Inflation concerns and policy responses, including interest rate hikes, led to a painful year for markets. For much of the year, investors struggled with whether to believe that the Fed would follow through with aggressive hikes, causing relief rallies that did not hold. Because of this uncertainty, we took a “one foot in, one foot out” approach for our clients, reducing equity exposure but remaining partially invested should a Fed pivot occur. This was not the first tactical reduction that we made. In the Fall of 2021, we reduced equity exposure in our longer-term growth strategies in favor of private real estate offerings, recognizing extreme equity valuations and doubt over future earnings continuing to support those valuations.
Tactical strategy adjustments are one way that we protect our clients’ lifestyles. Our needs-based approach to asset allocation is another. We identify client spending needs and goals and tailor investments accordingly. We dedicate a portion of investments to short-term needs using relatively conservative, liquid investments. Drawing from that portion of the portfolio allows longer term assets to remain invested for growth, with the time needed to recover from market downturns.
We remain tactically defensive due to recession uncertainty, but we believe market recovery will begin this year. Markets are laying bets on both sides, but we note a slight positive change in the mood vs just a few short months ago. Still, we must remain cognizant of the near-term risks before redeploying defensive capital into more aggressive assets.
Given the discounts that are in place today, once a recovery begins, the next year or two should see relatively outsized investment returns. As long-term investors, we are positioned to take advantage of this rebound. Extreme moves in markets (both up and down) like we have witnessed recently occur during turning points. There will be more volatility, but we have told our clients to expect additions to equity exposure during the early part of the year, primarily in international and small-caps, along with small positions in beaten-up industries and those poised for future growth.
As stewards of our client’s investment capital, we know how concerning the past year has been. Having adequate reserves on hand during times like these enables them to continue living their lifestyles while waiting for the tide to come in. This is why our financial planning and investment process is especially valuable.
We aim to allow you to sleep at night knowing you can live life and let us worry about how to sustain it.
Enjoy today and tomorrow, and let us do the worrying!
This year’s market declines have largely been a valuation “correction.” The price-to-earnings ratio (P/E) of the S&P 500 Index has declined about 25%, and stock prices are down more than 20%. We could see another decline phase based on company fundamentals (profits and losses).
What will company earnings be going forward? Projections for S&P 500 future earnings average $235/share. This will be more difficult with the Fed slowing the economy. Analysts have recently begun lowering estimates while ignoring the impact of a strong Dollar. Roughly 40% of S&P 500 company earnings are from overseas, which get converted into Dollars for reporting purposes. When foreign earnings are converted to Dollars this season, it could add to relative earnings declines and, therefore stock prices.
It is important for investors to know that historically the P/E ratio bottoms well before earnings do, roughly 6 months earlier. In fact, in the past 100 years of market cycles, the P/E ratio has already rallied 20% by the time actual earnings bottom out. The market is a forward-looking mechanism – one that discounts information more efficiently than any person or computer can. Waiting until economic data and earnings data reflect the improvement in underlying fundamentals to investing means missing out on the best returns.
We should be only a few Fed meetings away from a pause in rate increases, so the low point for the market could be sometime over the next six months. It is a constantly moving target, but that is our best guess given what we know today. No one ever said this was easy, which is why successful investors often partner with an advisor. We remain disciplined while investors may get emotional. We are more likely to get aggressive at the right time and take advantage of these short-lived low stock prices.
If you’re interested in our layered risk approach that brings clients greater peace, contact us about your situation.
We encourage our clients to continue living life without stressing over market conditions. Allowing us to focus on the markets and our clients to focus on enjoying life!
So, enjoy today and tomorrow, and let us do the worrying!
Our readers know that last Fall we reduced client stock exposure in light of what we thought was an overvalued market. For most clients, we allocated the proceeds to real estate, which has been their best-performing investment this year. We reduced stock exposure again early this year, anticipating higher interest rates and their impact on stock prices.
Our Approach
This “one foot in” approach kept growth accounts partially invested in case the Fed changed course and ignited a rocket ship rally. However, we now believe that instead of a pivot to reducing interest rates, the Fed will stay its course for the next two or three meetings and then pause rate increases.
Fed policy takes time to work through the financial system before getting the desired result – inflation on a course returning towards their target 2%. Inflation came from a demand imbalance which is correcting with supply improvements. However, with inflation hovering near 8%, there is still a long way to go without creating a recession.
Tamping down consumer demand remains challenging as most American household savings went up during COVID. This strength of the consumer will hopefully reduce the depth of a potential recession.
Sign up to receive our commentaries and read more about how we give clients more peace around investing.
We encourage our clients to continue living life without stressing over market conditions. Allowing us to focus on the markets and our clients to focus on enjoying life!
So, enjoy today and tomorrow, and let us do the worrying!
Markets do not like uncertainty, and that is all we have had this year. There are variables in play now that we have not experienced in a long time. Inflation is the driving factor behind the market volatility we are currently experiencing.
The Federal Reserve (Fed) is trying to make up for their lost opportunities in the fight against inflation and raised interest rates 0.75% last week. Chairman Powell’s comments that they will continue to raise rates until energy prices go down leads us to believe that the probability of recession is now high, and the timeframe is soon.
Consumers feel the pain of recession before economic data reflects it, and consumer sentiment is at all-time lows.
Broadly speaking, stocks have fallen more than 20% YTD. Most of that decline has been overpriced stocks correcting to a reasonable level. However, when the economy slows down, corporate earnings will decrease, and the market will go down further.
With both stocks and bonds down significantly, there are no safe havens.
Let us share our strategy to withstand even this type of scenario.
Our client’s investments are in a series of time-horizon strategies. So, each client has money tailored for when they want to spend.
Shorter-term spending needs are funded by our more conservative strategies, which include cash. They are not immune to interest rate sensitivity but are less volatile than stocks and generate income. This allows assets invested for long-term growth the time needed to ride out even today’s volatility. Effectively, growth assets are insulated by shorter-term income assets, so these price swings in stocks do not impact our clients’ emotional freedom to spend on their goals.
The ability for our clients to continue taking current income while providing time for necessary growth is more important than ever.
So, enjoy today and tomorrow, and let us do the worrying!
As things stand today, we could see a recession occurring sometime in 2023. We certainly do not expect a repeat of 2007/2008, but we do expect equity prices to lose value as all the fears associated with a recession are generated.
Typically, markets peak about 6 months before a recession which means there is still time for markets to absorb interest rates, assess the trajectory of inflation and supply chains, and recalculate prospective earnings and related valuations. Nascent softness in the demand for durable goods – which along with other related data points (mortgage demand, freight pricing, rent escalation, etc.) – could mean inflation is peaking as consumers pull back. Consumers have rarely been as financially healthy as they are today, but forward-looking consumer sentiment indexes are reflecting growing worries.
With the economy still strong, stocks could drift sideways or even rise for some time before the dampening effect of rising rates slows the economy. However, current valuations remain relatively high and with impending slowing economic growth, additional market gains from here will be muted.
All this argues for maintaining a cool head as we move forward.
Yes, we have challenges ahead and rarely have so many variables simultaneously been in play. We began to reduce our clients’ risk exposure towards the end of 2021 but are reticent to take a completely conservative risk posture. With so much negativity in abundance, it wouldn’t take much good news for markets to respond positively. Still, we are conservative by nature and recognize that the Fed has a very poor track record in cooling inflation without inducing a recession. Therefore, we anticipate shifting more conservatively during market rallies this year and assuming an even more conservative posture over the next year. We will endure elevated market volatility and tread carefully to get there.
We have the structural protections of segmenting client assets across time to weather serious downturns.
We encourage our clients to continue living life without stressing over volatile markets. Let us do the worrying! A downturn won’t last forever, and we plan for our clients to be in better shape than most coming out of it.
There isan old market expression that “interest rates move mountains”.
Current dynamics are a perfect example of how true this expression is. Gravity may be the most powerful force in the universe but when it comes to financial markets, it’s interest rates. As of the date of this writing, the benchmark 10-year Treasury yield moved from 0.5% to 2.8% in 12 months. Two-year yields are up from 0.1% to 2.5%. Bonds have lost value. Stocks have lost value. The IPO market is frozen. The trailing price-to-earnings (P/E) ratio of the S&P 500 dropped from 26 to 22. And the Fed has only raised interest rates 0.25%, while it is expected to raise them a full 2% this year.
While we anticipated higher interest rates from unwinding the Fed’s balance sheet, the war in Ukraine adds more uncertainty and stress on financial markets.The effects on energy supplies, agricultural inventories, and already strained supply chains are weighing on markets. All these factors add to global inflationary pressures. Companies are currently passing their rising input costs on to consumers in the form of higher prices. That may become more challenging later in the year and certainly into next year.
We’ve also seen a worrisome leading indicator, in some inversions of the interest rate curve (when short-term rates rise above long-term rates). This is a historically accurate signal of an impending recession. However, we have yet to see the most important portion invert: the 3month/10year rate. When this happens, recession is all but assured within 2 years. As things stand today, we could see a recession sometime during 2023.
Last Fall, we shifted a percentage of client stock positions to certain real estate assets.
This is one example of how we utilize assets that reduce market exposure while still retaining upside capabilities. We also incorporated structured notes into certain client portfolios as a way to diversify risk while generating strong yields.
We will continue to make tactical shifts to our clients’ portfolios to reduce the risk of capital erosion.
Read more from the Integras Partners team in the final portion of our Q1 2022 commentary below.
