What Persistent Inflation Could Mean for the U.S. Economy

April 30, 2024 — Sam H. Fawaz

Economic reports of late seem to point to a weakening economy and stubborn inflation.

On April 30, the Employment Cost Index for the first calendar quarter of 2024 showed a 1.2% increase (4.2% year-over-year); that was 25% higher than the consensus estimate of 0.9%.

The FHFA House Price Index for February 2024 was much hotter than expected, coming in at 1.2% versus 0.1% expected (7.0% year-over-year.) Similarly, the February Case-Shiller 20-City Home Price Index came in at 0.6% versus 0.1% expected (7.3% year-over-year.)

At the same time, two more economic reports were released on April 30.

The Chicago Purchasing Managers’ Index (PMI) was 37.9 (versus 45 expected).

The Conference Board’s Consumer Confidence Index also came in far below expectations (97 versus 104 expected).

The stock markets were understandably confused: Normally, lower economic activity means lower inflation. Instead, what we got was higher inflation and lower economic activity.

In the stock markets, confusion equals selling now and asking questions later. That’s what we are seeing now.

Persistent Inflation

On April 10, 2024, the U.S. Bureau of Labor Statistics released the Consumer Price Index (CPI) for March, and the increase in CPI — the most commonly cited measure of inflation — was higher than expected. The rate for all items (headline inflation) was 3.5% over the previous year, while the “core CPI” rate, which strips out volatile food and energy prices, was even higher at 3.8%. The month-over-month change was also higher than anticipated at 0.4%. (1)

The stock market then dropped sharply on this news and continued to slide over the following days, while economists engaged in public handwringing over why their projections had been wrong and what the higher numbers might mean for the future path of interest rates. Most projections were off by just 0.1% — core CPI was expected to increase by 3.7% instead of 3.8% — which hardly seems earth-shattering to the casual observer. But this small difference suggested that inflation was proving more resistant to the Federal Reserve’s high interest-rate regimen (raising interest rates is one of the most common ways to curb spending and corporate investing to reduce inflationary pressures.) (2)

It’s important to remember that the most dangerous battle against inflation seems to have been won. CPI inflation peaked at 9.1% in June 2022, and there were fears of runaway inflation similar to the 1980s. That did not happen; inflation declined steadily through the end of 2023. The issue now is that there has been upward movement during the first three months of 2024.(3) This is best seen by looking at the monthly rates, which capture the current situation better than the 12-month rates. March 2024 was the third increase month that points to higher inflation (see chart).

High for longer

While price increases hit consumers directly in the pocketbook, the stock market reacted primarily to what stubborn inflation might mean for the benchmark federal funds rate and U.S. businesses. From March 2022 to July 2023, the Federal Open Market Committee (FOMC or AKA the Fed) raised the funds rate from near-zero to the current range of 5.25%–5.5% to slow the economy and hold back inflation.

At the end of 2023, with inflation moving firmly toward the Fed’s target of 2%, the FOMC projected three quarter-percentage point decreases in 2024, and some observers expected the first decrease might be this spring. Now it’s clear that the Fed will have to wait to reduce rates. (4)(5)

Higher interest rates make it more expensive for businesses and consumers to borrow. For businesses, this can hold back expansion and cut into profits when revenue is used to service debt. This is especially difficult for smaller companies, which often depend on debt to grow and sustain operations. Tech companies and banks are also sensitive to high rates. (6)

As mentioned above, in theory, high interest rates should hold back consumer spending and help reduce prices by suppressing demand. So far, however, consumer spending has remained strong. In March 2024, personal consumption expenditures — the standard measure of consumer spending — rose at an unusually strong monthly rate of 0.8% in current dollars or 0.5% when adjusted for inflation. (7)

The job market has also stayed strong, with unemployment below 4% for 26 consecutive months and wages rising steadily. (8)

The fear of keeping interest rates too high for too long is that it could slow the economy, but that is not the case, making it difficult for the Fed to justify rate cuts.

What’s driving inflation?

The Consumer Price Index measures price changes in a fixed market basket of goods and services, and some inputs are weighted more heavily than others.

The cost of shelter is the largest single category, accounting for about 36% of the index and almost 38% of the March increase in CPI. (9) The good news is that measurements of shelter costs — primarily actual rent and estimated rent that homeowners might receive if they rented their homes — tend to lag current price changes, and other measures suggest that rents are leveling or going down. (10)

Two lesser components contributed well above their weight. Gas prices, which are always volatile, comprised only 3.3% of the index but accounted for 15% of the overall increase in CPI. Motor vehicle insurance prices comprised just 2.5% of the index but accounted for more than 18% of the increase. Together, shelter, gasoline, and motor vehicle insurance drove 70% of March CPI inflation. On the positive side, food prices comprised 13.5% of the index and rose by only 0.1%, effectively reducing inflation. (11)

While the Fed pays close attention to the CPI, its preferred inflation measure is the personal consumption expenditures (PCE) price index, which places less emphasis on shelter costs, includes a broader range of inputs, and accounts for changes in consumer behavior. Due to these factors, PCE inflation tends to run lower than CPI. The annual increase in March was 2.7% for all items and 2.8% for core PCE, excluding food and energy. The monthly increase was 0.3% for both measures. (12)

Although these figures are closer to the Fed’s 2% target, they are not low enough, given strong employment and consumer spending, to suggest that the Fed will reduce interest rates anytime soon. It’s also unlikely that the Fed will raise rates.

The Fed seems poised to give current interest rates more time to push inflation to a healthy level, ideally without slowing economic activity. (13)

And since higher interest rates mean more competition for investment dollars and lower corporate earnings, stock markets don’t tend to react favorably, especially when 3-4 interest rate cuts were expected earlier this year.

The Fed issues its next interest rate decision on Wednesday afternoon, May 1, 2024. No change in interest rates is all but a given. However, what Federal Reserve Chairman Jerome Powell says about the recent economic data and the Fed’s stance on when future rate cuts are coming will no doubt be parsed word for word for clues when the press conference is convened.

Please pass the popcorn.

If you would like to review your current investment portfolio or discuss any other retirement, tax, or financial planning matters, please don’t hesitate to contact us at 734-447-5305 or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client, an initial consultation is complimentary, and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client and your financial plan and investment objectives are different.

Footnotes:

1, 3, 8–9, 11) U.S. Bureau of Labor Statistics, 2024

2)The New York Times, April 10, 2024

4) Federal Reserve, 2023

5) Forbes, December 5, 2023

6) The Wall Street Journal, April 15, 2024

7, 12) U.S. Bureau of Economic Analysis, 2024

10) NPR, April 18, 2024

13) Bloomberg, April 19, 2024

Posted in American Economy, economy, General. Tags: , , . Leave a Comment »

What’s Going on in the Markets November 29, 2023

November 29, 2023 — Sam H. Fawaz

Who ya’ gonna believe? The headlines or the market?

The latest economic headlines read:

“Credit Card Defaults are on the rise”
“Household savings rates are at historic lows”
“Banking Credit Contracts to Levels Not Seen Since the Global Financial Crisis”
“Home Builder Confidence from the National Association of Homebuilders takes another sharp drop”
“Trucking Employment is Contracting at a rate not seen since the 2000 and 2008 Crises.”
“The Conference Board of Leading Economic Indicators Declined for the 19th consecutive month”
“Yield Curves are Steepening after being extensively inverted, a sign of recession”
“Overdue commercial property loans hit 10-year high at US banks”
“No End in Sight for the Ukraine-Russia War”
“Could The War in the Middle East be the start of World War 3?”
“World Panics as supply of Twinkies Shrinks” (OK I made that one up to see if you’re paying attention)

With headlines like these, you’d think the stock markets were crashing, and we’re already in a deep recession.

Instead, the markets are having one of their best Novembers in history (after an awful October), which has led to headlines like these:

“The stock market is following a rare pattern that could signal double-digit gains next year”
“Extreme investor bearishness suggests stock market gains of 16% are coming in the next 12 months”
“The S&P 500 could soar more than 20% in the next year after an ultra-rare buy signal just flashed”
“This stock market signal points to the S&P 500 surging 25% within the next year”
“The Dow just flashed a bullish ‘golden cross’ Two days after the bearish ‘death cross’ signal”

High inflation and interest rates, two prominent wars, and unprecedented dichotomies continue to mount throughout the market and the economy, which can only mean that Wall Street’s roller-coaster ride is far from over. Let’s take a closer look at some of the headlines driving the markets.

Leading Economic Indicators

The Conference Board’s Leading Economic Indicator (LEI) has warned of trouble all year. It has declined for 19 consecutive months, its third-longest streak on record. When viewed as a ratio with the Conference Board’s Coincident Economic Indicator (CEI), declines from peaks have typically led to recessions. When decreasing, this ratio provides evidence that coincident indicators are holding up, but leading indicators are deteriorating. The Leading-to-Coincident Ratio has steeply declined since its peak in December 2021. Never has this ratio fallen this far and at such a rapid rate without a corresponding recession.

Treasury Yields

Another warning sign still flashing red and has a near-perfect track record for predicting recessions is the yield spread between 10-year and 2-year Treasurys.

Typically, one would expect to receive a higher interest rate on longer-duration bonds, CDs, debt, etc. After all, the more time a debt is outstanding, the more risk the lender takes (e.g., default risk, interest rate risk, bankruptcy, death, etc.). 10-year Treasurys should normally pay a higher interest rate than 2-year Treasurys to compensate lenders (the public) for this added risk.

An inversion means shorter-duration Treasurys command a higher interest rate than longer-duration Treasurys. Historically, inversions are unusual and indicate the economy is vulnerable. After all, if you’re concerned about the economy, it means you’re concerned about corporations being able to pay back their debt. Hence, you’re more likely to buy shorter-term debt. That pushes shorter-term interest rates into inversion. Simply put, if you had concerns about your brother-in-law paying back a personal loan, you’re more likely to keep the term shorter rather than longer, right?

The most recent inversion of the 10-year treasury bill and the 2-year treasury bill interest rates began in July of 2022 and quickly became its deepest (widest) since the early 1980s. The initial inversion is an early warning sign of a potential oncoming recession, but when this yield spread moves back above 0.0 (or it un-inverts), historically, there are four months on average before the onset of a recession. So, this is another definite recession warning sign.

Institute for Supply Management (ISM) Economic Indicators

A few macroeconomic indicators bounced back from dire levels or improved earlier this year, spurring hopes of a soft landing. However, unfortunately, many of these improvements have recently reversed course.

The ISM manufacturing index, also known as the purchasing managers’ index (PMI), is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms. It is a key indicator of the state of the U.S. economy. The PMI measures the change in production levels across the U.S. economy from month to month. The PMI report is released on the first business day of each month.

The 50 level in the PMI (both manufacturing and services) is the demarcation between economic expansion and contraction. Above 50, it’s expanding; below 50, it’s contracting.

Late last year, the ISM Manufacturing PMI index fell into contraction territory (<50.0) and has yet to move back into expansion. It has contracted for 12 consecutive months, showing some improvement mid-year before dropping once again in October.

The ISM Non-Manufacturing (or services) Index is an economic index based on surveys of more than 400 non-manufacturing (or services) firms’ purchasing and supply executives. The ISM Services PMI comes out in the first week of each month and provides a detailed view of the U.S. economy from a non-manufacturing standpoint.

The ISM Services Index has been resilient this year, dropping below 50.0 just once since the pandemic. After initially improving in early 2023, it has declined for the past two months and is now at a five-month low. Because more than 70% of the economy is services-based, any contraction would not benefit the whole economy.

Housing and Real Estate

Housing, another major economic sector, accounts for 15-18% of U.S. GDP and is also on somewhat of a roller coaster ride of its own. Despite its improvement earlier this year, home sales have retracted and are at their lowest levels since 2010.

Existing home sales, which comprise most of the housing market, decreased 4.1% in October 2023 from the level in September to a seasonally adjusted annual rate of 3.79 million, the lowest rate since August 2010, according to the National Association of Realtors. October sales fell 14.6% from a year earlier.

New home sales for October came in lower than expected at 679,000, lower than September’s surprise of 759,000 but slightly higher than August’s 675,000. Despite being below expectations, these numbers are pretty robust (not surprising, given that existing homeowners with low mortgage rates are not selling).

Today’s housing market is still one of the most unaffordable in U.S. history. Home prices have exceeded the extremes of the 2005 housing bubble peak. With today’s high mortgage rates, high home prices, and ever-increasing ownership costs, housing activity seems to be at a standstill overall. Continued declines in home sales would hint at a bursting housing bubble.

On November 8, the Financial Times reported that overdue commercial property loans hit a 10-year high at U.S. banks. The Federal Reserve’s hiking campaign to curb inflation has caused borrowing costs of all types to surge this year, including in commercial real estate. Combined with empty building space from the pandemic work-from-home trend, commercial real estate is in a tight spot. The Green Street Commercial Property Price Index is now down nearly 20% from its 2022 peak and back to a level not seen since the short COVID-induced recession in 2020.

Inflation

While commercial property prices have fallen, price pressures elsewhere have reaccelerated in recent months, prompting consumers to expect inflation to remain elevated in the months ahead. After all, how many items at the grocery or department store have you seen come down in price (besides perhaps eggs and gasoline?)

For October, while headline and Core Consumer Price Indexes (CPI) improved slightly (inflation down), the recent acceleration in consumer inflation expectations indicates that this improvement could be temporary.

In consumer sentiment surveys, the first half of this year saw consumers growing more optimistic about the economy as inflation slowed; however, expectations of future inflation have surged since then, and consumers are becoming discouraged again. Discouraged consumers turn into non-confident consumers who tend to put away their wallets and walk away from discretionary purchases.

Since September, consumer expectations of higher inflation in 12 months have increased significantly to 4.4%. Meanwhile, inflation expectations in five years reached 3.2% as of October’s interim report, their highest level in over a decade. Despite the recent easing in the CPI data, this inflationary expectation pressures the Federal Reserve to keep interest rates elevated.

Inflation expectations notwithstanding, consumers have enthusiastically supported the economy this year despite inflationary challenges. However, the upward trend in credit card delinquency rates indicates an increasingly stressed consumer. Figures from the Federal Reserve show that credit card delinquencies have risen to 2011 levels, and delinquent auto loans are at their highest since 2010. Though not at the extreme levels seen during the Great Financial Crisis (2007-2009), these delinquencies are not slowing and could quickly surge higher if stronger parts of the economy begin to falter.

Jobs

Employment continues to be the last bastion of strength in today’s economy and is important to watch. Jobs remain plentiful, and employees increasingly view employment as transactional (as opposed to long-term). While the unemployment rate remains at historic lows, it has trended upward recently, which could become worrisome.

The unemployment rate in October clocked in at 3.9%, quite low by historical standards but 0.5 percentage points higher than the low rate we saw earlier this year (3.4%).  Increases in the unemployment rate of at least 0.6 percentage points from a cyclical low have confirmed the onset of nearly every recession of the past 50 years, with only one false signal in 1959. Accordingly, the unemployment rate is now just 0.1 percentage points away from reaching this threshold, which would confirm the onset of a recession. The November monthly jobs report and the unemployment rate are scheduled to be released on Friday, December 8.

The Stock Markets: What? Me Worry?

Since the start of November, the S&P 500 Index has been up about 8.5%. The tech-heavy NASDAQ index is up about 10.8%.

Rocket-boosted by the Magnificent Seven tech stocks (Amazon, Apple, Google, Meta, Microsoft, Nvidia, and Tesla), the indexes would not be anywhere nearly as strong without them. While the combined seven stocks are up about 80% year-to-date, the other 493 stocks in the S&P 500 Index are flat. While historically, a handful of stocks “carry” the indexes, we usually see better performance from the rest, and we’re largely not seeing that. Lately, the rally is showing signs of slowly broadening out, which is a good sign going into year’s end.

If you look at the S&P 500 Index on an equal-weight basis (where each stock has an equal “vote,” as opposed to a weighted approach based on company size), the index would be up only 3.8% year-to-date. The Mid-cap 400 index is also up 3.8% year-to-date, and the Small Cap 600 is up 3.3%.

Since we’re in the 4th quarter of a pre-election year, the markets have two reasons to be seasonally positive. True to form, November has reclaimed most of the losses from August to October and looks poised to take out the July high in December. As long as the S&P 500 Index holds the 4400 level, things look good. Daily new high prices among stocks that outnumber new low prices are also encouraging and add to the rally’s strength.

My main concern is with the valuation of the Magnificent Seven Stocks. Compared with the Nifty Fifty Stocks in 1972 and the Tech bubble in 2000, these seven stocks are just as overvalued. Momentum trading combined with valuations this extreme can turn great companies into terrible investments, so buyers at these levels should beware. Should the drive to buy anything related to AI (Artificial Intelligence) cool off in 2024, these seven stocks will have a disproportionate effect on the indexes, driving down the markets quickly, especially since so many portfolio managers have piled into them as “safe havens.” I’m not saying to sell them now, but if you’re overexposed to them and have enjoyed the ride, it would be prudent to trim them at their current levels (this is not a recommendation to buy or sell.)

Recession Watch

A strong consumer, robust labor market, the housing wealth effect, and the lasting effects of a zero interest rate policy held in place too long have made 2023 recession callers look foolish (including me).

Underestimating the U.S. Consumer has always been a bad bet, especially when locked down for months, saving their stimulus checks and unspent wages and ultimately coming out of the gates splurging. While their savings are nearly depleted, I would not completely count them out just yet, and a recession in 2024 is definitely not a sure thing, although I still believe we will have one next year.

As discussed above, there are signs that the post-pandemic fiscal and monetary drugs are starting to wear off for the world’s economies, and a hangover might be on the horizon. Whether and when that hangover turns gross domestic product in a negative direction and, therefore, an economic recession, is anyone’s guess. I like what Bloomberg Points of Return writer John Authers wrote this week on that topic:

“…Having got this far, there’s now a pretty good chance the US can get through the next two years without a recession. But the odds still point more to a downturn. That explains the negativity in opinion polls and surveys of consumers, even if it completely fails to explain the enthusiasm among consumers when they go shopping. And then there’s the issue of stock market sentiment, which is utterly baffling.”

It would be understandable to read this post and think that things look grim and that it’s time to batten down the hatches and sell everything. It’s not. When it comes to discounting the future, the markets usually have it right (looking out 6-9 months), and we may just be experiencing some economic indigestion that will resolve itself, and the stock markets will challenge and exceed the all-time highs in 2024.

Election years are positive for a reason: the incumbents want to be re-elected, so you can’t underestimate the levers they can pull to keep the economy firing on all cylinders and postpone any recession until a later year. Never underestimate what determined politicians can do.

I would like to take this opportunity to wish your family and you a very happy holiday season.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client, an initial consultation is complimentary, and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so are your financial plan and investment objectives.

Source: InvesTech Research

Posted in American Economy, General, Stock Market. Tags: , , , , , . Leave a Comment »

Should the Government Shut Up or Shut Down?

September 28, 2023 — Sam H. Fawaz

As September ends, the U.S. government seems headed for a shutdown, which would begin on October 1st. Although it is possible that a last-minute agreement could keep the lights on, that becomes less likely with each passing day. With all the nonsense that comes from Washington, would we rather have our government shut up rather than shut down?

Regardless, here’s a look at the federal funding process, the current situation in Congress, and the potential consequences of a failure to fund government operations.

Twelve appropriations bills

The federal fiscal year begins on October 1, and under normal procedures, 12 appropriations bills for various government sectors should be passed by that date to fund activities ranging from defense and national park operations to food safety and salaries for federal employees.

These appropriations are considered discretionary spending, meaning that Congress has flexibility in setting the amounts.  Although discretionary spending is an ongoing source of conflict, it accounted for only 27% of federal spending in fiscal year (FY) 2023, and almost half of that was for defense, which is typically less of a point of conflict. Mandatory spending (including Social Security and Medicare), which is required by law, accounted for about 63%, and interest on the federal debt accounted for 10%.1

Obviously, it would be helpful for federal agencies to know their operating budgets in advance of the fiscal year, but all 12 appropriations bills have not been passed before October 1 since FY 1997. In 11 of the last 13 years, lawmakers have not passed a single spending bill in time.2 That is the situation as of September 27 this year (although, one bill, to fund military construction and the Department of Veterans Affairs, has been passed by the House but not the Senate.)3

Continuing resolutions and omnibus spending bills

To buy time for further budget negotiations, Congress typically passes a continuing resolution, which extends federal spending to a specific date, generally at or based on the same level as the previous year. These bills are essentially placeholders that keep the government open until full-year spending legislation is enacted. Since 1998, it has taken an average of almost four months after the beginning of the fiscal year for that year’s final spending bill to become law.4

Even with the extension provided by continuing resolutions, Congress seldom passes the 12 appropriations bills. Instead, they are often combined into massive omnibus spending bills that may include other provisions that do not affect funding.  For example, the SECURE 2.0 Act, which fundamentally changed the retirement savings rules, was included in the omnibus spending bill for FY 2023, passed in late December 2023, almost three months into the fiscal year.

Current Congressional situation

The U.S. Constitution gives the House of Representatives sole power to initiate revenue bills, so the House typically passes funding legislation and sends it to the Senate. There are often conflicts between the two bodies, especially when they are controlled by different parties, as they are now. These conflicts are typically settled through negotiations after a continuing resolution extends the budget process.

In a reversal of the typical process, the Senate acted first this year, releasing bipartisan legislation on September 26 that would maintain current funding through November 17 and provide additional funding for disaster relief and the war in Ukraine. Although this is likely to pass the Senate later in the week, it was unclear how the House would react to the legislation.5

Late on September 26, the House cleared four appropriation bills for debate (Agriculture, Defense, Homeland Security, and State Department). It is unknown whether these bills will pass the House, and if they do, it will likely be too late to negotiate the provisions with the Senate. A proposed continuing resolution that would extend government funding and include new provisions for border security had not been cleared for debate as of the afternoon of September 27.6

Effects of a shutdown

The effects of a government shutdown depend on its length, and fortunately, most are short. There have been 20 shutdowns since the current budget process began in the mid-1970s, with an average length of eight days. The longest by far was the most recent shutdown, which lasted 35 days in December 2018 and January 2019, and demonstrates some potential consequences of an extended closure.7 However, in 2018-19, five of the 12 spending bills had already passed before the shutdown — including large agencies like Defense, Education, and Health & Human Services — which helped limit the damage. The current impasse, with no appropriations passed, could lead to an even more painful situation.8

Here are some things that will not be affected: The mail will be delivered. Social Security checks will be mailed. Interest on U.S. Treasury bonds will be paid.9 However, some programs will stop immediately, including the Supplemental Nutrition Program for Women, Infants, and Children, which helps to provide food for about seven-million low-income mothers and children.10

Federal workers will not be paid. Workers considered “essential” will be required to work without pay, while others will be furloughed.  Lost wages will be reimbursed after funding is approved, but this does not help lower-paid employees who may be living paycheck to paycheck.11 In an extended shutdown, the greatest hardship would fall on lower-paid essential workers, which would include many military families. Furloughed workers would struggle as well, but they might look for other jobs, and in many states would be able to apply for unemployment benefits.12 Members of Congress, who are paid out of a permanent appropriation that does need renewal, would continue to be paid (shocked, aren’t you?).13

Air travel could be affected. In 2019, absenteeism more than tripled among Transportation Security Administration (TSA) workers, resulting in long lines, delays, and gate closures at some airports. According to the TSA, many workers took time off for financial reasons.14 Air traffic controllers, who are better paid, remained on the job without pay and without normal support staff. However, on January 25, 2019, an increase in absences by controllers temporarily shut down New York’s La Guardia airport and led to substantial delays at airports in Newark, Philadelphia, and Atlanta. This may have been the impetus to reopen the government later that day.15

Unlike federal employees, workers for government contractors are not guaranteed to be paid, and contractors often work side-by-side with federal employees in government agencies. In 2019, it was estimated that 1.2 million contract employees faced lost or delayed revenue of more than $200 million per day.16 A more widespread shutdown would put even more workers at risk.

While essential workers will maintain some federal services, furloughed workers would leave significant gaps. At this time, it’s unknown exactly how each agency will respond to a shutdown. In 2019, some national parks used alternate funding to maintain limited access, which caused problems with trash and vandalism and was deemed illegal by the Government Accounting Office. This year, all parks might be closed during an extended shutdown.17 Many other federal services may be delayed or suspended, ranging from food inspections to small business loans and economic reports.18 Delays in economic statistics could make it more difficult for the Federal Reserve to judge appropriate monetary policy.19

Although a shutdown would cause temporary hardship for workers and the citizens they serve, the long-term effect on the economy would be relatively benign, because lost payments are generally made up after spending is authorized. A shutdown might decrease gross domestic product (GDP) for the fourth quarter of 2023, but if the shutdown ends by the end of the year, GDP for the first quarter of 2024 would theoretically be increased. Even if delayed spending is recovered, however, lost productivity by furloughed workers will not be regained. And an extended shutdown could harm consumer and investor sentiment.20

Surprisingly, previous shutdowns generally have not hurt the broad stock market, other than short-term reactions. But the current market situation is delicate to begin with, and it is impossible to predict future market direction.21

For now, it’s wise to maintain a steady course in your own finances. Based on historical precedent, the shutdown is a non-event as far as your investment portfolio is concerned. But in the event of a shutdown, be sure to check the status of federal agencies and services that may affect you directly.

And the next time you see your favorite federal government politician, let them know you’d prefer them to shut up rather than shut down.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so are your financial plan and investment objectives.

Sources:

1) Congressional Budget Office, May 2023

2, 4, 8) Pew Research Center, September 13, 2023

3) Committee for a Responsible Federal Budget, September 27, 2023

5, 6, 9, 18, 19) The Wall Street Journal, September 26, 2023

7, 11) CNN, September 21, 2023

10) MarketWatch, September 26, 2023

12) afge.org, September 25, 2023 (American Federation of Government Employees)

13) CBS News, September 25, 2023

14) Associated Press, January 21, 2019

15) The Washington Post, January 25, 2019

16) Bloomberg, January 17, 2019

17) Bloomberg Government, September 12, 2023

20) Congressional Research Service, September 22, 2023

21) USA Today, September 26, 2023

Posted in American Economy, Financial Planning, General, Social Security Benefits. Leave a Comment »

Is a Recession Looming?

July 31, 2023 — Sam H. Fawaz

With inflation falling, the housing market stabilizing, and consumer spending showing surprising resiliency in the face of rising interest rates, both Wall Street and Main Street are passionately embracing the outlook for an economic soft landing.

Despite enthusiastic buying in the stock market of late, some major recession warning flags have not disappeared, consumer financial stress is increasing, and the Federal Reserve has just increased short-term interest rates by another 0.25% to 5.25%, and signaled that they may not be done raising interest rates.

The question on everyone’s mind: is a recession looming?

To answer that question, with help and data from InvesTech Research, let’s look at both sides: the economic “soft-landing” camp and the “hard-landing” camp, and see if we can’t draw any conclusions using a weight-of-evidence approach.

Evidence Supporting a Soft Landing

Inflation is Coming Down: The Consumer Price Index (CPI) is leading the optimistic charge in the media, with reports of decreasing inflation over the last twelve months. Headline CPI fell from 4.0% to 3.0% in June on a year-over-year basis. While much of this decline was driven by cyclical factors like energy costs, it still increases the odds of a soft landing.

Contributing to the decrease in overall prices are both the manufacturing and services sectors. The services sector saw inflationary pressures subside starting in early 2022. The Institute for Supply Management Services Prices Paid Index has declined by 30.4 points from its all-time high in December 2021. It has been down for the last seven out of eight months and remains in expansion territory (for now). This, too, supports a possible soft landing.

With decreasing inflation comes decreasing inflation psychology. Recently, consumers have reduced their expectations of inflation over the next year significantly. This measure fell in June to 3.3%, its largest decline since 2008, while the longer-term 5-year expectations remain more firmly anchored at 3.0%.

Actual inflation partially depends on what consumers expect it to be. If consumers expect inflation to be lower next year, businesses will plan to price their goods or services accordingly. It’s likely that the expected inflation rate will continue its downtrend and make a soft landing more likely.

Parts of the economy remain surprisingly resilient: In addition to easing inflation pressures, persistent strength in parts of the economy also supports a potential soft landing. Specifically, the service sector appears to remain resilient.

Services: The Institute for Supply Management Services Index (Non-Manufacturing) remains solidly in expansion territory with a reading of 53.9 last month (any reading above 50 is considered expansionary) and only one month of contraction in the last decade (outside of the pandemic). With services accounting for over 75% of U.S. gross domestic product (GDP), the current Index levels show continued growth. While there is no guarantee this will be maintained, its recent strength provides recession-free hope.

Labor: The relentlessly tight labor market has remained a stronghold of the economy for the last few years. June’s Non-Farm Payrolls report showed 209,000 new jobs created, another banner month for this indicator. The monthly average of new jobs added since January 2022 is almost twice as high as it was during the same period in 2018-2019 prior to the pandemic. In addition, the unemployment rate is currently at 3.6%, just fractionally above its 50-year low. With job growth holding up so well, it doesn’t point to a recession, despite being a heavily revised figure.

Housing: The last bit of soft-landing evidence is one of its strongest – New Home Sales. Sales of new construction have rebounded sharply. New homes currently account for a near-record 29% of all homes for sale, while the historical average is less than half that at just 13%. This recent rebound is driven by a resurgence in enthusiastic buyer psychology, reflected in a rise in traffic of prospective buyers and a reluctance by existing homeowners to sell their homes because of: 1) their current ultra-low mortgage interest rates, 2) higher home replacement costs and 3) potential capital gains taxes on highly appreciated primary residences. Whether this increase is sustainable will be clearer in the coming months.

Evidence Supporting a Hard Landing

A recession may nonetheless be in the cards: While I’ve laid out the evidence in support of a soft landing, many significant indicators just don’t add up, and therefore a recession may still be in the cards.

Leading Economic Index (LEI): The most glaring evidence against a soft landing is the Conference Board’s LEI, which has fallen for 15 consecutive months. Declines of this magnitude have always corresponded to a hard landing, and when the LEI falls below its 18-month moving average, a recession almost invariably follows. Additionally, the LEI’s 6-month rate of change (ROC) is deeply negative, further solidifying this warning flag (red flags are when the 6-month ROC breaks through the zero level prior to a recession). The LEI is historically a reliable indicator, and it is not sending an optimistic signal.

Yield Spreads: Another indicator that is screaming hard landing is the Federal Reserve’s Yield Spread model, which measures the risk of recession in the next 12 months. It’s based on the difference between long-term and short-term Treasury bond yields and recently hit a 42-year high of 71% before retreating slightly to 67% in June. This highly dependable indicator has never reached this level without a resulting recession, although lead times can vary significantly.

Consumer Spending: Lastly, consumer spending has supported the economy for much of the last few years, bolstered by trillions of dollars in stimulus payments and other benefits. Excess savings and lockdowns have helped fuel this strength, though it may be starting to slow.

Within retail sales, “Same-Store Sales” measures growth in revenue from existing (not new) store locations.  Johnson Redbook’s latest Same-Store Sales year-over-year figure went negative, indicating fewer purchases compared to a year ago. If this continues to deteriorate, it implies consumers are spending less overall than before, and a recession becomes more probable.

The Federal Reserve’s (a.k.a. The Fed) job is far from over: A potential soft landing combined with some weak economic indicators is a conundrum that puts the Fed in a tight spot. In addition, while headed in the right direction, inflation is still well above the Fed’s 2% target.

Sticky inflation, which tracks items that change in price very slowly, has not come down as rapidly as overall measures. Sticky Price CPI from the Atlanta Fed has started to decline on a 12-month ROC basis but is still quite elevated, with the current reading at 5.8%.

The shorter, 3-month annualized ROC is much lower but still not close enough to the Fed’s target. It’s very likely that Sticky CPI will continue to decline, but the elusive 2.0% will take much longer to reach than the Fed would like.

Core PCE: Yet another, perhaps more important, inflation indicator is the Core Personal Consumption Expenditures (PCE) Price Index, which measures PCE excluding food and energy. This is the Fed’s preferred measure of inflation and remains at more than twice of the 2.0% inflation target. On Friday, the latest PCE measure came in at 4.1% YoY for June, declining from 4.6% in May.

Making the situation even worse, Core PCE has been flat for the past year and is falling very slowly. Even if it does start to trend lower, it will take quite a long time to reach the target level, putting pressure on the Fed to keep interest rates higher for longer.

Wage Growth: When it comes to inflation, one of the stickiest components is wage growth. The labor market remains tight, there are still more job openings than available employees, and wages continue to rise. The Atlanta Fed’s Wage Growth Tracker is off its all-time high, but at 5.6%, it is still far above its historical average. While increasing wages are beneficial for consumers, it’s a problem for the Fed as failure to control wage growth could risk another inflation surge.

Consumer Distress as a Potential Systemic Risk: Consumers amassed over $2 trillion in excess savings after the pandemic, primarily due to government support and lockdowns. This backlog of cash has helped smooth over many underlying problems in the economy.  After lockdowns ended, consumers spent as if they had unlimited funds. Tack on a decades-high level of inflation, and they’ve now burned through over 80% of their excess savings. Based on current trends, these savings will be completely exhausted by the end of this year. Once savings are depleted, some consumers will likely resort to what is now very expensive revolving debt.

And some already have. Despite the amassed excess savings in some households, consumers still took on more debt than ever after the pandemic. As a result, the combination of auto loans, credit card debt, student loans, and other debt is now at a record high – 72% higher than during the Great Financial Crisis.

Regarding student loan debt, the Consumer Financial Protection Bureau reported that half of borrowers whose payments are scheduled to restart soon have other debts that are at least 10% more expensive now than before the pandemic. If these trends persist, consumers may struggle to bring their savings back to pre-pandemic levels.

Those who have opened new credit cards in recent years or regularly carry credit card debt are quickly coming under more severe financial stress. Monetary tightening has driven average credit card interest rates to over 22% in May – the highest rate since the Federal Reserve began tracking the data in late 1994. Extremely high credit card interest rates combined with record consumer debt outstanding could prove to be an ominous combination.

Consumer spending is the ultimate driver of the economy, making up almost 70% of GDP. If consumers can no longer afford to spend, this systemic risk can become a reality.

The Weight of Evidence

While the evidence is compelling in both the economic soft-landing and the hard-landing camps, more upcoming near-term economic data will help tip the scale solidly into one of the camps.

While it’s easy to say that a recession is inevitable, one could make that statement anytime during our lifetimes. Indeed, it’s not a matter of whether we’ll have a recession because we will. It’s all about the “when” of the recession.

In my opinion, the weight of current evidence supports a recession starting within six months. To be honest, I personally thought we were already in a recession, but the economic data has not supported that opinion, which means I have been wrong so far.

Regardless, a continued deterioration in consumer spending, increasing debt levels, growing layoffs, and higher short-term interest rates will have a detrimental impact on consumer confidence, which constitutes a negative feedback loop that will lead to even further reduced consumer spending and increasing layoffs.

The next few months will be very revealing…. if not exciting!

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so are your financial plan and investment objectives.

Source: Investech Research

Posted in American Economy, Financial Planning, retirement planning, US Stock Market. Tags: , , , . Leave a Comment »

Are Interest Rates Signaling a Recession?

January 31, 2023 — Sam H. Fawaz

According to Investopedia, the yield curve shows the relationship between bond yields (the interest rates on the vertical axis) and bond maturity (the time on the horizontal axis).

Long-term bonds generally provide higher yields than short-term bonds because investors demand higher returns to compensate for the risk of lending money over an extended period. Occasionally, however, this relationship flips, and investors are willing to accept lower yields in return for the relative safety of longer-term bonds. This is called a yield curve inversion because a graph showing bond yields in relation to maturity is essentially turned upside down.

Imagine going to the bank and being told that a 1-year certificate of deposit yields 4.0%, but the 5-year CD only yields 3.0%. Few people would lock up their money for five times as long and earn a lower rate. This is an example of a yield inversion.

A yield curve could also apply to any bonds that carry similar risk, but the most studied curve is for U.S. Treasury securities, and the most common focal point is the relationship between the two-year and 10-year Treasury notes. Although Treasuries are often referred to as bonds, maturities up to one year are called bills, while maturities of two to 10 years are called notes. Only 20- and 30-year Treasuries are officially called bonds.

The two-year yield has been higher than the 10-year yield since July 2022, and beginning in late November, the difference has been at levels not seen since 1981. The biggest separation in 2022 came on December 7, when the two-year was 4.26%, and the 10-year was 3.42%, a difference of 0.84%. Other short-term Treasuries have also offered higher yields;  the highest yields in early 2023 were for the six-month and one-year Treasury bills. (1) 

Predicting Recessions

An inversion of the two-year and ten-year Treasury notes has preceded each recession over the past 50 years, reliably predicting a recession within the next one to two years. (2)  A 2018 Federal Reserve study suggested that an inversion of the three-month and ten-year Treasuries may be an even more reliable indicator, predicting a recession within about 12 months. (3) The three-month and ten-year Treasuries have been inverted since late October 2022, and in December 2022 and early January 2023, the difference was often greater than the inversion of the two- and 10-year notes. (4)

Weakness or Inflation Control?

Yield curve inversions do not cause a recession; rather they indicate a shift in investor sentiment that may reflect underlying economic weakness. A normal yield curve suggests investors believe the economy will continue to grow and interest rates will likely rise with the growth. In this scenario, an investor typically would want a premium to tie up capital in long-term bonds and potentially miss out on other opportunities in the future.

Conversely, an inversion suggests that investors see economic challenges that are likely to push interest rates down and typically would instead invest and lock in longer-term bonds at today’s yields. This increases demand for long-term bonds, driving prices up and yields down.

Note that bond prices and yields move in opposite directions; the more you pay for a bond that pays a given coupon interest rate, the lower the yield will be, and vice-versa.

The current situation is not so simple. The Federal Reserve has rapidly raised the benchmark federal funds rate (short-term) to combat inflation, increasing it from near 0% in March 2022 to 4.50%–4.75% today. The fed funds rate is the rate charged for overnight loans within the Federal Reserve System.  The funds rate directly affects other short-term rates, which is why yields on short-term Treasuries have increased rapidly. The fact that 10-year Treasuries have lagged the increase in the federal funds rate may mean that investors believe a recession is coming. But it could also reflect the confidence that the Fed is winning the battle against inflation and will lower rates over the next few years. This is in line with the Federal Reserve’s (The Fed) projections, which see the funds rate peaking at 5.0%–5.25% by the end of 2023 and then dropping to 4.0%–4.25% in 2024 and 3.0%–3.25% in 2025. (5)

Inflation has been slowing somewhat in October-December, but there is a long way to go to reach the Fed’s target of 2% inflation for a healthy economy. (6)  The fundamental question remains the same as it has been since the Fed launched its aggressive rate increases: Will it require a recession to control inflation, or can it be controlled without shifting the economy into reverse?

Other Indicators and Forecasts

The yield curve is one of many indicators that economists consider when making economic projections. Among the most closely watched are the ten leading economic indicators published by the Conference Board, with data on employment, interest rates, manufacturing, stock prices, housing, and consumer sentiment. The Leading Economic Index, which includes all ten indicators, fell for nine consecutive months through November 2022. Conference Board economists predict a recession beginning around the end of 2022 and lasting until mid-2023. (7) Recessions are not officially declared by the National Bureau of Economic Research until they are underway. The Conference Board view would suggest the United States may already be in a recession.

In The Wall Street Journal’s October 2022 Economic Forecasting Survey, most economists believed the United States would enter a recession within the next 12 months, with an average expectation of a relatively mild 8-month downturn. (8) More recent surveys of economists for the Securities Industry and Financial Markets Association and Wolters Kluwer Blue Chip Economic Indicators also found a consensus for a mild recession in 2023. (9)

For now, the economy appears strong despite high inflation, with a low December 2022 unemployment rate of 3.5% and an estimated 2.9% 4th quarter growth rate for real gross domestic product (GDP). Nonetheless, the indicators and surveys discussed above suggest an economic downturn in the next year or so. This would likely cause some job losses and other temporary financial hardship, but a brief recession may be the necessary price to tame inflation and put the U.S. economy on a more stable track for future growth.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so are your financial plan and investment objectives.

(1), (4) U.S. Treasury, 2023

(2)  Financial Times, December 7, 2022

(3) Federal Reserve Bank of San Francisco, August 27, 2018

(5) Federal Reserve, 2022

(6) U.S. Bureau of Labor Statistics, 2022

(7)  The Conference Board, December 22, 2022

(8) The Wall Street Journal, October 16, 2022

(9) SIFMA, December 2022

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What’s Going on in the Markets September 25 2022

September 25, 2022 — Sam H. Fawaz

The markets finally bounced on Friday afternoon after taking a terrible beating the rest of last week.  On Wednesday, when the Federal Reserve (the Fed) announced another 0.75% increase in short-term interest rates to help battle inflation, this led market participants to conclude that the Fed wasn’t yet close to being done raising interest rates.  And as discussed in our newsletter last week, higher interest rates typically lead to a lower stock market which eventually leads to lower prices for goods and services.

From the way the market is behaving, one might think that some of the world’s largest and most profitable companies are suddenly becoming dramatically less valuable.  Are they all laying off workers, slashing prices, closing factories, and declaring imminent bankruptcy?
 
If all this market action and talk is sending you to anxiously scan the headlines, don’t bother; none of that is happening.  Even as stock prices have fallen, and the Fed has done their best to cool the economy, earnings have grown—a fact that has been routinely ignored by the media.
 
Stock prices have never been a precise indicator of what companies are worth.  They are a very good indicator of what people are willing to pay for their shares at any moment, and right now there seems to be an abundant supply of nervous sellers. There’s little reason to join them if you’re a long-term investor.

Why?  The reasons for bear (down-trending) markets are seldom rational—which, of course, is why bear markets end and stocks return to (and always, in the past, have surpassed) their original highs. 
 
What’s happening right now is not unlike what happens when one of our children is diagnosed with an illness, and the remedy is a daily dose of some awful-tasting medicine.  The illness, in this case, is inflation, which absolutely must be cured if we are to experience a healthy economic life.  Few things are worse than having the money you’ve saved up deteriorate in value at double-digit rates, which is precisely what has been happening this year and will continue to happen if it’s not dealt with.
 
The cure, which any child will tell you is more unpleasant than the illness itself, is the U.S. Federal Reserve raising interest rates, which is one way of reducing the amount of cash sloshing around in the economy.  Rising consumer prices, just like rising stock prices, come about when there is more demand than supply.  Reducing the available cash reduces the number of buyers in relation to sellers (ironically, both in the consumer marketplace and on Wall Street), and eventually slows down the inflation rate to manageable levels. 
 
We can already see how this works in the housing market, where, just a few short months ago, multiple would-be buyers were bidding against each other to pay more than the asking prices.  As mortgage rates have risen, the frenzy has completely dissipated.  The process takes longer in the consumer marketplace at large, but you can bet it’s slowly working behind the scenes.
 
Additional evidence that inflation is cooling can be found in gasoline prices that are solidly below their summer peak levels above $5.00 a gallon, and used car prices, which are normalizing as supplies of new cars on dealer lots are increasing.
 
Doesn’t less spending mean less economic activity?  Doesn’t that lead to a recession?  The answers, of course, are yes and maybe.  But at this point, a recession might not be all that bad for the economy.  Recessions act like a cleansing mechanism, exposing/eliminating waste and inefficiency, ultimately creating a healthier economy when we come out the other end.
 
It’s impossible to know exactly which direction stock prices will go next since stock prices are inherently irrational in the short term. They may rise from here, or go down from here. We know the media’s position will always be one of doom and gloom. Tune them out.
 
I wish I could say that the volatility is over and that we’ve reached bottom.  It’s possible, but it’s more likely that we’ll thrash around the current levels for a few more weeks as we approach the most favorable period in the markets, historically between November and April.
 
Meanwhile, market conditions are heavily stretched to the downside, meaning that we could see a robust snap back this coming week to relieve some heavily over-sold market conditions.  Think of this as your opportunity to unload any losing stocks that have come down so much and have little chance of recovering in the next bull market.  If you’re invested too heavily and have been losing sleep over the current market turmoil, take advantage of the rally to lighten up on some stocks/funds (Disclaimer: this is not a recommendation to buy or sell any securities. Please consult with your own financial advisor or talk to us).
 
I can’t rule out that the markets test lower levels in the weeks ahead; in fact, they likely will. But eventually, this bear market shall come to an end and a great buy point will emerge with a new bull (uptrending) market.
 
For our client portfolios, we took additional defensive action this past week and plan more defensive action in the coming week, depending on the weight of evidence presented by any coming bounce in the markets. If you’re managing your own portfolio, consider whether your own invested percentage is consistent with your risk tolerance and adjust it if you think your portfolio risk level is too high.
 
For now we’re taking our medicine, and boy, does it taste awful.  We are also, collectively, suffering an economic illness.  Anybody who has come down with a bug and taken medicine to cure it knows that the former unpleasantness doesn’t last forever, and therefore neither does the latter.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: https://www.nytimes.com/2022/05/14/business/inflation-interest-rates.html

Posted in American Economy, Financial Planning, General, retirement planning, US Stock Market. Leave a Comment »

What’s going on in the Markets June 20, 2022

June 20, 2022 — Sam H. Fawaz

With ten days to go in the 2nd calendar quarter and the end of the first half of 2022, we’ve witnessed one of the worst yearly starts in the markets since 1962 with a decline of about 23% in the S&P 500 index. This makes this year the 3rd worst start for the index in market history.  

The good news? Of the fourteen other worst starts to the year since 1931, ten of them went on to turn in positive returns for the rest of the year, although only five of those fourteen years turned things around and closed with positive returns for the entire year.

Mid-term election years (the 2nd year of a president’s term) have historically been lackluster, but that doesn’t entirely explain why this year has been so awful. Of course, the same culprits outlined in my What’s Going on in the Markets May 8, 2022 newsletter are still front and center today: 1. The war in the Ukraine; 2. Rising inflation; 3. Higher interest rates. A resolution in any of these three culprits could send the markets on a big trek higher.

To be fair, the markets were rife with speculation in all manners of stocks, special purpose acquisition companies (SPACs), initial public offerings, crypto-currencies, non-fungible tokens (NFTs) and other insane valuations of art, homes, antiques, etc. Most of this rampant speculation was fueled by the unprecedented fiscal and monetary stimulus unleashed in the markets by the Federal Reserve and Federal Government to combat a potential economic depression caused by COVID-19. As happens most often, a pendulum that swings too far in one direction must swing too far in the other direction to correct the excess. That’s the nature of cycles-both economic and markets.

From the pandemic low in March 2020 to the high in January 2022, the S&P 500 index more than doubled (+108%), so a market that moves that far in less than two years would historically be expected to give back (retrace) some of those gains at some point. To most students of long-term markets, giving back 50% or more of those gains would not be unusual at all before the uptrend might resume. At a closing level of about 3,678 as of last Friday, that would take the S&P 500 index to around 3,500, about 5% lower than Friday’s close. Nothing says it must stop there, but that level historically would be expected to generate at least a decent bounce or short-term rally.

Adding insult to injury, this has also been one of the worst starts in over 40 years in the bond markets. Long adding ballast to portfolios and a relative haven from the stock market storms, bonds on average are down over 12% year-to-date, with long term treasuries down over 24%. Even 1–3 year treasury bills are down about 3.7%, making even the safest and shortest of duration government bonds not immune from the carnage. Of course, when bond prices decline, their yields increase, so they become more attractive for new investments.

The perfect storm of a bond and stock market decline means that there have been few places to hide, other than energy and commodity stocks. Of course, energy and commodity stock outperformance mean higher prices for goods, which is at the heart of the inflation problem we now have.

Inflation Marches Higher

When so much stimulus enters the economy and markets in a short time, inflation inevitably rears its ugly head. Think of fiscal and monetary stimulus as money printing, and you can quickly understand how adding so many dollars to the money supply would tend to de-value those dollars. Indeed, when the inflation numbers were released for April and May (8.6% and 8.4% consumer price index respectively), they were higher than expected.  Relief in the supply chain logjam was not enough to offset the increased cost of labor, energy, and commodities (mostly raw materials and foodstuff).

Obviously, inflation at this level cannot be sustained longer term and needs to be tamed before it crashes the economy as consumers begin having trouble affording necessities, let alone discretionary purchases. It’s one of the two mandates of the Federal Reserve (The Fed): to reel in inflation using the tools at their disposal to prevent an economic crash.

Interest Rate Hikes

The dual mandates of The Fed are to:

1. Maintain price stability (by keeping inflation to 2% or less) and,

2. Ensure maximum employment.

With unemployment at historic lows, maintaining price stability is currently job #1 for The Fed.

When the pandemic hit, you may recall that The Fed immediately reduced short-term interest rates from 2.25% to 0% to counter the expected economic contraction effects of the COVID-19 pandemic. They also launched one of the biggest asset purchase plans (bond buying) in history as an emergency measure to ensure enough liquidity in the financial system to keep the economy and commerce from seizing up. The Fed kept these asset purchases up through March of this year (far longer than necessary in my opinion), thereby flooding the markets with stimulus.

Beginning in April, The Fed raised short term interest rates by 0.25% for the first time and announced that the bonds bought over the past several years would be sold off over time. Of course, if injecting the markets with all that stimulus and maintaining low interest rates props the markets up, withdrawing that liquidity and raising interest rates should have the exact opposite effect–and of course it has.

The Fed followed up with a 0.5% and 0.75% short term interest rate hike in May and June respectively, bringing the short-term rate to around 1.5%. During the June meeting, The Fed telegraphed that a further 0.5% or 0.75% interest rate hike could be forthcoming in July (and future months) if inflation doesn’t ease in the coming month. Of course, with inflation running over 8%, The Fed, with short term interest rates around 1.5%, is still woefully behind the curve. Many pundits and critics want them to move much faster to tame inflation.

Low interest rates (near 0% for over two years) represent “cheap money” to individuals and companies, encouraging investment, spending, borrowing, and of course speculation. All of that tends to make for an overheated economy, pushing prices higher. Raising interest rates tends to curb the demand for capital and overall spending, thereby reducing pressure on the supply of goods and services, and in turn, reducing pressure on prices. But by doing so, The Fed risks pushing the economy into a recession.

Recession or Soft Landing

The Fed has acknowledged that lifting interest rates may curb consumer and corporate demand enough to push the economy into a recession. Fact is, it’s possible that we’re already in a recession but don’t know it yet.

The textbook definition of a recession is at least “two consecutive calendar quarters of negative gross domestic product or GDP.” For the first quarter of 2022, the economy did register a negative GDP of 1.3%, and the second quarter could potentially register a similar small negative GDP. As of Friday June 16, the Atlanta Federal Reserve lowered GDP estimates for the 2nd quarter to about 0%, which means that it could easily turn negative by the end of the quarter, putting us into a an official recession.

Regardless of how the 2nd quarter plays out, textbook recession or not, I would expect that any recession would be another mild or short one (like the short-lived COVID recession of 2020) as we try and squeeze out much of the excesses brought on by the post-COVID over-stimulus. While you’re likely to be bombarded (and scared witless) by the news media about how the economy has officially fallen into a recession, it remains to be seen how long and how bad it might get. With housing and employment still strong, and corporate earnings holding steady, (albeit weakening somewhat with everything else), the recession should prove to be mild or moderate in my opinion.

What To Do Now

The market is currently in what I would characterize as “no-man’s land”. That’s to say that it’s too late to sell and yet probably too early to buy. As mentioned above, we have the potential to visit the 50% retracement level of S&P 500 at 3,500, 5% lower from here. But the selling was so intense last week, that could be considered somewhat exhaustive, or capitulatory as some refer to it in the business. While bad things tend to get worse in the markets before they get better, the proverbial rubber band to the downside is firmly stretched, meaning that a strong snapback rally could start as early as tomorrow, if not later this week or next.

In a mid-term election year, we tend to see a summer rally from late June into mid-July, with weakness or sideways movement persisting throughout the August-October period. But post-election, a year-end relief rally into the spring tends to be strong. So unfortunately, any relief rally in June/July may prove fleeting, with much better probabilities for a long-term rally coming in the 4th quarter. Of course, this is all crystal ball prognostication, relying on history to project future returns. This should not be relied on to make investment/portfolio decisions.

So, what about nibbling at stocks and stock funds (and even bonds) with the market down so much? While dollar cost averaging over time has a successful track record, the key is your own personal discipline to continue investing at regular intervals and knowing that it may take months or years to become profitable on new buys, especially if this market doesn’t find a bottom until late this year or next.

Those who bought in mid-2008 thinking that the bottom was in found out that they had to endure another 30% drawdown until the ultimate bottom in March 2009. In the end, this all turned out great for long term holders, albeit with a little pain.

If you are confident that you won’t sell everything if the market continues lower and reach your own capitulation point, there’s nothing wrong with nibbling on names that have come down to attractive levels. Personally, I prefer to see signs of strong demand returning from large institutions, something that is still absent at these levels. The path of least resistance, as of today, is unfortunately lower, but that could easily change in a day or two of strong buying.

For our client portfolios, we came into the 2nd quarter with one of our lowest allocations to stocks and bonds in years. We continue to be hedged with cash, stock options and bear market funds, and we continue to harvest profits and raise cash. If we see further weakness and no return of demand from institutions, we will further increase our hedges and continue to sell underperforming positions into any rallies that “peter out” in short order.

If you find yourself stuck in positions that no longer meet your initial criteria for buying them in the first place, consider using upcoming rallies to sell them (even at a loss) and upgrade your portfolio with better performing companies at the right time. Instead of big bites, take little nibbles, and keep in mind that bear market rallies are very good at sucking in investors and convincing them that the selloff is over, only to roll over and make lower lows. This is not a recommendation to buy or sell any security.

No one knows how deep the market will pull back. Have we seen the lows, or do we have some ways to go? I personally think we may have seen the worst of it, but that’s just a gut feeling. That doesn’t mean that I believe that the sell-off is over. Similarly, we have no idea if the next rally will mark the bottom of this pullback or just be another “suckers’ rally”.

In the end, these somewhat painful periods always end, paving the way for a new long-term uptrend (a.k.a., a bull market). As I always echo, investing in the stock market is great for long term returns, as long as you don’t get scared out of it at the wrong time. After all, enduring volatility is the price we pay for outsized long-term returns. Be patient and stay small with buys to keep your risk in line with your own tolerance.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Posted in American Economy, Financial Planning, General, retirement planning, US Stock Market. Leave a Comment »

What’s Going on in the Markets May 8, 2022

May 8, 2022 — Sam H. Fawaz

It was another down week in the stock markets, which, under the surface, was worse than the Dow Jones Industrial Average and S&P 500 indexes being down only about 0.25% might have suggested. Volatility continues to rule the markets daily as investors and traders try to discount the effects of inflation, interest rate hikes, a raging war, and the possibility of a recession in the coming months.

Speaking of interest rate hikes, the Federal Reserve (The Fed) met last week and raised short-term interest rates by 0.5% (bringing them to 0.75%-1.00%). The Fed signaled that more 0.5% interest hikes were likely coming and also mentioned that single day 0.75% hikes were not being considered. Although the markets breathed a sigh of relief on Wednesday and rallied about 3% from the day’s lows, that rally was short-lived as the markets gave it all back and more on Thursday and Friday.

As of Friday’s close, the S&P 500 index is down about 13.5%, while the harder-hit tech-heavy NASDAQ is down about 22.3% year-to-date. Those figures, however, don’t reflect the level of carnage under the surface, where some growth stocks are down as much as 80% from their prior peaks. Strength in the markets is found in energy stocks (where oil prices continue to float above $100 a barrel) and defensive stocks (consumer staples, some healthcare, and utilities).

Even bonds, long known to provide ballast to stocks, are down about 11% year-to-date and have not held up their end of the bargain. Bonds are having one of their worst starts to the year since the 1970s. Even if you’re hiding out in 1–3 year short-term treasury bonds, you’re still down about 3.1% since the beginning of the year. The typical 60/40 (stock/bond) portfolio has provided no shelter from the recent market storm.

When you see both stocks and bonds down in tandem, the usual culprit is an inflationary environment. Last month’s government report on inflation, the Consumer Price Index (CPI), showed inflation rose 1.2% in March, translating to an annualized rate of 8.5%. This coming Wednesday, we get the read on April inflation, which should see inflation easing from March levels (based on reports of declining used car prices, lower demand for homes, and supply chain improvements).

The Fed has two core mandates as its mission: 1) keep unemployment low and 2) maintain price stability.

At this point, The Fed has no choice but to raise interest rates to try and tame the inflation beast. Unfortunately, raising short-term interest rates has the side effect of slowing economic activity because capital becomes more expensive for both consumers and companies, thereby forcing a slowdown of discretionary purchases and capital improvements (and stock buybacks, which buoy the markets). We are already seeing a slight easing in housing market pressures as 30-year mortgage rates tick above 5%.

Inflation at the current rates is simply not tenable, and therefore The Fed must do what it can to keep the prices of goods and services at prices that consumers can afford.

Further taming of the inflation beast with short-term interest rate hikes can sometimes cause such a slowdown in the economy that we see negative growth in the gross domestic product (GDP), as was reported in the 1st quarter of 2022 when GDP unexpectedly contracted by 0.4% (which is an annualized rate of 1.4%).

As of the end of the 1st quarter, we had only experienced a single 0.25% short-term interest rate hike by The Fed, so that was not the proximate cause of the decline in GDP. More likely, the side effects of the ongoing war in Ukraine, a complete lockdown in parts of China because of COVID resurgence, and inflation worries all weighed on the economy in an otherwise environment of robust consumer demand.

The definition of an economic recession is two consecutive quarters of contracting GDP, so 2nd quarter 2022 GDP is pivotal in determining whether we’re already in an economic recession. Perhaps that’s what has the markets worried.

Also on the economic front, both the Institute for Supply Management’s (ISM) Manufacturing Index and the ISM Services Index remained at high levels last month; however, there is some weakness developing under the surface. The ISM Manufacturing Index has fallen in five of the last six months, while new orders for the services sector fell to a 14-month low. At the same time, prices have remained stubbornly high in both indexes, which raises the possibility of economic stagflation (inflation + slowing economy) in the coming months.

What About Now?

While the markets continue their correction (pullback), we have continued to get more defensive in our client portfolios by selling more (underperforming) positions, adding to our hedges, and tightening up our option selling. Unfortunately, in a rising volatility environment, the fruits of our option selling labor don’t begin to show up in client portfolio results until after the volatility subsides, or those sold options expire. That doesn’t mean we won’t continue to allocate to those strategies to reduce portfolio risk, but in the short term, they may not display the intended positive portfolio effects.

While I don’t have a working crystal ball, I’ve seen little evidence that the volatility is about to subside anytime soon. Though the markets are oversold (stretched to the downside) on a short-term basis, we have not seen any bounces that have lasted longer than a day or two, at least not since late March. We are certainly overdue for a robust bounce that lasts at least a few weeks or months, but I don’t see any evidence to believe that we’re at a durable long-term bottom yet.

Therefore, this back-and-forth choppy action may continue until after the mid-term elections, as is typical for this part of the presidential cycle. We may also need to shake out more weak hands in the short term and get to some level of capitulation or panic in order to get a sustainable rally.

One contrary indicator, investor sentiment about the markets, is at some of the lowest levels–some levels on par with sentiment during the great financial crisis in 2007-2009 and the COVID crisis, hinting that investors are not very exuberant about investing in the markets. Another contrary indicator, mutual fund flows, shows that investors of late are cashing out of stocks in recent weeks, which means at some point, many will be forced to buy back their stocks in the near future.

If you’re not a client of ours, I hope you have taken some action with your portfolio during the prior market rallies, to reduce your overall risk and exposure to the stock market. Whether selling some underperforming positions, buying some bear market funds, or just hedging your portfolio in one way or another, figure out a way to reduce your overall portfolio risk. Don’t wait until the market is down a lot before taking some action. You want to have some cash on hand to pick up some “bargains” once the market resumes its uptrend.

If you have not, or if you still feel overexposed, you should consider doing so during the next market rally to bring your portfolio more in line with your own personal risk tolerance. This is especially true if you find yourself worried about your investments more than usual these days. Remember, no one can control what the market does, but you and only you can control the risk you’re taking and the amount of the loss you wish to sustain. If you’re picking up anything on this downturn, keep it small and expect that you’ll have to wait some time to become profitable on these positions. Disclaimer: None of the foregoing should be construed as investment advice or a recommendation to buy or sell any security. Please consult with your own financial advisor or talk to us if you need help.

In a rising interest rate environment where inflation is not yet under control, and where The Fed is now a net seller of bond assets (instead of a buyer), stocks will have a hard time making it back to old highs, not to mention making new ones. While the 13-year-old bull market may not be finally dead, I don’t see this environment as friendly to investing as it has been in the recent past. Don’t assume that the “beach-ball” market that absorbed all manner of “meme stocks”, special purpose acquisition companies (SPACs), Ponzi stocks, a flood of IPOs, and additional stock offerings is going to come roaring back, because I don’t believe that it will anytime soon. Remember, if your favorite stock is down 50%, you need it to double just to get back to even. I don’t think you can count on that anytime soon either.

There’s a saying in the investing world that most have heard: “Don’t Fight The Fed.” That means when The Fed is accommodative with low-interest rates and is actively providing liquidity to the markets (as they mostly have for the past 13 years), you’re essentially investing with the wind at your back. In that environment, you want to be a net buyer, not a net seller of securities.

If you believe that saying is true during the accommodative periods, then trying to fight the Fed when they are withdrawing liquidity and raising interest rates and insisting that the market should go up in the face of those headwinds would not make much sense during the non-accommodative period we’re experiencing right now.  A time of Fed accommodation will return at some point but be patient and cautious with new investments until then.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Posted in American Economy, Financial Planning, General, retirement planning, Stock Market, US Stock Market. 1 Comment »

What’s Going on in the Markets February 27, 2022

February 27, 2022 — Sam H. Fawaz

Since our last post on What’s Going on in the Markets on January 30, 2022, the market has seen a flurry of volatility trying to come to grips with higher than expected inflation, the Russian invasion of Ukraine, and the coming interest rate increases by the Federal Reserve. Our hearts go out to those suffering in Ukraine because of yet another unnecessary war.

Since the beginning of the year, while the S&P 500 Index has seen a maximum decline of approximately 11% on a daily closing basis, the carnage under the surface in many stocks and sectors of the markets has been far worse with some stocks down more than 75% on the year. In this post, we’ll look at the factors that may call for further declines or for a coming rally.

The Good

We’ve previously written about how markets undergo a pullback greater than 10% on average every 10-12 months, also called a correction. Therefore, the current correction, which was long overdue by the time it arrived in January, is part of the normal course of ebbs and flows in the stock markets. No one really knows if a correction will devolve into a full-blown bear market until after the fact (a bear market is a decline of 20% or more from the last market peak). While bear markets tend to be harbingers of coming recessions, they don’t always forecast them with 100% accuracy (nothing does).

Historically speaking there are no bells rung at the start of a bear market. In fact, market tops are notoriously difficult to identify except in hindsight, as they are often quite volatile and take months to unfold. The good news is that we’ve been preemptively defensive in our portfolio decisions. The bad news is that a few bear market warning flags are starting to sequentially wave and resemble some of the ones we’ve seen in the most significant bull market tops in history. But it’s not yet a sign to sell everything.

Corporate earnings are the primary driver of the stock market. Simply put, the better the earnings, the higher the market can go. Towards that end, the corporate earnings reports for the 4th quarter of 2021 were better than expected from a revenue and net income perspective, and corporate guidance (forecasting) relating to 1st quarter 2022 earnings were equally positive. Earnings guidance for the rest of 2022 tended to be even more positive and points to a reacceleration of the economy in the back half of the year. That tends to indicate that a recession is off the table, which is consistent with my beliefs and would stave off a bear market.

From a COVID-19 standpoint, since we’ve tamed the Omicron variant, the country is starting to plan for a return to a bit of normalcy with the relaxing of masking requirements around the country and less onerous vaccination mandates. This alone ought to put a bid into the travel, entertainment and leisure industry, as pent-up demand picks up steam and drives further spending. This also adds to the “no recession on the horizon” narrative.

The joblessness and employment figures are surprisingly to the good side, with unemployment levels lower and jobs numbers steadily improving. And employees and new hires are seeing higher wages, which again, will drive higher spending that will stave off a recession (but unfortunately, also drive inflation higher).

While the effects of the Russian invasion of Ukraine may have some impact on the delivery timeline of various goods and services, the supply chain constraints that plagued the economy in 2021 seem to be subsiding, removing some inflationary pressure, and allowing more deliveries of materials and finished goods to factories and consumers respectively.

The Bad

With one trading day left in the month, the S&P 500 Index is down about 3% for the month and down 8% from the year-end 2021 close. While totally within the realm of normal expected volatility, especially for a mid-cycle election year, it’s never fun to experience that kind of decline. That’s because, as mentioned above, many sectors and stocks have been hit far harder. Fortunately, the last couple of days saw a robust bounce in the markets from the depths of fear at the start of the invasion of Ukraine.

Inflation continues its domination of headlines as the last consumer price index clocked in at an annualized rate of 7.5% for January. Energy prices continue to rage higher as we saw oil a touch above $100 a barrel overnight last Thursday as news of the Ukraine invasion started to hit the headlines (the price of oil settled slightly under $92 at Friday’s close, but is spiking again in the Sunday overnight futures market). Food and commodity prices don’t seem to have found a ceiling yet. While some easing of inflationary pressures is expected as supply chains get back to normal and as jobs get filled, it won’t be enough to stave off interest rate hikes by the federal reserve, which are needed to keep inflation in check. I believe that we may have seen the worst of the inflation fears in January.

Speaking of interest rate hikes, estimates vary widely as to how many hikes the federal reserve will have to implement to tame the inflation beast (economists estimate between three and nine 0.25% hikes in 2021 alone). Even if we get eight 0.25% hikes this year, which I consider unlikely, we’ll still be at a 2% federal funds rate, which is quite accommodative for the economy and is generally still quite favorable for the stock market. Unfortunately, higher interest rates have a negative impact on bond prices, which have not yet found a footing this year either (but haven’t collapsed either).

Investor sentiment/psychology (feelings about the stock market) and consumer confidence are somewhat worrisome as they continue to remain moribund in the face of an economy that’s firing on all cylinders and a job seekers’ market that puts them somewhat in control (versus employers) and favors continued robust spending. Highly confident consumers tend to spend more, which drives the economy.

There is convincing evidence today that housing prices are in bubble territory. This carries strong implications for financial markets and the economy given the importance of housing to consumers’ views of their personal balance sheets. Unlike the 2005 Housing Bubble, which was largely predicated on subprime lending and credit default risk, today’s bubble has far more to do with affordability and interest rate risk. Mortgage rates have been suppressed over the past decade by the Federal Reserve’s ultra-accommodative monetary policies, including direct purchases of trillions of dollars in mortgage-backed securities and near-zero interest rates.

Mortgage rates dropped to a record low of 2.7% in early 2021 after the Fed threw the proverbial kitchen sink at the economy in response to the pandemic. However, the recent rise in long-term interest rates, along with the Federal Reserve’s decision to taper their asset purchases, have caused mortgage rates to spike back to 3.7% – the highest level in nearly two years. The combination of rising rates and rising prices has made the average mortgage payment on the same property approximately 30% more expensive than just a year ago. Monitoring the state of the housing market will be crucial in the months ahead as the Federal Reserve is due to begin tightening monetary policy as discussed above.

The Ugly

The Russian invasion of Ukraine is without a doubt an ugly, if not a well telegraphed development. If there was a wild card for the world economic recovery from the pandemic, it’s this–which has the possibility of derailing the recovery by disrupting supply chains and the flow of essential commodities from the region. Economic sanctions unfortunately tend to affect citizens more than the leaders they target, and also have an indirect adverse effect on the countries imposing them. Wars are of course unpredictable, so predicting the outcomes or effects is crystal ball type of speculation.

As the war stakes are raised, so too are the risks to the markets. If calmer heads prevail and escalation to the unthinkable can be avoided, then this should be another one of those bricks in the proverbial walls of worry of the stock markets. A protracted war that draws in other countries will lead to a market that no doubt will sell first and asks questions later.

However, one important historical insight is that most geopolitical crises or regional conflicts do not have a negative long-term impact on the stock market. In the few instances where geopolitical events have weighed on the market, it has been a result of either a broad-based global military conflict or a rise in energy prices (inflation) that puts upward pressure on U.S. interest rates (monetary policy). Of the last eleven crises/conflicts leading to war, only four of them led to a decline of 20% or more in the S&P 500 Index.

The current Russia-Ukraine conflict is likely to cause even higher energy prices, yet at the same time, might reduce the possibility of a full 0.50% rate hike from a concerned Federal Reserve in March.

The biggest concern from fighting a protracted war is a possible global slowdown, which forces us into a recession. Should that happen, I imagine it will be mitigated by a slowing of interest rate hikes and perhaps monetary stimulus. I consider this scenario unlikely at this time.

Now What?

We continue to expect volatility during this mid-term election year and remain cautious and defensive in our positioning. A deeply oversold market resulted in a big bounce on Thursday and Friday of last week, but the escalation in the rhetoric, a worsening of war tactics and increasing economic sanctions over the weekend are likely to trump any oversold markets, and we could see a big give-back of the gains of the last two days come Monday, the last trading day of February. The futures markets on Sunday night portend a very weak open for Monday morning.

There is no doubt that there is a higher-than-normal degree of risk in the market today, and there has already been a significant amount of damage under the surface.  While the S&P 500 Index is currently only 8% off its January high, virtually half of all S&P 500 stocks (and an estimated 80% of NASDAQ stocks) are already down over 20% from their highs.

The jury is out on whether this will be a protracted correction or a major bear market. However, we know that every bear market started out as a pullback, some pullbacks led to a correction, some corrections led to a small bear market, and every big bear market started out as a small bear market. And that makes the next 60-90 days perhaps the most critical in this market cycle stretching back to its start in 2009 (excluding the COVID-19 crash).

Like everything else in life, there is no crystal ball when it comes to navigating the eventual end of a market cycle. Rather, a disciplined assessment of the weight of the evidence allows us to proactively position client portfolios to be defensive when it really matters. Going forward, we are prepared to further increase portfolio defenses depending on how the events in the market unfold. Using options, inverse funds, reducing under-performing positions and harvesting profits are all ways we can reduce client portfolio risk without necessarily exiting the markets (Disclaimer: none of this is a recommendation to buy or sell any securities).

“In the end, navigating a [probable] bear market is not about putting your money under a mattress and waiting for the sky to fall. Instead, the focus should be on proactively managing risk to carefully navigate a wide range of outcomes and positioning oneself for that next great buying opportunity.”-James Stack, InvesTech Research

No doubt these can be scary times for your hard-earned nest egg, and no one enjoys giving back a chunk of market gains. But as we’ve said before, the best way to profit from the stock market is to not get scared out of it. Enduring volatility is the price we pay for the outsized gains we get from investing in the stock market, but if you find yourself losing sleep over your portfolio, talk to your financial adviser (or contact us) so you’re invested in a portfolio that has the right amount of risk for your personal temperament.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: InvesTech Research

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Did You Exit After Brexit?

August 6, 2016 — Sam H. Fawaz

The pundits had it all wrong with the Brexit vote (I too was wrong on the British vote to exit from the European Union).

With the benefit of hindsight, we can see that it would have been a bad idea to sell your stock holdings after the Brexit vote; you would have locked in a 5% to 10% loss in a market that has trended upward to new record highs.  The same is true of the aftermath of the World Court decision that slapped China in the face by declaring that man-made islands don’t transform an ocean into territorial waters, the attempted coup in Turkey, or, really, any other alarming headline which doesn’t materially affect a company’s ability to run its operations or earn a profit.

But the bigger issue is that, even if you knew the outcome of the vote, you still wouldn’t have known how markets were going to react.  How would you know whether quick-twitch traders would buy or sell the event?  After the Brexit vote, it took a weekend for investors and traders to realize that this was Britain’s problem, not theirs.  Realistically, it could have taken a month, or even a year to play out.

The same is true for the time period that we’re heading into now.  As you can see from the accompanying chart, the average return for various months of the year has been pretty much the same across the spectrum.  But August, September and October have seen bigger highs and (most alarmingly) also deeper lows, on average, than other months.  This additional volatility seems to be random, and is, once again, impossible to time.  People who decide to side-step the late summer and early fall would miss out on average yearly gains for September and October of 1.05% and 1.21%.  (Skipping August would have saved you modest losses of less than 1%, on average, but one suspects that this is a statistical anomaly.) The month of August in election years, even during the bear market of 2008, tends to have a positive bias; will this year be one of them?

CA - 2016-8-3 - Riding the coaster

Finally, biggest picture of all, the current bull market, which started March 9, 2009, has now become the second-longest bull market on record, beating the June 1949 to August 1956 rally.  It is second only to the December 1987 to March 2000 advance.  In terms of percentage change, we are experiencing the fourth strongest bull market on record.

Doesn’t that mean it’s time to take our chips off the table?  If we knew how to consistently time the market, if we could be sure that the market run won’t continue to run up for another few years, then the answer would be yes.  But with the economy continuing to churn out positive gross domestic product (GDP–the measure of our output of goods and services), with inflation low and unemployment continuing to fall, and central bankers supplying liquidity and stimulus to the markets, it’s hard to see what would cause U.S. stocks to be less valuable in the near future than they are today.

Meanwhile, once again, even if we did exit, how would we know when to get back in?  Investors who bailed during the 2008 downturn missed much of the surprise upturn that began this current bull run.  Those who hung on more than made up for their losses, even though it seemed like every year would be the bull market’s last. One thing that I’ve learned from doing this for so long, is that moves in the market (in both directions) usually go on far longer than most people can imagine.

There isn’t a day where some market “expert” or pundit comes out and says he likes nothing in this market and to sell everything? … Really?? Sell everything?! It angers me how reckless these statements are. Giving blanket advice to people is irresponsible. You don’t know the person’s goals, age, risk tolerance, time-frame, etc. But fearful headlines will always attract eyeballs, and most of these pundits have something to sell you. Don’t buy it. Maybe you should sell some things, but always do your own due diligence and always keep in mind your long-term goals.

It’s nearly certain that there will be a lot of scary headlines between now and the end of the year, and it’s quite likely that the investment roller coaster is about to get bumpy.  All of us wish that we had a working crystal ball to help us navigate through uncertainty, but all we have is the historical record, which says that after the next downturn, the market will eventually experience a new high (yes, this will happen regardless of who becomes our next president).  We want to be there to celebrate it.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources: 

https://www.washingtonpost.com/business/get-there/given-the-brexit-brouhaha-how-did-your-investments-hold-up/2016/07/22/a7bc1198-4d03-11e6-a7d8-13d06b37f256_story.html

http://www.investmentnews.com/article/20160801/FREE/160809992/if-history-is-a-guide-market-volatility-is-about-to-spike

http://www.cnbc.com/2016/07/13/merrill-second-longest-bull-market-ever-has-further-to-run.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

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