September Market Update: A New Direction?

Wealthy Behavior: September Market Update: A New Direction?
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00:00:10 – 00:05:06
Welcome to Wealthy Behavior, talking money and wealth with Heritage Financial. The podcast that digs into topics strategies and behaviors that help busy successful people build and protect their personal wealth. I’m your host, Sammy Azzouz president of Heritage Financial, a Boston based wealth management firm working with business owners, executives and retirees for more than 25 years. Now, let’s talk about the wealthy behaviors that are key to a rich life.

Welcome to another investment edition of the wealthy behavior podcast where I talk to our Chief Investment Officer, Bob Weiss, about what’s going on in the markets and investment universe right now. Bob and I have been having these conversations at the beginning of every month and we’ll continue to do so. So please look for them wherever you get your podcasts. So Bob, things have changed a little bit since our August conversation where, you know, markets had a very strong July, some disinflation news helped the markets, but August was pretty choppy. And I think chairman Powell’s speech at Jackson Hole really maybe kicked things off rattled the markets a little bit. But what have you seen since the last time we talked? Yeah, thanks, Sammy. I think the big thing that kicked off a change in direction markets was Powell’s speech at Jackson Hole a couple of weeks ago. I think he caught markets off guard. He was pretty negative, bearish, hawkish, whatever you want to say, talking about economic pain that is to come and how this pain is necessary to slow down inflation. The market’s been throwing around a term from a fed pivot or a Powell pivot, meaning changing the direction from raising rates and slowing down the economy to, okay, we’ve slowed things down enough now let’s cut rates. Let’s cut back down to zero or lower so we grow. And he basically said, don’t count on a pivot. So it was a nasty fed statement and markets didn’t like it, and they sold off, both stocks sold off in bond sold off. So bond yields are higher and stock valuations are more attractive now. So Bob, was it a nasty pivot and something that the markets shouldn’t have expected? It was a little more negative than markets expected. Should they have been expecting it? I don’t know, but just a quick price reaction shows you that it was a little more than the market was expecting. A lot of what the fed does, it’s behavioral, it’s mental, it’s not always economic dollar and sense. And they’re flexing their muscles and saying, I’ve got the power here. I’m going to squash inflation out all the costs and everyone get in-line and the market got in-line. So in the past, we’ve seen that the market has come to expect the fed as some sort of tool or boost to the market when it’s struggling. The market has, in the past, blinked when it wanted to do things and the market reacted negatively. So is your thought that over the summer people still weren’t a 100% convinced that the fed was going to be as aggressive as it said it was going to be to cut inflation until they heard Powell’s very short speech basically saying, don’t look at us we’re going after this thing guns blazing and it’s going to hurt. Yeah, I think that’s fair. The fed maybe has gone from on one hand, you know, the “fed put” that’s in there to save the day when things get bad, to okay, the fed’s more neutral, this will go both ways, to now they’re in the bad camp where they’re out to hit inflation at all costs. And don’t fight the fed mantra. So I think that’s fair that they’re a bit of a hurdle for investors right now. And just trying to convince them that we’re serious basically this time as you’re thinking about what to do. It’s almost like a pseudo rate hike, right? You talk people into being afraid has got the same effect or a similar effect to actually raising rates the next time around. Exactly. Powell says there will be economic pain and companies are going to struggle, there’s going to be slow growth. Then a company that says, hey, should we hire? Should we open a new plant? Should we expand business? Maybe not, the economy is not working so good I just heard Powell say this. Okay. Well, let’s not hire, let’s not expand. So just the words can have an impact and I think that’s very intentional. They’re aware of that. So that’s the elephant in the room justifiably so, the fed is really what is driving a lot of what’s going on in the market these days. Obviously with inflation being where it is, what are you seeing as you look below that level with the consumer, with housing, with inflation, what are we seeing that maybe feeding into what the fed is thinking about? Yeah, the two things that are really catching my eye at the macro level are housing and energy.

00:05:08 – 00:10:10
The amount of data I’ve seen on the housing market slowing down is really impressive. It had been hot since pretty early in 2020. Everyone staying in their home longer, the generational changes of home buyers here in a supply demand imbalance, but now we’re seeing more price cuts than we’ve seen in a long time. Days on market is going up so houses are sitting on the market a lot longer. New mortgage applications are going down 30 year mortgage rate is over 6% now, on average. So it’s just data point after data point that’s showing that this housing market is slowing down, whether or not we enter a housing recession, some people are saying we don’t know, but I think the days of that COVID era housing bubble with your price to house going up ten or 20% year over year, that’s behind us. And what probably now more in the place where the fed wants us to be with housing, where yeah, your house will go up 2% to 3% a year. That’s what it should do. But if anything, there might be more risk on the downside on that, you know, maybe it’s to correct by 10 or 20 %. So I think we’re definitely seeing slowdown in the housing market. And shelter is the term, I think it’s about 29% of the CPI calculation-it’s the largest individual component. So when you talk about inflation, it’s high, we need to slow it down. Number one, shelter, and I think that’s happening. So from someone who is concerned about inflation and looking at the fed to me, that’s kind of check the box that that one’s being addressed. Well, when we talked about that, it’s similar to a conversation we had about deflation versus disinflation. So I guess maybe not to alarm people, when we’re talking about the housing market slowing down, you talked about both scenarios, but the base case was that the price hikes and the price increases will slow down from here, not that we’ll reverse course and go into price declines. Right. The best case is the era of crazy bidding wars, houses get sold overnight with 6 above market offers – hopefully that insanity is behind us and now it’s a normal housing market. That it’s at more equilibrium. More equilibrium and you have to hit that on the demand side. People talk economic supply and demand – supply there’s only so many houses available for sale and it is a low. So on the demand side by pushing mortgage rates up, by this hawkish fed talk, they will slow people down and hit demand so then you have more equilibrium and less craziness and more price stability. So I cut you off a little bit, I think you were going to talk about energy prices or gas prices as well. Yeah, that’s the second point. Energy prices have come down a lot. As we’re recording this, I think oil is down 5% today. It’s now below $82 for WTI crude, which is below where it was before Russia invaded Ukraine. So that whole Russia Ukraine spike that led to higher energy prices and contributed to inflation – we’re now below that level. So that’s come down quite a bit. Gasoline prices are down a lot. There’s a cute line, “The cure for high energy prices is high energy prices.” You think yeah, okay, it’s gonna cost me 5 or 6 bucks a gallon to fill up the tank maybe I’m not going to go on a road trip, and you just hit demand and the price goes down. So, you know, rolling it up to CPI calculation, energy is a big component directly. We all use energy to heat our home, for transportation, and then it’s also a component of one of the other largest components of CPI like food. Food needs to travel, it needs to get into my refrigerator so energy is huge and seeing energy prices go down is good for slowing inflation. So what’s going on there? I’m very surprised by what you just said about oil prices kind of being back to where they were pre the war. What is accounting for that swift drop? I think it is, in this case, both supply and demand. I am not an expert on the oil markets in particular, but I think they have pushed production, so production has been increased and OPEC is releasing reserves. So when you just hit the market with more supply, just throw more oil available, even if you hold demand constant, the price goes down. But then also on the demand side, like I said, you know, the cute line earlier with high prices demand can go down a little bit too. So how’s the consumer doing in all of this? So when you look at a lot of data, you have leading lagging and then coinciding and a lot of the consumer data we see is lagging and coinciding and so far so good.

00:10:11 – 00:15:09
Unemployment rate is low. Something good we saw was an increase in workforce participation, so more people are working, which is great. And the consumer balance sheets are strong. So people have saved and their net worth, you could say, have gone up so the consumers better position certainly than if you go back to the financial crisis in the 2007-2009 period. Consumers are in a lot better position now than they were going into that era. So while housing might be a little frothy, it’s backed by a much stronger consumer than we had then. So what do you think this all means for the economy Bob? You were in the camp, I think pretty consistently, that we were going to have a recession, we weren’t going to have a “soft landing”. Where do you see things right now? Yeah, it may be happening. We may be in a recession now. If not in that process and stocks are down 20%, which is right around maybe the low end of the range that you’d see in a recession, so I’d probably say it’s here or right around the corner as we are seeing a lot of these signs of things slowing down. You’re not heading into the soft landing camp. You do think there will be a recession. It could be mild, but and we could be in it right now, but all of this stuff is leading to something. Yes. What do investors do about that? Right now, one of the key things is to look at your fixed income allocation. Okay. Put investors really in two buckets, accumulators, people who are saving, working, extra cash flow saving. And then people who are living off their portfolio. If you’re working and saving, keep investing, keep saving, because one way to think about it is if say you’re going to work for the next 20 years and stocks are going to return 8% a year. If it’s a linear 8%, you just always invest and you get your 8, but in reality markets go up and down. And the last thing you want to do as an accumulator is wait for them to go down. That’s like, oh, I don’t know, a recession is coming I’m not going to put my extra cash to work this month, or this quarter, or this year. And then things get better and you put it to work. So for the people who are saving stick to your plan, keep putting money to work at these better prices. For the people who are living off their portfolio it’s a little trickier. They feel that the pain of market declines more, so that’s where diversification is important – it’s critical. And that’s where I was saying fixed income. Bond yields are much more attractive now than they were at the beginning of the year, 10 year treasuries or really all treasuries, are in the threes, there have been short term treasuries around three and a half. So then you take some spread assets and you can get a high quality fixed income portfolio yielding 4%. So have fixed income that brings you stability, especially if we enter a recession. That’s when things slow down, people want bonds, and that’s a place to draw from. So just make sure your asset allocation is right is the short answer. And can we be a bit more specific if people are looking at their bond allocation and they do own bonds? Are the areas of the market that you like now more or less than you did to start the year when we hadn’t had the rate hikes and the higher yields? Yeah, across the board the market sold off, but trying to be more specific, I would say quality. Just seeing that you have the AA, AAA, I guess even A rated fixed income, that’s something that we think you can count on if stocks go south as we’re in a recession. So just seeing that that’s built out municipal bonds are an area that we have added to, but also just your traditional treasuries, mortgage backed securities, agency mortgage backed securities, like Fannie Mae, Freddie Mac, but yeah, something we’ve been doing and we’ll continue to do is to not be too cute with our fixed income as far as credit risk. We take credit risk, but don’t go overboard, so maybe the flip side of your question within fixed income, I’m not saying pile into high yields right now. You can have some, but that’s not a place that you want to count on if things slow down. So credit quality is important, quality yield, the other thing I know that your team looks at when managing bond portfolios is duration. And could you explain duration briefly and if your thoughts on duration have changed over the last year? Yeah, so duration is a measure of the bonds price sensitivity to a change in interest rates.

00:15:09 – 00:20:05
So the way to think about it is if I buy bonds today and it has a 3% coupon and then markets move, fed raises rates, and now someone can buy that same bond with a 4% coupon. If I were to sell it, no one’s going to pay me what I paid for it, I’m going to have to sign at a discount because rates went up. So I’m going to sell it at a lower rate, lower price, so it essentially yields 4%. So when rates go up, prices go down, and duration is a measure of how much the price goes down. So when you look at how much interest rate sensitivity you want in your portfolio, you do have to have a view on the risk and interest rates. We have been increasing our duration slightly this year, in the last two quarters in particular. So we’re increasing our sensitivity to interest rates because we think that interest rate risk is more attractive – you’re getting a higher level of compensation for buying longer term bonds right now. So when you’re getting three and a half percent or so on treasuries, you have more room for rates to move because you get in more income with it. So just kind of stepping back- it’s a risk compensation discussion. A 1% change in rate is going to hit the bottom line about the same amount. But how much yield are you getting for the risk of stomaching that 1% move? You’re getting more return for that now so we want to take a little more of that interest rate risk. And so I think it’s important to tee this up for people to understand our starting point, correct me if I’m wrong, we were short duration heading into the year, so when you’re saying increase we’re not necessarily going long. We are just going longer. Correct. The bond benchmark, the total bond market has a duration of about 6 and a half. We started the year in the mid to upper threes and now we’re in the low fours. Okay, so not moving mountains, still under the bond market, but going call it from mid threes to four and a quarter, to four and a half. That’s in the direction of where we are and where we’re moving. Touching on a couple of things that we’ve talked about in prior conversations, where’s the VIX? The VIX is still on the lower end compared to where you see it in periods of we’ll call it market bottoms. Like 70 is that the real March of 2020 or November of 2008, like real extreme level is 70. The average in pure complacency market might be ten to 12. And right now, we’ve been in the 20s to 30s. Right now, I think we’re around 25. So elevated, but not off the charts, not like, wow, there’s a ton of volatility and time to back up the truck. So high, but not sheer panic. And what does that tell you? It tells me that we’re in a volatile market, but there’s not a lot of overreaction, probably. It’s just that there’s some pessimism, but it’s not like I was saying, it’s not a backup the truck and buy stocks because people are panicking. Yeah, that makes sense. And we’ve talked about this before, but corporate earnings-how are they looking or how are they coming in during this reporting season? So yeah, you asked two different questions in one. They came in about in line with expectations, came in showing there’s about 10% year over year growth in Q2 earnings. But I think the asterisk is all of that growth can be attributed to the energy sector. So energy to earnings were up something like 300% as energy companies made a lot more money. If you look at companies ex energy earnings were flat year over year, but they at least came in the line with expectations, on average. But what we’ve seen is above average cuts in guidance. So reducing expectations for Q3 and Q4, analysts cutting estimates, companies lowering guidance, so we’ve seen that theme above average to a degree. So companies and analysts are setting expectations for the next few quarters to be below where they have been. So it’s more like it’s been pretty good, but things are slowing is the big picture. Got it. And what is your team looking at? It sounds like you’ve been pretty active. You’re obviously monitoring what’s going on in the markets. Is there anything else on your radar screen that we haven’t touched on in this investment conversation so far? In this one no, a theme that we’ve been acting on the last few months has been real assets.

00:20:05 – 00:25:08
That’s really been a theme this year. How we built up an allocation in late last year and going into this year and that worked nicely. It ties to the inflation theme, and then we’ve been cutting it and putting that into other places so it’s classic rebalancing. Buy and low selling high and that’s where we’ve had some nice wins. And that’s the area that performs with high inflation. So it’s taking chips off the table and the high inflation bet, and buying positions like bonds that will perform well, we think, if inflation slows. Yeah, thank you, Bob. And for those of you looking for some more information on real assets, we recently did a podcast with a real asset chief investment officer and there’s more resources available at our blog at heritagefinancial.net. Pivoting a little bit here, Bob, you know, I recently shared a post through the Boston Adviser called understand your messengers agenda, which is basically, hey, it’s a golden age of information out there, it’s a golden age of misinformation out there, and if nobody has the time to absorb and process everything that they need to know to make good financial decisions, so you got to really be careful where you’re getting information from. A good starting point is to understand if your messenger has an agenda and what that agenda is so you can filter that information. And I shared my agenda just in terms of, you know, ultimately, I think people can do well over time, investing in a diversified portfolio through an adviser to hit their long-term financial goals and make sure that their financial plan is taken care of and kept up to date along the way. I wanted to ask you, and I think this will be a fun conversation, when you’re consuming investment information out there or when you see that our clients are, who are some of the people that you find valuable and who are some of the people that you would warn people away from either on TV, articles, blogs, so forth and so on. Yeah, that’s an interesting question. Maybe I’ll answer it a little differently. When you hear someone say something, step back, listen, and look at fact versus opinion. And specifically, or it can be an opinion, but is it supported by data, what you want to hear from someone is them providing you information that’s data, like mortgage applications are going down, or energy prices are below the point when Russia invaded Ukraine, and when you hear things like that that make sense, that supports an opinion, that has merit. And even if you’re not saying, you know, this person is bullish, so I’m bullish. You look at and you learn data from them, they shared an interesting tidbit that makes sense to me. So what I’m cautioning people against is the fluff out there where it’s. You know I got these things from clients and people like, oh, so and so said we should get out of stocks. Well, why? Well, here’s the article. They still get out of stocks, but there’s no substance. So always look for data to support a case. Now, more to directly answer your question. I do like the folks at Schwab. I think Liz Ann Sonders is great, Jeffrey Kleintop, when you look at a piece they put out, it’s full of charts of information. Tables to look at valuations and measure market valuations ten different ways. So you talk about the yield curve, Jeffrey Kleintop, says it’s not is an inverted or not, it’s how many points is it inverted? So there’s a lot of information. They look at sentiment, so some charts on sentiment where they work with Ned Davis research. So I like people who provide a lot of information supporting their view and another one is the Leuthold Group. They are a small shop out of Minnesota, but they’re market technicians just pour through historical data to support views. So that’s more just how I look at it as less talk and more give me numbers, teach me something about markets. It’s not just opinion. And it sounds like you process that information piece by piece. If there’s data that helps you that’s great you aren’t necessarily absorbing the whole message or story, you’re trying to filter through and learn because they’re gathering information that they’ve basically curated and provided to you. Exactly. Yeah, that’s where it’s form your own opinion. And you do have to be aware of the messenger, is this data that you’ve never heard of before and they’re just making it up to tell a point, or is this really meaningful? And I go back to the energy example. I feel like that’s a pretty straightforward one-the price of crude oil is down. So looking at things like that that make sense and form your own opinion. But listen to people to become more informed on facts, not more informed on consensus opinion. And are there people, maybe you’re too nice to answer this, but are there people who you just dismiss? And maybe not dismiss entirely because again, they’re sharing data, but you just worry that they take their conclusions too far.

00:25:09 – 00:30:02
You gave me an out by being too nice to answer, I don’t want to be telling you who not to listen to. Well, I’ll share one because I think we all have a tremendous amount of respect for the GMO team and Jeremy Grantham, who’s really prominent, and I just read a long piece of his yesterday about a super bubble that we’re in. And they make a lot of good points. I think they tend to extrapolate things to bearish extremes that we don’t see pan out. I’ve heard you say before, you know, directionally they’re right, but they’re just way too pessimistic with the directional points that they’re making. So very informative, I hesitate to push people in that direction because it all seems like the world’s about to end with those guys. Yeah, so an example of how I interpret their research at times is they may say stocks are going to go down 50% because valuations are X and they should be Y. Well, what’s Y? And Y might be the average multiple since 1928? So okay, I got that. So now you think, well, should we be at average since 1928? The world has changed a little bit. There is more history of the U.S. stock market. There’s more regulation in the stock market, companies are bigger and more profitable, there’s more technology, markets are deeper – is it fair to say that the stock market in the year 2022 does have a little less risk than the stock market in the year 1930? If the answer is yes, then maybe we don’t need to go back to average. Maybe we don’t need to go down by 50%. I’m just making up numbers. So that’s where yeah, their point is some things might be expensive, but also do we need to go back to average is just one way to look at that. I agree with you on the people that you shared that you enjoy reading and I do as well. Another one is for me is Howard Marks, he writes very thoughtful investment related memos, they’re long, but they do have a podcast version of them now if you don’t want to read through the whole thing. And on the flip side, you know, there’s people like Peter Schiff or John Hussman, and they’re seeing a catastrophe around every corner and I just don’t think that there’s much of value with those folks. And there’s also people who made one good call and then after that everybody wants to kind of hop on board their subsequent calls. And I know Meredith Whitney made a great call back during the great financial crisis about banks and then she kept making other calls about muni bonds and things just didn’t pan out. And so you I think, have to be careful, you know, anointing gurus because that’s not really what you’re looking for. You’re not looking for a feast or famine major moves. Yeah. Yeah, and to add to the names, Eddie Yardeni Research, he puts out a ton of good charts that are updated just about daily. And you can Google him, Yardeni Research. And Richard Bernstein at Richard Bernstein Advisers. He’s pretty good too, he’s a little more active and will have views, but I do like the research he puts out. One other thing on this topic, CNBC used to have a little thing where they’d interview one person, they’d pick a stock like Google and they’d have someone who was bullish and bearish, and the bullish person makes their case, the bears person makes their case and they wrap it up and that’s what makes a market because everything’s at equilibrium – for every buyer there’s a seller. So there’s always someone on the other side. So that’s where it’s just almost, just be careful, don’t listen to too much of this nonsense and separate facts from opinion. Got it. Great advice. Bob, thanks for our conversation today. I’m sure our listeners always find it valuable to hear from the chief investment officer managing a lot of money, what is going on with markets, with the economy, and what priorities they should have as they’re reviewing their portfolios. So thank you very much. Thanks Sammy.

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