.
· Retirement Timing: When do you plan to retire? Do you have enough money to retire, and what type of liquidity needs will you need during retirement? Figuring out the timing of Social Security can be another variable that may factor into your retirement timing decision (see also Can You Retire? Getting to Your Number).
· DIY or Hire Advisor: When it comes to managing your investments, do you plan on doing it yourself (DIY) or hiring a financial advisor? Many people are not adequately equipped to manage their own investments, however identifying a proper financial advisor still requires significant legwork and research as well. Check out a recent webinar I produced with key questions to ask when looking for a financial advisor (Click here: Questions to Ask When Looking for a Financial Advisor).
In summary, there are a lot of frightening news headlines, but you will be better off focusing on those things you can control. The harsh reality is Americans are not saving sufficiently for retirement. It is true, you can survive off a smaller nest egg, if you plan to subsist off cat food and live in a tent, but most Americans and retirees have become accustomed to a higher standard of living. Also worth noting, we humans are living longer. Thanks to the miracles of modern medicine, lifespans are expanding, with the pandemic caveat. But inflation remains stubbornly high, and you do not want to outlive your savings. Drained savings during retirement may just land you a job as a greeter at Wal-Mart in your 80s.
Although the summer travel season is fast approaching, if you feel you are not satisfactorily prepared for retirement, this is a perfect time to invest attention to this important area. Do yourself a favor and devote at least as much time to answering the key retirement questions above as you do in planning your summer vacation. You may be partying like a rock star now, but if you have not been properly saving for retirement, I will ask you the following question: During retirement, do you want to vacation at the Motel 6 off a local freeway or would you prefer vacationing at a Four Seasons somewhere in Europe? I know what my answer is.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (May 1, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Air Bags Deployed to Cushion Bank Crashes
In recent years, COVID and a ZIRP (Zero Interest Rate Policy) caused out-of-control inflation to swerve the economy in the wrong direction. However, the Federal Reserve and its Chairman, Jerome Powell, slammed on the brakes last year by instituting the most aggressive interest rate hiking policy in over four decades.
At the beginning of last year, interest rates (Federal Funds Rate target) stood at 0% (at the low end of the target), and today the benchmark interest rate stands at 5.0% (at the upper-end of the target) – see chart below.
Source: Trading Economics
Unfortunately, this unparalleled spike in interest rates contributed to the 2nd and 3rd largest bank failures in American history, both occurring in March. The good news is the Federal Reserve and banking regulators (the Treasury and FDIC – Federal Deposit Insurance Corporation) deployed some safety airbags last month. Most notably, the Fed, FDIC, and Treasury jointly announced the guarantee of all deposits at SVB, shortly after the bank failure. Moreover, the Fed and Treasury also revealed a broader emergency-lending program to make more funds available for a large swath of banks to meet withdrawal demands, and ultimately prevent additional runs on other banks.
Investors were generally relieved by the government’s response, and the financial markets reacted accordingly. The S&P 500 rose +3.5% last month, and the technology-heavy NASDAQ index catapulted even more (+6.7%). But not everyone escaped unscathed. The KBW Bank Index got pummeled by -25.2%, which also injured the small-cap and mid-cap stock indexes, which declined -5.6% (IJR) and -3.5% (IJH), respectively.
Nevertheless, as mentioned earlier, slamming on the economic brakes too hard can lead to unintended consequences, for example, a bank failure or two. Well, that’s exactly what happened in the case of Silicon Valley Bank (SVB), the 2nd largest bank failure in history ($209 billion in assets), and cryptocurrency-heavy Signature Bank, the 3rd largest banking collapse in history – $110 billion in assets (see below).
Source: The Wall Street Journal
How did this Silicon Valley Bank failure happen? In short, SVB suffered a bank run, meaning bank customers pulled out money faster than the bank could meet withdrawal requests. Why did this happen? For starters, SVB had a concentrated customer base of financially frail technology start-ups. With a weak stock market last year, many of the start-ups were bleeding cash (i.e., shrinking their bank deposits) and were unable to raise additional funds from investors.
As bank customers began to lose confidence in the liquidity of SVB, depositors began to accelerate withdrawals. SVB executives added gasoline to the fire by making risky investments long-term dated government bonds. Essentially, SVB was making speculative bets on the direction of future interest rates and suffered dramatic losses when the Federal Reserve hiked interest rates last year at an unprecedented rate. This unexpected outcome meant SVB had to sell many of its government bond investments at steep losses in order to meet customer withdrawal requests.
It wasn’t only the large size of this bank failure that made it notable, but it was also the speed of its demise. It was only three and a half weeks ago that SVB announced a $1.8 billion loss on their risky investment portfolio and the subsequent necessity to raise $2.3 billion to fill the hole of withdrawals and losses. The capital raise announcement only heightened depositor and investor anxiety, which led to accelerated bank withdrawals. Within a mere 24-hour period, SVB depositors attempted to withdraw a whopping $42 billion.
Other banks, such as First Republic Bank (FRB), and a European investment bank, Credit Suisse Group (CS), also collapsed on the bank crashing fears potentially rippling through other financial institutions around the globe. Fortunately, a consortium of 11 banks provided a lifeline to First Republic with a $30 billion loan. And Credit Suisse was effectively bailed out by the Swiss central bank when Credit Suisse borrowed $53 billion to bolster its liquidity.
While stockholders and bondholders lost billions of dollars in this mini-banking crisis, financial vultures swirled around the remains of the banking sector. More specifically, First Citizens BancShares (FCNA) acquired the majority of Silicon Valley Bank’s assets with the assistance of the FDIC, and UBS Group (UBS) acquired Credit Suisse for more than $3 billion, thereby providing some stability to the banking sector during a volatile period.
Many pundits have been predicting the U.S. economy to crash into a recession as a result of the aggressive, interest rate tightening policy of the Federal Reserve. So far, Mark Twain would probably agree that the death of the U.S. economy has been greatly exaggerated. Currently, the first quarter measurement of economic activity, GDP (Gross Domestic Product), is estimated to measure approximately +2.0% after closing 2022’s fourth quarter at +2.6% (see chart below). As you probably know, a definition of a recession is two consecutive quarters of negative GDP growth.
Source: Trading Economics
Regardless of the economic outcome, investors are now predicting the Federal Reserve to be at the end or near the end of its interest rate hiking cycle. Presently, there is roughly a 50/50 chance of one last 0.25% interest rate increase in May (see chart below), and then investors expect at least one interest rate cut by year-end.
Source: CME Group
Last year was a painful year for most investors, but stocks as measured by the S&P 500 have bounced approximately +18% since the October 2022 lows. Market participants are still worried about a possible recession crashing the economy later this year, but hopefully last year’s stock market collision and subsequent banking airbag protections put in place will protect against any further financial pain.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Apr. 3, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in SIVB, FCNA, UBS, FRB, CS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
From Hard Landing to Soft Landing to No Landing?
I haven’t received my pilot’s license yet, but in trying to figure out whether the economy is heading for a hard landing, soft landing, or no landing, I’m planning to enroll in flight school soon! With the Federal Reserve approaching the tail end of an aggressive interest rate hiking cycle, investors have been bracing for a hard landing. However, with near record-low unemployment (3.4%) and multi-trillion dollars in government stimulus still working its way through the system, others see an economic soft landing. More recently, economic data has been flying in at an accelerating pace, which could mean the economy will stay in the air and have no landing.
For those waiting for an imminent recession, it looks like there could be a delay. In other words, bearish pessimists may be waiting at the gate longer than expected. As you can see in the chart below, economists at the Atlanta Federal Reserve are currently forecasting economic growth (GDP – Gross Domestic Product) to increase to a respectable +2.8% rate for the first quarter.
How have investors been interpreting this confusing array of landing scenarios? The stock market has stabilized and risen since last October (S&P +13.7%) but has also hit a temporary air pocket last month (-2.6%). Similarly, the Dow Jones Industrial Average has rebounded +13.9% since October, but pulled back further in February (-4.2%). As mentioned earlier, investors are having difficulty reading all the economic dials, instruments, and controls in the cockpit because there is no consensus on interest rates, inflation, economic growth, corporate earnings growth, and employment.
At the one end of the spectrum, you have a consumer who remains employed and willing to spend his/her savings accumulated during the pandemic. Case in point, air travel has hit pre-pandemic levels of 2019, despite business travelers staying at home conducting business on Zoom (see red line on chart below).
At the other end of the spectrum, we are witnessing the crippling effects that 7% mortgage rates can have on the $4 trillion real estate industry. As you can see from the chart below, sales of existing homes have plummeted at the fastest rate since the beginning of the 2008 Financial Crisis.
With all of that said, there is a consensus building that inflation is steadily coming down. Even the very skeptical and hawkish Federal Reserve Chairman, Jerome Powell, acknowledged that the “disinflationary process has begun.” We can see that in this inflation expectation chart below (green line), which measures the average anticipated inflation over the next five years by comparing the difference in yields between the five-year Treasury Notes and the five-year TIPS (Treasury Inflation Protection Securities).
Although, currently, there are many financial crosswinds swirling, the good news is that in the near-term, the economy has been maintaining its elevation and there is no imminent sign of a hard landing. We certainly could face the potential of turbulence and changing weather conditions, but that is always the case when you invest in the financial markets. If, however, inflation continues to move in the same direction, and growth continues to surprise on the upside, there may be no landing at all. Under this scenario of maintaining a comfortable altitude, I guess I can put my pilot training on hold.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Mar. 1, 2023). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Recession Storm Fears Reign Supreme as Stocks Gain Steam
Commentators continue to shout the doom-and-gloom forecasts of a hard landing recession, but after an economic hurricane in 2022 there are some signs the financial clouds have begun to lift this year. The stock market has reflected this positive fundamental shift during January, as the S&P 500 catapulted +6.2%, NASDAQ +10.8%, and the Dow Jones Industrial Average +2.8%.
Last year, a major influencing cause to the -19% downdraft in the stock market (S&P 500) was due to the highest inflation readings experienced in four decades, compounded by a Federal Reserve hell-bent on slamming on the interest rate brakes. A big contributing factor to the surge in inflation was the spike in consumer spending fueled by trillions in government stimulus, coupled with widespread shortages in goods triggered by supply chain disruptions.
Fortunately, the headwinds of inflation now appear to be abating. Recently released inflation figures showed core inflation dropping from a peak of 9.1% last year to 3.5% in the fourth quarter (see chart below). Although the Fed will likely raise its interest rate target by 0.25% up to 4.75% this week, the downward reversal in inflation has raised the probabilities of the Federal Reserve “pausing” or “pivoting” on the direction of previous rate hikes. The odds of a halt or cut in rates will likely only increase if the descending trajectory of inflation persists and other upcoming economic data weaken further.
No Signs of Recession…Yet. Investors Waiting for Another Flood
While the calls for a hard economic landing remain, healthy GDP growth (+2.9% in Q4), generationally low unemployment (3.5%), and relatively stable earnings (see chart below) all point to a stable economy with the ability to navigate a soft landing. China’s new reopening of the economy and Europe’s seeming ability of dodging a recession provide additional evidence for a soft landing scenario.
As you can see further from the 25-year earnings chart above, the drop in S&P 500 earnings in recent months has been fairly modest compared to previous downturns, and the forecast for 2023 earnings is currently estimating a modest gain on a year-over-year basis. Over the last 25 years, we have arguably experienced three 100-year floods (2000 Tech Bubble, 2008 Financial Crisis, and 2020 COVID pandemic), so investors have been bracing for another enormous financial hurricane.
Although the bursting of the 2000 Tech Bubble had an outsized impact on the technology sector, the effect on the overall economy was more muted, as you can observe from the shallow decline in the earnings. As the earnings show, during the Financial Crisis (2008) and COVID (2020), the crash in earnings was much more severe. Thus far in 2023, there has been no earnings plummet or sign of recession, and if financial conditions continue to soften, there is no reason we couldn’t undergo a more vanilla, garden-variety recession like we did in 1990 and 2000.
Stairs & Elevators
While the future always remains unclear, nobody knows for certain whether a recession will occur this year or if the 2022 bear market will endure into 2023. However, as you can notice below, history over the last 70 years shows the duration of bull markets (average of about 6 years) are much longer than bear markets (approximately 1 year). I like to compare bull markets to walking up stairs in a tall building, and bear markets to going down an elevator. The main difference is that the stock market elevator generally never goes to the bottom floor and the stairs keep growing to record heights over the long-run. Since World War II, Americans have experienced 13 economic recessions (see also Recession or Mental Depression?). Not only are investors batting 1,000% in successfully surviving these recessions, they have thrived. From 1956 until the present, the S&P 500 has vaulted approximately 80-fold.
Presently, economic skies might not all be clear, blue, and sunny, but the fact that inflation is dropping, our economy is still growing, labor markets remain healthy, China has reopened for business, and Europe hasn’t cratered all leave room for optimism. It may not be time to bust out the sunscreen quite yet, but the dark economic clouds of 2022 appear to be lifting slowly.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Feb. 1, 2023). Subscribe Here to view all February articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
New Year, New Clean Slate
Stock and bond market returns in 2022 were disappointing, but we now get to start 2023 with a clean slate. Before we turned the page on another annual chapter, Santa Claus chose to finish last year by placing a lump of coal in investor stockings, as evidenced by the S&P 500 index decline of -5.9% during December.
Good News & Bad News
There is some good news and bad news as it relates to this year’s underwhelming stock market results (-19.4%). The bad news is last year turned out to be the 4th worst year in the stock market since World War II (1945) and also marked the worst year since 2008. Here’s a summary of the S&P 500’s worst years over the last eight decades:
2008: -38.5%
1974: -29.7%
2002: -23.4%
2022: -19.4%
Source: CNBC (Bob Pisani)
The good news is that the stock market is up 81% of the time in subsequent years following down years. The average increase in bounce-back years is +14%. In another study of down years, the analysis showed that after the stock market has fallen -20% or more, stock prices were higher on average by +15% one year later, +26% two years later, and +29% three years later. Nothing is guaranteed in life, but as Mark Twain famously stated, “History does not repeat itself, but it often rhymes.”
2022: The Year of No Shock Absorbers (Worst Bond Market Ever)
The stock market receives most of the media glory and reporting, however the bond market is the Rodney Dangerfield of asset classes, it “gets no respect.” Typically, during weak stock markets (i.e., “bear markets”), the bond or fixed income investments in a diversified portfolio act as shock absorbers to cushion the blow of volatile stock prices. More specifically, in a typical bear market, the economy generally slows down causing demand to decelerate, and interest rates to decline, which causes the values of bonds to increase. Therefore, as stock prices decline, the gains from bonds in your portfolio usually help offset stock losses. Unfortunately, this scenario didn’t happen in 2022, but rather investors experienced a double negative whammy. Not only did stocks experience one of its worst years in decades, the bond market also suffered what many pundits are describing as the “Worst Bond Market Ever” – see chart below.
Why in particular did bonds perform so poorly this year, when they commonly outperform in slow or recessionary economic conditions? For starters, interest rates spent most of 2022 increasing at the fastest pace in more than four decades (see chart below). An unanticipated rise in inflation was the main culprit, which was caused by spiking energy prices from Russia’s invasion of Ukraine; COVID-related supply chain disruptions; unprecedented fiscal stimulus (trillions of dollars in infrastructure spending and incentives); record monetary stimulus (QE – Quantitative Easing); and extended years of ZIRP (Zero Interest Rate Policy). For these reasons, and others, bonds collapsed in sympathy with deteriorating stock prices.
Room for Optimism in 2023
Last year was challenging, however, not all is lost. The Federal Reserve, inflation, interest rates, Ukraine, and cryptocurrency volatility (e.g., Bitcoin down -64% in 2022) dominated headlines this year, but many of these headwinds could abate or reverse in 2023. For example, there are numerous indicators pointing to peaking and/or declining inflation, which, if true, could create a tailwind for investors this year. Bolstering this argument are the current weakening trends we are witnessing in the housing market, which should ripple through the economy to cool inflation (see chart below).
And if it’s not declining home prices, lower energy prices have also filtered through the global economy to lower transportation and shipping costs (e.g., freight rates from China to West Coast are down -90%). What’s more, a stronger dollar has contributed to declining commodity prices as well.
Although inflation still has a long way to go before reaching the Federal Reserve’s 2% target rate, broad inflation measures, such as the GDP Deflator, are showing a significant decrease in inflation (see chart below). By analyzing the various disinflationary tea leave markers, we can gain some confidence regarding future interest rates. Observing the fastest rate hike cycle by the Fed in decades informs us that we are likely closer to an end of rate hikes (i.e., pause or cut), rather than the beginning. If correct, tamer inflation means 2023 could prove to be a better environment for both stock and bond investors.
In summary, last year was painful across the board, but investors are starting this year with a clean slate and signs are pointing to a potential reversal in inflation and interest rate headwinds. With the change of the calendar, a messy 2022 could turn into a spick-and-span 2023.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Jan. 3, 2023). Subscribe on the right side of the page for the complete text.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Feasting on a Full Plate of Concerns
Investors and Thanksgiving feasters alike had a full plate to consume last month – and there has been a lot to digest. The buffet of issues includes the Federal Reserve’s fastest rate hike cycle in decades (see chart below), spiking inflation, a slowing economy, an unresolved war between Russia and Ukraine, declining home prices, and a volatile stock market to boot.
Source: Visual Capitalist (*Note: Current year line estimated to reach midpoint of 4.00% – 4.50% this month)
Let’s not forget the bankruptcy of Bahamas-based cryptocurrency exchange (FTX), and the downfall of its 30-year-old, billionaire founder Sam Bankman-Fried. Unfortunately for Fried, he has essentially lost his whole $16 billion fortune, and after his recent resignation he will be spending the subsequent years in court fighting charges of fraud and misappropriated funds.
Nevertheless, despite the laundry list of concerns swirling around, this year’s Thanksgiving feast was quite delicious with the S&P 500 surging +5.4% last month. It’s hard to believe for many, but after a strong performance in October and November, stock market losses during 2022 have registered in at a mere -4.8%, as measured by the Dow Jones Industrial Average. This reasonable drawdown in stock prices is not too shabby, considering the meteoric gains of 2019-2020-2021 (+90% cumulatively), as I have highlighted on numerous occasions (see my July Newsletter, Winning Teams Occasionally Lose).
Part of the credit for the current market surge can be attributed to the dessert Federal Reserve Chairman, Jerome Powell, just served up to investors. In a statement yesterday, Powell suggested interest rate hikes would likely slow from an aggressive 0.75% pace to a slower 0.50% rate after an unprecedented string of increases. Bets are changing daily, but after starting the year at a 0.0% Federal Funds target rate, the Fed is likely to exit the year at 4.5%. Whether this will be the peak rate (or near the peak rate) will depend on the direction of economic data, especially as it relates to inflation and employment. We get a fresh helping of unemployment figures this Friday, which could provide clues regarding the direction of future Fed policy.
While the Federal Reserve is sucking a lot of wind out of the present news outlet airwaves, there are other factors contributing to the latest stock market upswing. For starters, the broadest measure of U.S. economic activity, GDP (Gross Domestic Product), was just revised higher for this year’s third quarter from +2.6% to +2.9%. But wait, there’s more! The latest growth forecast for the fourth quarter of 2022 is expected to accelerate to +4.3%, which was also revised higher, recently. Ever since the Fed started hiking interest rates this March, all we have been hearing from the so-called pundits has been the doom-and-gloom discussion of a definite, looming recession knocking at our door. I freely acknowledge there can be a negative economic lag effect from the significant rise in interest rates this year, however, the bark could prove much worse than the bite as everyone waits for the R-word, which may or may not arrive at all.
Another positive development supporting climbing stock prices relates to what I have been writing about for quite some time – peaking and declining inflation numbers. Scott Grannis at Calafia Beach Pundit has done a great job of explaining how monetary policy (M2 – see chart below) and fiscal stimulus, during the peak-COVID era (combined with supply chain disruptions), have fed the explosion in monetary supply growth, which directly relates to the spiking inflation we all have experienced. Thankfully, the shift from a looser COVID monetary policy to a tighter monetary policy (i.e., Quantitative Tightening and rate hikes), in conjunction with less government spending (i.e., improving government deficit), has led to a dramatic drop in money supply growth (actually negative growth), hence creating a better outlook for inflation.
Source: Calafia Beach Pundit
Inflation Picture Improving
You can clearly see the improving inflation picture breaking through in the Producer Price Index (PPI – see chart below), a measure of wholesale inflation that has come down dramatically in recent months.
Source: Calafia Beach Pundit
Thanksgiving often involves a lot of gorging, but for investors, digesting a full plate of concerns has caused some indigestion in the stock market this year. The good news is inflation appears to be peaking, the economy and the consumer remain on solid footing, despite the Federal Reserve’s rate-hiking rampage, and the unemployment rate remains near generationally low levels. If a steep recession doesn’t come to fruition, as many expect, you may be able to toast for a better 2023 with champagne rather than Pepto Bismol.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Armageddon or Time to Get In?
Halloween is a scary time, and the stock market has experienced a frightening 2022 as well. If you turn on the television or read the news, you may think Armageddon has arrived, the last battle of biblical proportion between good and evil. Fortunately, reality is often less dire than the headlines make it appear. Given the horrific -19% decline in the stock market (S&P 500 index) this year, arguably much of the current and future dreadful news is already expected and discounted into today’s stock market prices. So, perhaps, the end of the world is not upon us, and the sentiment is shifting from “Armageddon” to “time to get in!” The soaring +4,007 point increase (+14%) in the Dow Jones Industrial Average this month, the best month since 1976, may be an indication of changing investor attitudes.
We may not be completely out of the woods just yet, however a lot of the bad cat news is arguably out of the bag. For example, the Federal Reserve has already been hiking interest rates with reckless abandon since March, and this week another increase of 0.75% to roughly 4.00% is widely expected. This move should get us much closer to a Fed “pause” or “pivot”, which could soon turn the perception of a half-empty economic glass into a half-full one?
Inflation has also been running wild for months, but many indicators have shown price levels peaking or declining (i.e., commodities, housing, autos, transportation costs, etc.). Mortgage rates that have more than doubled this year to 7.08% (see chart below) are contributing to declines in home price growth.
High mortgages and high home prices have cooled the white-hot housing market because affordability has been reduced, thereby forcing rental rates to soar. And as a result, stubbornly high rents have been a major factor contributing to persistently high inflation in recent months. If home prices continue to decline (month-to-month) as shown below, this should provide some much-needed relief to rental prices, and ultimately inflation.
And although there does not appear to be a clear end in sight to the Russia-Ukraine war, Ukraine’s recently successful land recapture accomplishments from the Russians could pressure both parties to settle at the negotiation table.
Sweet October Treats
Stock market investors received a sugar high this month with sweet index gains of +8.0% and +14.0% for the S&P 500 and Dow Jones, respectively. While it has been mostly gloomy in 2022, some of the sunshine beaming through the clouds this month came in the form of better-than-expected GDP economic figures that measure the health of the overall economy. Rather than show an impending recession, the freshest 3rd quarter data shows the economy growing at a very respectable +2.6% annualized rate after falling -0.6% in the 2nd quarter (see chart below).
And contrary to many of the doomsday-er recession forecasting mongers, corporate profits have remained tenaciously high near record levels (see chart below), with no sign of collapsing as in 2020 (COVID) or 2008 (Financial Crisis). That doesn’t mean profits can’t contract further, because the dampening effect of higher interest rates could take some time before working its way through the economic python like a pig.
One month does not make a trend, but the largest one month gain in 46 years may be evidence that the world is actually not coming to an end anytime soon. Therefore, it might be a great time to “get in” before booking your fresh trip to “Armageddon”.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Fed Ripping Off the Inflation Band-Aid
Inflation rates have been running near 40-year highs, and as a result, the Federal Reserve is doing everything in its power to rip off the Band-Aid of insidious high price levels in a swift manner. The Fed’s goal is to inflict quick, near-term pain on the economy in exchange for long-term price stability and future economic gains. How quickly has the Fed been hiking interest rates? The short answer is the rate of increases has been the fastest in decades (see chart below). Essentially, the Federal Reserve has pushed the targeted benchmark Federal Funds target rate from 0% at the beginning of this year to 3.25% today. Going forward, the goal is to lift rates to 4.4% by year-end, and then to 4.6% by next year (see Fed’s “dot plot” chart).
How should one interpret all of this? Well, if the Fed is right about their interest rate forecasts, the Band-Aid is being ripped off very quickly, and 95% of the pain should be felt by December. In other words, there should be a light at the end of the tunnel, soon.
The Good News on Inflation
When it comes to inflation, the good news is that it appears to be peaking (see chart below), and many economists see the declining inflation trend continuing in the coming months. Why do pundits see inflation peaking? For starters, a broad list of commodity prices have declined significantly in recent months, including gasoline, crude oil, steel, copper, and gold, among many others.
Outside of commodities, investors have seen prices drop in other areas of the economy as well, including housing prices, which recently experienced the fastest monthly price drop in 11 years, and rent prices as well (see chart below).
Anybody who was shopping for a car during the pandemic knows what happened to pricing – it exploded higher. But even in this area, we are seeing prices coming down (see chart below), and CarMax Inc. (KMX), the national used car retail chain confirmed the softening price trend last week.
Pain Spread Broadly
When interest rates increase at the fastest pace in 40 years, pain is felt across almost all asset classes. It’s not just U.S. stocks, which declined -9.3% last month (S&P 500), but it’s also housing -8.5% (XHB), real estate investment trusts -13.8% (VNQ), bonds -4.4% (BND), Bitcoin -3.1%, European stocks -10.1% (VGK), Chinese stocks -14.4% (FXI), and Agriculture -3.0% (DBA). The +17% increase in the value of the U.S. dollar this year against a basket of foreign currencies is substantially pressuring cross-border business for larger multi-national companies too – Microsoft Corp. (MSFT), for example, blamed U.S. dollar strength as the primary reason to cut earnings several months ago. Like Hurricane Ian, large interest rate increases have caused significant damage across a wide swath of areas.
But for those following the communication of Federal Reserve Chairman, Jerome Powell, in recent months, they should not be surprised. Chairman Powell has signaled on numerous occasions, including last month at a key economic conference in Jackson Hole, Wyoming, that the Fed’s war path to curb inflation by increasing interest rates will inflict wide-ranging “pain” on Americans. Some of that pain can be seen in mortgage rates, which have more than doubled in 2022 and last week eclipsed 7.0% (see chart below), the highest level in 20 years.
Now is Not the Time to Panic
There is a lot of uncertainty out in the world currently (i.e., inflation, the Fed, Russia-Ukraine, strong dollar, elections, recession fears, etc.), but that is always the case. There is never a period when there is nothing to be concerned about. With the S&P 500 down more than -25% from its peak (and the NASDAQ down approximately -35%), now is not the right time to panic. Knee-jerk emotional decisions during stressful times are very rarely the right response. With these kind of drops, a mild-to-moderate recession is already baked into the cake, even though the economy is expected to grow for the next four quarters and for all of 2023 (see GDP forecasts below). Stated differently, it’s quite possible that even if the economy deteriorates into a recession, stock prices could rebound smartly higher because any potential future bad news has already been anticipated in the current price drops.
Worth noting, as I have pointed out previously, numerous data points are indicating inflation is peaking, if not already coming down. Inflation expectations have already dropped to about 2%, if you consider the spread between the yield on the 5-Year Note (4%) and the yield on the 5-Year TIP-Treasury Inflation Protected Note (2%). If the economy continues to slow down, and inflation has stabilized or declined, the Federal Reserve will likely pivot to decreasing interest rates, which should act like a tailwind for financial markets, unlike the headwind of rising rates this year.
Ripping off the Band-Aid can be painful in the short-run, but the long-term gains achieved during the healing process can be much more pleasurable.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in MSFT, BND and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in KMX, XHB, VNQ, VGK, FXI, DBA or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Heartburn Pains After Digesting Market Gains
After gorging on +9% gains in the stock market (S&P 500 index) during July, investors suffered some heartburn pain in August (-4%). The indigestion really kicked in after Federal Reserve Chairman, Jerome Powell, gave a frank and candid outlook during his annual monetary policy speech at Jackson Hole, Wyoming. His key takeaways were that further interest rate increases are necessary to control and bring down inflation. And these economically-slowing measures, coupled with the Fed’s $95 billion in quantitative tightening policies (QT), will according to the Fed Chairman, “bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
But not everything is causing stomach pains. Yes, inflation is elevated (the rate declined to 8.5% in July from 9.1%), but there are multiple signs that overall prices are peaking. For example, gasoline prices have declined for 11 consecutive weeks to pre Russia-Ukraine invasion levels around $3.81/gallon nationally. There are also signs that housing prices, rent, used car prices, and other commodities like wheat, beef, and copper are all declining in price, as well. Even Bitcoin and other cryptocurrencies are joining in the deflation parade.
And while the Fed is doing its darnedest to bring a halt to gut-wrenching inflation, the job market remains on fire (see chart below). The unemployment rate registered in at a near a generational-low of 3.5% last month, but we will receive a fresh, new figure this week to see if this trend continues.
The economy’s ravenous appetite for workers can also be found in the just-released JOLTS job opening data (see chart below), which shows there are 11.2 million job openings, a total that is almost double the number of available workers (5.7 million).
Stimulus – Trillion Style
The subject of politics is not my strong suit, so perhaps only time will tell whether the net result of two large pieces of government legislation totaling more than $1 trillion (Inflation Reduction Act and Student Loan Forgiveness) will accelerate growth in the economy (Real GDP) or hasten the pace of inflation.
More specifically, the $565 billion Inflation Reduction Act is designed with the intent of investing in clean energy and healthcare initiatives, while negotiating lower pharmaceutical prices with drug companies, and raising tax revenues. The key measures planned in the legislation to fund the spending and forecasted deficit reduction are a minimum corporate tax, the termination of the carried interest tax loophole, and a doubling of the IRS (Internal Revenue Service) budget to hunt down tax dodgers.
With respect to the Student Loan Forgiveness Plan, the cost of the bill is estimated to be between $469 billion to $519 billion over a 10-year budget window, according to the University of Pennsylvania. The debt cancellation will apply to lower income individuals (earning less than $125,000 annually) with the potential of erasing debt of $10,000 – $20,000 per eligible person.
While the government passes various investing, spending, and tax-raising initiatives, corporations continue to crank out record results (see profit charts below), despite talks of an impending recession (see last month’s article, Recession or Mental Depression?).
Pessimists point to the economic strength as only temporary, as they brace for the Fed’s interest rate hiking medicine to take larger effect on the patient. Optimists point to the durability of corporate profits, relatively low interest rates (3.13% yield on the 10-Year Treasury Note), positive Q3 – GDP growth estimates of +1.6%, and reasonable valuations (17x Forward Price/Earnings ratio), given the evidence of peaking and declining inflation.
In view of all the current countervailing factors, the near-term volatility will likely create a lot of stomach-churning uneasiness. However, in the coming months, if it becomes clearer the Fed is closer to the end of its rate-hiking cycle and inflation subsides, you might be gleefully enjoying your tasty gains rather than complaining of financial heartburn and headache pains.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in BRKA/B or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact Page.
Recession or Mental Depression?
“Recession is when your neighbor loses his job. Depression is when you lose yours.” -Ronald Reagan
So far, 2022 has been a volatile year in the financial markets, and as a result, investors have been on an emotional rollercoaster, questioning whether we are going into a recession, or are already in one? Rampant inflation caused by COVID, supply chain disruptions, the Russia-Ukraine conflict, monetary policy, fiscal policy, wage increases, and other factors have been contributing to all the anxiety. Economic data (GDP – Gross Domestic Product) just released last week showed the economy contracting by -0.9% in the 2nd quarter after declining -1.6% in the first quarter of 2022 (see chart below).
Typically, economists have defined a recession by two consecutive quarters of negative GDP growth, which we have now technically achieved, as shown in the chart above. But, not so fast. The official, mutually agreed upon arbiter of a U.S. “recession” is the NBER (National Bureau of Economic Research), which defines a recession more broadly. In order to prevent recession declaration mistakes, the NBER typically waits until long after the fact before making a definitive recession proclamation, in part because the recently released data could eventually be revised higher to a positive level. Revisions, both positive and negative, are commonplace in the never-ending flood of economic data. In addition to negative GDP output figures, the NBER committee considers other factors. For example, household income and unemployment, which by many measures remains white hot and currently remains at generationally low levels (3.6% unemployment rate) are considered when classifying a recession (see the historically low unemployment claims chart below).
So, this begs the question, “Does it really matter whether we are in a recession or not?” The short answer is “no”. The dynamics that really matter are the ones relating to the future. Ultimately, the stock market is forecasting how much worse or better will the economy become? And how long will the pain last? Getting correct answers to these questions is always challenging, but what we do know is that we have had 12 recessions since World War II, and our country is batting 1,000% on recoveries. And the economy has grown stronger coming out of each recession, every time. Therefore, now is not the time to get depressed and climb under a rock. Rather, it’s time to sharpen your pencil and go bargain hunting for opportunities during these corrections.
Well, investors (at least the ones still remaining) came out of their caves this month and actually bought stocks. For the month, the S&P 500 impressively climbed by +9.1% and the NASDAQ index soared by +12.4%. How did we suddenly go from gloom and doom to boom and zoom this month? For starters, although inflation has remained stubbornly high, there are signs of a disinflation light at the end of the tunnel. Anecdotally, we see gasoline prices coming down, while housing prices are softening and various food prices are beginning to come down from the stratosphere. On the economic data front, the Federal Reserve’s inflation measure of choice (Core PCE) appears to be stabilizing as well (see chart below). Core PCE for June rose by 4.8%, but this metric was down from 5.2% in March, and it is up a smidge from the 4.7% figure reported during May.
Another factor contributing to investor optimism this month revolves around the Fed’s monetary policy. Just last week, Fed Chairman Jerome Powell and the members of the FOMC (Federal Open Market Committee) decided to set the Fed Funds target higher by +0.75% to a range of 2.25% – 2.50%, the fourth increase this year (see chart below). For many traders, they interpreted this move as getting one step closer to a terminal rate in the 3.0% – 4.5% range by next year. In other words, a broad number of market participants are beginning to view the rapid escalation of rates this year as a way of accumulating dry powder for potential stimulative interest rate cuts in 2023, if the economy continues to weaken or stagnates further.
There are plenty of challenging forces surrounding us, including an overhanging recession, that could push you into a depression, however the ability to invest in certain areas of the market where prices are on sale should bring plenty of happiness. As investing legend Peter Lynch stated, “I’m always more depressed by an overpriced market in which many stocks are hitting new highs every day than by a beaten-down market in a recession.” Said differently, no matter what transpires in the coming months, “This too shall pass.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in BRKA/B or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact Page.
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