What Goldman Sachs Thinks About Markets: Conference Key Takeaways

Contributed by: Jaclyn Jackson, CAP®

Due diligence meetings are a core part of the Center’s investment research strategy.  They give us a chance to vet investment strategies for our clients. They also allow us to get data from global financial institutions and industry leaders that most advisors typically don’t have the resources to aggregate themselves. 

This fall, I attended the Professional Investor Forum at the Goldman Sachs Conference Center in New York. The three-day conference highlighted research from the company’s thought leaders about markets and the current economic landscape. 

Here are Goldman’s views on a few questions that have been top of mind for investors.

Q: Are we facing another “Great Recession”?

Investor anxiety is reminiscent of the Great Recession, but the root of market volatility is quite different. Market volatility in 2007-2008 was triggered by unhealthy company fundamentals, particularly in the financial sector. The volatility was micro-driven.

Current market volatility is macro-driven with inflation and fed policy expectations largely dictating the investor experience. Since company fundamentals are relatively healthy, Goldman believes a recession would be shallow – especially compared to the Great Recession.

Q:  What’s going on with equity markets?

Rates and higher bond yields have affected the US equity market. Today, the market trades at around 15 times forward earnings compared to 21 times forward earnings at the beginning of the year. A lot of this compression is coming from high growth companies, particularly “long-duration” tech companies where the valuation of the company is attributable to the earnings that are well into the future. 

The gap between shorter-duration stocks and longer-duration stocks has been very significant in terms of the relative performance. This is a tough environment for long-duration stocks because rates will likely stay high. Companies with more nearer-term visibility on their cash flows are likely to do better in this environment. (There are tech companies with more near-term visibility, so no need to dump all tech from your portfolio.)

Inflation clarity is important because that helps us understand the direction of Federal Reserve policy and interest rate policy. Greater investor confidence about corporate earnings might be the impetus for equity volatility to decline - freeing equity prices to move higher.

Equity markets are figured out when inflation is figured out.

Q: How low can equity markets go?

Goldman Sachs expects the inflation rate to lower and for markets to recover in late 2023. This is how they see the timeline unfolding:

• The Fed will be raising rates several more times this year and early part of 2023.

• At the end of the year, the S&P 500 will likely close somewhere between 3,400 and 3,600, modestly down from the current level.

• Markets will be down in the early part of next year until we see inflation data trending lower.

• Equity market moves higher by the end of 2023.

Note, there is a case to be made for a recession. In a recessionary scenario (where the Fed hikes so much that we move into recessionary territory), Goldman believes we could hit a low of around 3,150, which is meaningfully below where we are now.

Q: When will market volatility lighten up?

Goldman Sachs Economics expects the rate of inflation (as measured by core PCE) to decelerate from close to 5 percent to roughly 3 percent. If that actually happens, they believe equity prices will do okay. Nevertheless, that won’t be clear until sometime in the middle of 2023, so uncertainty will probably continue another six months.

Q:  Where should I be invested?

According to Goldman, we’ve move from a “there is no alternative” or TINA environment to a “there are reasonable alternatives” or TARA environment.

If investors wanted yield they would invest in equities, especially US equities. However, chasing yield through equities leaves the door open to greater risk vulnerability. With interest rates on short-term cash positions starting to approach 4 percent, investors can get an attractive rate of return from an income point of view. In the words of David Kostin, Goldman’s Chief US Equity Strategist, “the idea of pure cash returns pushing almost 4 percent and the expectation that the Fed Funds rate will be somewhere between 4.25 and 4.5 percent by the early part of next year, that would suggest that there are reasonable alternatives (to equities), just on the cash positions alone.”

To be clear, this does NOT mean one should sell all of their equities and buy short-term cash positions. Equity positions in your portfolio should generally align with your strategic allocation. This is suggesting that investors don’t have to take unwarranted risks with over-exposure to equity markets to get yield because there are reasonable alternatives (TARA). Short-term cash positions are one example of this. The key here is that now, investors don’t have to over-do-it with risks when looking for yields.

Fed tightening is a big focus, but other parts of financial conditions are tightening too - higher bond yields, wider credit spreads, stronger dollar, lower equity prices. All of these contribute to tightening financial conditions. The type of companies in the equity market that do well in this environment are companies with stronger balance sheets, companies with higher return metrics, return on equity, return on capital, companies with less drawdown in terms of their share prices, more stable growth in terms of different metrics. In short, “quality” companies are likely to help investors in the uncertain environment of tightening financial conditions.

Jaclyn Jackson, CAP® is a Senior Portfolio Manager at Center for Financial Planning, Inc.® She manages client portfolios and performs investment research.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author, and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Standard deviation measures the fluctuation of returns around the arithmetic average return of investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns. Performance of hypothetical investments do not reflect transaction costs, taxes, or returns that any investor actually attained and may not reflect the true costs, including management fees, of an actual portfolio. Changes in any assumption may have a material impact on the hypothetical returns presented. Illustrations does not include fees and expenses, which would reduce returns.

Part 2: Are International Equities Dead?

Contributed by: Nicholas Boguth, CFA®

In part 1 of this 2-part blog series, we discussed the importance of diversified investing despite the recent pain that many asset allocations have felt. We're now turning our attention to a key asset class when thinking about diversification…international stocks.

The S&P 500 (U.S. Large Stocks) returned over 14% annualized for the past ten years. The MSCI EAFE (International Large Stocks) returned a "mere" 7% annualized over the same period. 

This run of outperformance from U.S. stocks has been nothing short of astounding. Between the past outperformance and the current geopolitical conflict overseas, you might feel pressure to throw in the towel on international stocks and invest all of your money in the U.S. stock market. Still, we're here to share some perspectives on why that may not be to your benefit. 

My colleague, Jaclyn Jackson, CAP®, Senior Portfolio Manager and Investment Representative, RJFS, shared some research and statistics on the benefits of diversification in a total portfolio. Spreading bets across many asset classes has historically provided a smoother ride for investors and ultimately led to a higher expected value for portfolios.  

The same principle applies within asset classes. History has repeatedly shown that owning many types of stocks, rather than concentrating on one type of stock, may help maximize investors' chances of achieving return goals and limits the chances of major financial loss.

Beyond the timeless lesson from diversification, international stocks are trading at a larger discount to U.S. stocks than we've seen in a long time. History has also shown us that neither asset class has held a permanent premium when comparing U.S. to international. Lower valuations now suggest higher returns in the future, so valuation is a compelling story if you're looking for a reason to stick to your international allocation. 

Chasing performance is a significant pitfall of both novice and professional investors, but rarely leads to improved investment outcomes. The recent, prolonged outperformance of the U.S. stock market may make it tempting to think that the U.S. will continue to outperform indefinitely, but history suggests otherwise. We don't believe international equities are dead, and we'll continue to stick to the timeless practice of diversification in our portfolios.

Nicholas Boguth, CFA® is a Portfolio Manager at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Nick Boguth, CFA® and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Standard deviation measures the fluctuation of returns around the arithmetic average return of investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns.

The MSCI is an index of stocks compiled by Morgan Stanley Capital International. The index consists of more than 1,000 companies in 22 developed markets.

The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations.

Part 1: Are International Equities Dead?

Contributed by: Jaclyn Jackson, CAP®

This is part one of a two-part blog series. We'll talk about diversification generally in this blog, then zoom in on international equity diversification during the second part of the series.

Amid geopolitical tension and pandemic backlash, equities have taken a beating; bond prices have fallen as the Fed raises rates, and even cash under the mattress is no match for inflation. Looking at our current market environment, I am reminded of the Motown classic sung by Martha and The Vandellas, "Nowhere to Run." For decades, investment professionals have preached the merits of asset allocation and portfolio diversification, but what do you do when it all stinks?

The answer is simple (but the action is hard): Stay the Course! That advice doesn't feel helpful during market turbulence, but honestly, it's the best advice for long-term investors. Let me explain…

Why Diversification Works

Craig L. Israelsen, Ph.D. and Executive-in-Residence in the Personal Financial Planning Program at Utah Valley, did compelling research around portfolio diversification worth reviewing. He compared five portfolios representing different risk levels and asset allocations over 50-years, from 1970 to 2019. While there is much to glean from his research, let's focus on his comparison of two moderately aggressive portfolios (as they most closely resemble the average investor experience):  

• Traditional “Balanced” Fund: 60% US stock, 40% bond asset allocation

• Seven Asset Diversified Portfolio: 14.3% allocation to seven different asset classes (asset classes included large U.S. stock, small-cap U.S. stock, non-U.S. developed stock, real estate, commodities, U.S. bonds, and cash)

In 2019, a year dominated by the S&P 500, the Traditional "Balanced" Fund (having a larger composition of the S&P 500) predictably outperformed Seven Asset Diversified Portfolio. On the other hand, over the 50-year period, the latter had a similar annualized gross return with a lower standard deviation. An investor with a diversified portfolio experienced comparable returns without taking as much risk.

Grounding his research in numbers, Israelsen evaluated a $250,000 initial investment for each portfolio over 26 rolling 25-year periods from 1970 to 2019 and assumed a 5% initial end-of-year withdrawal with a 3% annual cost of living adjustment taken at the end of each year. The Traditional "Balanced" Fund had a median ending balance of $1,234,749 after 25 years compared to the Seven Asset Diversified Portfolio median ending balance of $1,806,565.  

The research illustrates why planners have a high conviction in diversification. The Seven Asset Diversified Portfolio provided risk mitigation (as measured by standard deviation) and supported robust returns even with annual withdrawals.

Stay Tuned

We've discussed the merits of diversification in a general sense. In part two of the series, we'll speak more directly about international equities and explain why we believe it is still a diversifier worth holding.

Jaclyn Jackson, CAP® is a Senior Portfolio Manager at Center for Financial Planning, Inc.® She manages client portfolios and performs investment research.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Jaclyn Jackson, CAP®, and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Standard deviation measures the fluctuation of returns around the arithmetic average return of investment. The higher the standard deviation, the greater the variability (and thus risk) of the investment returns.

Focusing on What You Can Control

Contributed by: Josh Bitel, CFP®

May is Mental Health Awareness Month, and as we all know, managing stress can go a long way in improving mental health. Personally, I have always been a bit of a “worry wart” and often have to remind myself not to sweat the small stuff and focus on what I can control. And of course, as a financial planner, I find this very easy to relate to investing and saving for retirement! Below is a graphic from J.P. Morgan that I have shared many times with clients. Just as we try to do in our personal lives, managing what we can control and not worrying about other factors can go a long way in relieving some of the stress that comes with saving for retirement.  

The major area that we as investors often become fixated on (and rightfully so!) is market returns. Ironically, as the chart shows, this is an area we have no control over. The same goes for policies surrounding taxation, savings, and benefits. As you can see, employment and longevity are things we do have some control over by investing in our own human capital and our health. In my opinion, the areas that we have total control over—saving vs. spending and asset allocation and location—are what we need to focus on. We try to have clients focus on consistent and prudent saving, living within (or ideally, below) their means, and maintaining a proper mix of stocks and bonds within their portfolio. Over the course of 35+ years of helping clients achieve their financial goals, The Center has realized that those two areas are the largest contributors to a successful financial plan. 

With so many uncertainties in the world we live in that can impact the market, it is always a timely reminder to focus on the areas we have control over and make sure we get those right. If we do, the other things that we might be stressing over will potentially fall into place. If you need help focusing on the areas of your financial well-being that you CAN control, give us a call! We are always happy to help.

Josh Bitel, CFP® is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® He conducts financial planning analysis for clients and has a special interest in retirement income analysis.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Josh Bitel, CFP® and not necessarily those of Raymond James.

Battle of the Brackets…Portfolio Management Edition: A Center Spin-Off Competition

Contributed by: Nicholas Boguth, CFA®

I believe certain things make our team outstanding here at The Center, and a few of them were in the spotlight this past month amid the March College Basketball Tournament:

• We constantly practice our company values.

• We have a heavy focus on charitable giving.

• And ultimately, we are just a cool place to work.

In the spirit of education, teamwork, and some friendly competition, we ran a bracket competition with an investment focus (we did a normal bracket game too, but mine was busted the first day, so there is no need to talk about that). Every team member chose an asset class to represent their “team” in the tourney. The winner of each round is the asset class that outperformed over the week, and we are repeating for five weeks until we have our champion.

Some team members chose more stable asset classes like short-term U.S Treasuries or investment-grade bonds, while some chose more volatile options like Emerging Market stocks or commodities. Overall, it is fun for the entire team to collaborate and for all of us (not just those in investment roles) to watch how different asset classes move with economic news*.

*We all know there is no shortage of economic news lately from the U.S. and overseas. Markets have been volatile, and times like these stress the importance of having a plan in place. As always, we are here to help answer any questions you may have about your plan. One small but powerful tool in investment management that we have taken advantage of is tax-loss harvesting during volatile markets. Read more about that here.

The cherry on top of this competition is that we are playing for some of our favorite local charities. The Center’s Charitable Committee donated $1,000 to the winning four team members’ charities of choice. Check out the results from last year, as we ran the same competition using individual stocks instead of asset classes. We will continue to find new ways to collaborate, learn, and partner with charities here at The Center. We hope you follow our blog as we update along the way!

Nicholas Boguth, CFA® is a Portfolio Manager at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

Any opinions are those of Nicholas Boguth, CFA® and not necessarily those of Raymond James. Every Investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment, Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Tips for Investors During Times of Market Volatility

Contributed by: Michael Brocavich, CFP®, MBA

When faced with volatility in the market, emotions can be triggered in investors that can impact their judgment and potentially affect returns. These pullbacks can make folks want to pull up stakes and run – a reaction that is often a mistake, especially for long‐term investors.

The likelihood that we will continue to see volatility this year is high. The Fed has slowed down its bond buying activities and is raising interest rates, the threat of a new COVID variant that could shut down the economy still exists, and there are supply chain and labor issues around the globe. To top it all off, we are gearing up for mid‐term elections in November.

Here are some tips to consider when we do face a volatile market. Having a plan during this time can help provide clarity, confidence, and even strategies to take advantage of the volatility.

• First, we need to remember that market volatility is normal. As investors, when we experience long periods of upward markets with little volatility, we forget how regular market volatility really is. We need to remember that historically, the market will dip by 5% at least three times a year. Also, on average, the market will have a 10% correction once a year. Understanding that volatility is a natural process of investing and challenging to avoid can help curb some emotions triggered by these markets.

• Make sure your employer retirement accounts are rebalanced appropriately. Over the last few years, money invested in stocks have severely outperformed the bond market. Now is a good time to revisit the allocations in your Employer‐Sponsored Retirement plans to make sure your allocation is still within your risk tolerance. You will want to make sure that your allocation to stock funds and bonds funds is appropriate for the amount of risk you want to take. If you are unsure of how you should

• Increase Plan contributions when markets are down. For younger investors still in the accumulation stage, a volatile market is a great time to increase your contributions. Though it may seem scary to increase your contributions when markets are volatile, you are actually buying into the market when prices are on sale. Contributions added when the market is down 5‐10% from the previous high have much more earning power than contributions made when the market is up 5‐10% from its last high.

• Have additional cash on hand to invest in dips and corrections. For investors who have been able to max out their Employer‐Sponsored plans and still have additional cash to invest, a volatile market can make for an excellent opportunity to do so. Consider talking with your advisor about moving extra cash to your investment accounts to invest on dips and corrections. Together, you can develop a strategy to get your cash invested over time or all at once, depending on market conditions.

Stumbling through bad times without a strategy makes a troubling situation even worse. If you do not have a retirement or investment plan, you will not accurately assess the damage when markets do take a dive. This could increase stress and cause investors to make bad decisions.

These periods of volatility are an opportunity to connect with your advisor, enabling them to act as a sounding board for your concerns. By talking about current events in light of your overall financial plan, your advisor can provide a reassuring perspective to help you stay the course or even invest extra cash during an opportune time.

Michael Brocavich, MBA is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® He has an extensive background in both personal and corporate finance.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Past Performance does not guarantee future results.

Inflation Hedges Explored

Contributed by: Nicholas Boguth, CFA®

Our Director of Investments, Angela Palacios, recently wrote about the factors influencing current inflation rates. She shared a helpful chart from JPMorgan and summarized, “you may be surprised to see the strong average performance from varying asset classes in this scenario. Inflation that is reasonable and expected can be a very positive scenario for many asset classes.”

As the debate continues over whether or not inflation is “transitory,” some investors are thinking about how to protect their portfolios from rising inflation.

Most bonds, aside from TIPS, are generally expected to perform poorly if inflation rises. This should make sense as the fixed income stream from a bond investment will deteriorate if inflation rises. To protect against inflation, one might conclude that removing bonds from a portfolio makes sense, but not so fast. Bonds are typically in a diversified portfolio to protect from the more common (and devastating) risk – a stock market decline. Be sure to know how your portfolio’s risk exposure would shift before considering a move away from bonds.

Vanguard recently released some research on the topic of inflation hedging and concluded that commodities were the best asset class to protect from unexpected inflation. While commodities are generally accepted to be pretty good inflation hedges, one major risk of owning them has been on display for the past ten years. Their return stream can look significantly different than stocks’. Admittedly, this has been one of the best decades in history for U.S. stocks and one of the worst for commodities. To demonstrate just how “different” the returns can be, if you would’ve held one of the largest commodity ETFs over the past ten years, you would’ve underperformed the U.S. stock market by almost 400%.

Trailing 10-year performance of two ETFs that represent the U.S. stock market and the broad commodities market. SPY (green line) tracks the S&P 500, and DBC (blue line) tracks a basket of 14 commodities. Total return. Source: koyfin.com.

Some portfolio managers like Ray Dalio or First Eagle portfolio managers, Matthew McLennan and Kimball Brooker, have been long time proponents of gold as a hedge against inflation. Gold can be a powerful diversifier in a portfolio, but has also seen sustained periods of underperformance that may make it hard to hold over the long term. Here’s a similar chart of how a popular Gold ETF has performed over the past ten years compared to the red hot S&P 500.

Trailing 10-year performance of two ETFs that represent the U.S. stock market and the price of Gold. SPY (green line) tracks the S&P 500, and GLD (blue line) tracks the gold spot price. Total return. Source: koyfin.com.

You may even see articles claiming that bitcoin is the best inflation hedge to add to your portfolio. These opinion pieces make some compelling arguments, but it is important to remember that they are just opinion pieces; emphasis on opinion. We haven’t truly had an inflationary period since bitcoin became popular in the past decade, so there is no way of knowing if its performance has any correlation to U.S. inflation.

Above all else, before jumping to action on your portfolio, remember that inflation is quite hard to forecast. There are an infinite amount of moving parts and multiple ways to measure them. Professional forecasters don’t even agree on what it will look like in the next 12 months, let alone the next ten years or the remainder of your investment time horizon. One of the best ways to hedge against inflation is to talk to your financial advisor and understand how rising inflation might affect your financial plan. That is why we’re here.

Want to know what The Center thinks about inflation? Check out these resources: Inflation and Stock Returns and How Do I Prepare my Portfolio for Inflation.

Nicholas Boguth, CFA® is a Portfolio Administrator at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

Opinions expressed are not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Past performance is not a guarantee of future results. Investing involves risk and investors may incur a profit or a loss. Treasury Inflation Protection Securities, or TIPS, adjust the invested principal base by the CPI-U at a semiannual rate. Rate of inflation is based on the CPI-U, which has a three-month lag. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. Investing in commodities is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated. Bitcoin issuers are not registered with the SEC, and the bitcoin marketplace is currently unregulated. Bitcoin and other cryptocurrencies are a very speculative investment and involves a high degree of risk.

2021 Third Quarter Investment Commentary

Contributed by: Center Investment Department

Crisp Air, Cool Breeze, Fall Leaves. All the things that Autumn brings here in Michigan. As the third quarter comes to a close and we enter the last quarter of 2021, we find a cool breeze passing through markets as volatility picks up - as is often the case in September and October. A diversified benchmark portfolio consisting of 60% stocks (split between U.S.-S&P 500 and International-MSCI EAFE) and 40% bonds (Bloomberg Barclays U.S. Aggregate Bond Index) is up just over 7% year-to-date as of September 30th, with the S&P 500 leading the way at +15.9%, international stocks (MSCI EAFE) at +8.35%, and U.S. Aggregate Bonds at -1.55%.

Check out this video to recap some of our thoughts this quarter and continue to read below for some more detailed insight!

Volatility has picked up as the recovery appears to be in a holding pattern. Investors worry about the delta strain and are concerned about a surge in additional strains that could come with the winter flu season. Stock markets don’t have a clear driver of upward returns right now, and we are currently in the middle of two of the most challenging months (September and October) of the year historically for markets. Until September, the S&P 500 hadn’t experienced a 5% decline (which usually occurs 2-4 times per year) since October 2020. The market broke this long streak in late September. Headlines from the government, worry about bonds rates increasing, Chinese real estate headlines, and inflation fears have caused a pause in the steady upside we all had grown quite comfortable to!

It’s important to remember markets frequently experience short-term pullbacks. The below chart shows intra-year stock market declines (red dot and number), as well as the market’s return for the full year (gray bar). This chart shows us that the market is capable of recovering from intra-year drops and still finishing the year in positive territory, which helps us remember to stay the course even when markets get choppy!

Fed Tapering – Will It Cause Volatility?

Google searches on tapering peaked in late August and again in late September surrounding the Federal Reserve (the Fed) meeting. The Fed has fully telegraphed their intention to make this move that, likely, isn’t starting until late this year. It’s important to remember that tapering isn’t tightening. The Fed is lessening the rate they are buying government bonds. Investors wonder, “Will interest rates spike when they stop buying so much?” The answer is maybe. However, there won’t be as much debt being issued next year without fiscal stimulus as has been in the past year and a half. So, current buyers other than the Fed should be able to absorb supply. Also, U.S. Treasury bonds are still paying much more than other government’s bonds that are similar in quality. If rates go up, they will likely be met with headwinds because pension funds and other governments will want that increased yield buying the bonds and thus forcing rates back down again.

Over the summer, the Fed started to unwind the secondary market corporate credit facility that was announced early on in the pandemic to support corporate bonds and fixed income exchange-traded funds. The Fed’s holdings peaked at $14.2 Billion as the move quickly restored stability in markets at the time – March 2020 - and no further action was needed. They are planning the sales in an orderly fashion as not to disrupt markets.

Washington D.C. – A Game of Political Chicken

There have been a lot of headlines toward the end of the third quarter from the government, including government shutdown possibility, reconciliation, infrastructure bill, debt limit increase, and tax increase plans. 

First, the temporary funding bill and debt limit caused short-term volatility as investors were nervous that politicians not seeing eye-to-eye would cause another government shutdown or worse - default on U.S. debt. Fortunately, the President signed a bill funding the government through December 3rd, just hours before the deadline. You may not realize how often we have stood at this precipice before, though. According to the Congressional Research Service and MFS, “There have been 21 government shutdowns in history when our nation’s lawmakers failed to agree on spending bills to fund government outlays for a fiscal year that begins annually on October 1st. The most recent shutdown, a 35-day stoppage that ended on 1/25/19, was the longest closure in history. 11 of the 21 shutdowns lasted three days or less.” Interestingly enough, there are many similarities between now and 2013 when the FED was rolling out their plan for tapering, debt ceiling debate, and government shutdown. While what happened in the past isn’t necessarily what is going to happen now, we believe it offers a helpful perspective. You can see that in 2013 there was an uptick in volatility and a short-term market retreat, but overall the markets continued to move higher through year-end.

Source: Raymond James Chief Investment Officer, Larry Adam

In September, we gained some clarity on the tax increase proposals to assist in paying for the infrastructure bill. Check out our blog on some of the details, as well as our upcoming webinar! Capital gains tax proposals can potentially disrupt markets in the near term, but the increase in those taxes would go into effect as of mid-September 2021 (retroactively). This is important because it prevents a rush of selling to harvest capital gains before an effective date.

China Headlines

Why has China and emerging markets lagged recently? China is the 2nd biggest economy in the world and the 2nd biggest equity market in the world. China represents 35% of the Emerging Market index, so when China lags, the entire asset class tends to lag too. Active management can be important in this area to navigate the complexities of these varying countries. China has shifted gears recently, choosing to focus on social stability (or “Common prosperity”) rather than pure growth as in the past. China’s Communist Party has turned its eye to the ultra-wealthy, politically outspoken citizens and technology usage.

Most alarmingly, however, has been Evergrande’s debt woes. Evergrande is one of China’s largest real estate developers with a massive amount of debt. They have been forced to sell off assets in order to meet debt repayments, which is having a ripple effect through their customers, suppliers, competitors, and employees. This is so impactful because one-third of China’s Gross Domestic Product is related to real estate. As you can see in the chart below, housing represents over three-quarters of financial assets in China versus a much lower percentage (less than one-third) here in the U.S.

Initially, there was fear of contagion spreading from the Chinese High Yield debt market to the U.S., but this hasn’t occurred.

We remain disciplined in the consistent and proactive execution of our investment process that is anchored in the fundamentals of asset allocation, rebalancing, and patience. From time to time, we may choose to express our forward-looking opinions of the state of stock and bond markets but always strive to do so without subjecting you to unnecessary risks. Even though we close this quarterly note similarly each time, please understand that we thank you for the trust you place in us to guide you through your investment journey!

We have more thoughts to share on investment current events coming soon. Stay tuned for our investment blogs about inflation hedges and Biden’s corporate tax rate proposal.

Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.

Any opinions are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. Diversification and asset allocation do not ensure a profit or protect against a loss. Dividends are not guaranteed and must be authorized by the company's board of directors. Special Purpose Acquisition Companies may not be suitable for all investors. Investors should be familiar with the unique characteristics, risks and return potential of SPACs, including the risk that the acquisition may not occur or that the customer's investment may decline in value even if the acquisition is completed. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not a guarantee or a predictor of future results. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.

Inflation and Stock Returns

Contributed by: Nicholas Boguth

There is a lot of talk about inflation in the news lately, and whether or not the recent spike is “transitory” or if the recent rise in price levels will persist into the coming months, years, or even longer. The problem with forecasting inflation is that it cannot be accurately forecasted. It is a complex topic with ever-changing variables beyond the Fed and money supply including (but not limited to) consumer spending, saving rates, supply chains, government policy, demographics, technological advancements, and much more.

For some high-level context, I wanted to look at the relationship between inflation and stock returns over the past 30 years.

Below, you’ll see a scatter-plot of 1-year changes in CPI and the S&P500. What stands out to me is that an overwhelming majority of those dots are in the top right corner of the graph – positive inflation and positive stock returns. A lot of news headlines we see will put the word “fear” directly next to the word “inflation” because, well…that is what headline writers are paid to do. The reality is that if you look at the long term history of stock performance, you will see that it is positive a vast majority of the time regardless of what happened with inflation.

Source: Morningstar Direct. S&P 500 TR. Monthly return data.

 Investors need to prepare one way or another, and a great way to do that is to talk to your financial advisor and make sure that you are setting yourself up for success no matter what happens with inflation. Helping to maximize your probability of success is something we help all of our clients with, and it may look different for each investor depending on time horizon, risk tolerance, and investing/spending goals. Give us a call or shoot us an email if you have any questions on how to help maximize yours.

Nicholas Boguth is a Portfolio Administrator at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Indices are not available for direct investment.  Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Nick Boguth and not necessarily those of Raymond James.

How Do I Prepare my Portfolio for Inflation?

Contributed by: Angela Palacios, CFP®, AIF®

Inflation is common in developed economies and, generally, more healthy than deflation. When consumers expect prices to rise, they go out and purchase goods and services now rather than waiting until later. While it is likely that inflation will continue to trend higher here in the U.S. in the coming months the question is “Can this harm my portfolio’s ability to help me achieve my goals?” Consider the following factors contributing to or detracting from the inflation outlook.

Our investment committee has discussed inflation at length for several years now. Here are some highlights from our discussion.

Factors influencing inflation in the short term and long term:

1. Large amount of monetary and fiscal stimulus

   There has been a record amount of stimulus being pushed into the pockets of American’s by the government. The consumer is healthier than it has ever been and demanding to purchase.

2. Supply chain disruptions

   Whether due to shipping constraints or lack of manpower, companies can’t make enough of many different products to meet current demand. Does this sound familiar? It should because a year ago all we could talk about is not having enough toilet paper and disinfectant wipes. People were paying big prices for even small bottles of hand sanitizer.

   Fast forward one year and the shelves are now overflowing with these items and prices have normalized. Once people have spent the money they accumulated over the past year, demand will likely return to normal.

3. Starting from a very low base

   The point to which we are comparing current inflation is one of the biggest influences on the calculation. Right now, for year-over-year inflation, we are comparing to an economy that had very little to no economic activity occurring. When you compare something to nothing, it looks much larger than it actually is. A year from now we will have a more normal comparison base.

4. Wage inflation

   One of the biggest factors in the lack of inflation over the past decade was a lack of wage inflation. We are now seeing wage inflation because companies can’t hire enough people to meet the current demand for their goods or services. Wages are going up trying to entice people back to work. Once government transfer payments slow or run out, many of these individuals will likely return to the workforce again causing wages to return to more normal levels (although it is possible wages settle at a new base that is higher than they were before).

5. A complete lack of velocity of money

   While banks are flush with cash, they still aren’t lending. Why? Because the banks, due to banking regulation changes over 10 years ago, only want to loan large amounts of money to someone who is creditworthy. The creditworthy consumer is so healthy that they don’t need to borrow money.

6. Technology increasing productivity

   A large portion of the country just increased productivity by reducing commute time over the past year via remote working capabilities. Companies that would never have considered allowing remote work now find themselves reducing office space and making permanent shifts in working style. This is just one example of how growth in technology can increase productivity which, over time, puts downward pressure on prices.

It is important to understand what investments could do well if we are surprised and inflation is around the corner.

First of all, your starting point is very important. Are you starting from low inflation or are your inflation levels already elevated? The answer is we are starting from a long stretch of time with very low inflation rates. So in the chart below you would reference the lower two boxes. Then you need to ask, is inflation rising or falling. Low and rising inflation is the bottom left box. You may be surprised to see the strong average performance from varying asset classes in this scenario. Inflation that is reasonable and expected can be a very positive scenario for many asset classes.

In our Second Quarter investment commentary we will dive a little deeper into the asset classes that perform well and how we think about incorporating that into your portfolios!

Angela Palacios, CFP®, AIF®, is a partner and Director of Investments at Center for Financial Planning, Inc.® She chairs The Center Investment Committee and pens a quarterly Investment Commentary.