RHP Market Talk
Complicated economic topics distilled into digestible and palatable investing principles.
Hosted by Natalie Picha, Partner and CXO of RHP Wealth Management.
RHP Market Talk
Still On The Rollercoaster.
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Geo-political tensions. Inflation. Labor shortages. Interest rates.
Royal Harbor Partner's Natalie Picha, Glenn Royal and Jason Strzyzewski unpack current risks in the financial markets.
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You're listening to the RHP Market Talk Podcast from Royal Harbor Partners Wealth Management, located in the beautiful Gulf Coast of Houston, Texas serving families from across the country.
Natalie PichaWelcome to the RHP Market Talk Podcast, Episode number 17, I'm Natalie Picha...
Glenn Royal...and I'm Glenn Royal.
Natalie Picha...and along with Michelle Jones, we are the founding partners of Royal Harbor Partners Wealth Management. Today, along with our investment analyst, Jason Strzyzewski, we're going to be discussing the most recent risk-off sentiment in the markets. In episode 15, we talked about the rollercoaster ride that we expected for 2022, and markets have certainly delivered. I recently heard the phrase, don't get off the rollercoaster in the middle of the ride. Which is probably a pretty good analogy for the investors these days. So Glenn, lots to talk about.
The Geo-Political Climate
Glenn RoyalYes, there is.
Natalie PichaWhy don't we just start with some very recent market jitters and just kick it right off with the geopolitical climate that we're looking at, and how markets may be looking at the Ukraine Russia situation right now?
Glenn RoyalWell, it's true . It certainly has crossed our radar, as any of these events would, as you expect. I think having that number of troops along the border of a sovereign nation has us a little bit nervous concern with what's going on. The big impact there, of course, is what will happen to oil. Russia is a member of OPEC. An OPEC Plus member. What will be the consequences of oil? Against that oil backdrop, you know , potential of disruptions and what it could spike. We're almost looking at a hundred bucks WTI today, is you do have the Iranians coming back to Geneva and trying to get their nuclear inspection deal taken care of. So Iran can bring on a great deal of oil to maybe offset some of these issues in the Ukraine. So, we are kind of watching these different things as they play out. But as far as broader markets, historically, when we've had battles or conflicts , a lot of it of course is dependent upon the time. But most of them have been contained economic damage to that region and not spread out globally. So kind of an old saw as a trader, as we used to buy when the bombs were dropping. It was kind of wild. All the advanced anxiety of war drums is into the markets. Being priced in before the actual event happens.
The Inflation Story
Natalie PichaRight? Well, I mean, markets had been in risk-off mode. He year, pretty much since, since the beginning here , this year of 2022, lots of lots of, I guess, risks being priced in, we always talk about markets are forward looking , right? So they price in ahead of based on what risks you may see. And so that Russia Ukraine is, is just one of the many, right. We're looking at inflation, rising interest rates, we're looking at potential labor shortages and things like that. It's hard to even encapsulate in one conversation, everything that's kind of going on in this market. Let's talk a little bit about the inflation story, because I think even mid-year last year, we were talking about where we thought things were going to go in in terms of inflation coming off and what those things would look like. Where are we today in terms of the inflation?
Glenn RoyalYeah , I think part of the story when, the pandemic originally hit. The expectations for inflationary pressures on the supply chain like that, were there, those things did occur. We didn't think that much of it because we expected that. But what we didn't anticipate, was that it started to broaden out. So, for example, food prices globally, a re up 25%, Excuse me, they are at 25 year highs. An d t he prices of food, Things are starting to broaden out gl obally and that's got everyone's attention. Including the Fed, that's now focused on fighting inflation in a pretty aggressive manner. We will see. And I think, you kno w, there's so many tools they can use to do that. We can tal k about how they might go a bout this. But you're seeing the market that is setting up an expectation of a Fed hike cycle, the exit. Basically exiting quantitative easing, that they've been on since 2008 and they're exiting zero interest rate policy programs around the world. We're not alone at this. Others are doing the same. But at different measure paces. Now China is actually going into o ppos ite route. They a re lo wering interest rates. To get their economy going after a lot of the issues they've had in the last year. Ba s i ca lly, reorganizing capitalism in that country. So, you're seeing some changes, on differences, ECB u nd e r C h risti ne Lagar... that sh e 's s aying, hey, you know , d o n't do too much. You're hearing some different Fed officials. Because if we do too much, you're going to see financial conditions start to tighten. They already are. And the m ark et and the Fed hasn't even done anything. All they've done is they taper dow n the amount of asset purchases they do. Currently, they're buying 20 billion of treasuries in se cu ri ti es right now in this m ar ket. They're still pumping money in the syste m. W hile the bond market investors had front ru n the F ed. And rerated all this. Almost to a point where you kind of won der i f it's overdone. A little bit.
Natalie PichaRight?
The Rate Hikes
Natalie PichaSo that's a great question, is we anticipate and based on the Fed minutes and what we're, you know, looking at that we could be looking at a 50 basis point hike here in March. That's what we anticipated. But you're seeing analysts raise their expectations from , maybe three hikes, four hikes. Now where somebody are saying six or seven.
Glenn RoyalSix this year. So, yeah, I know . So, let's go back to that. In my career, I've now had four Federal Reserve Governors I've operated under. I came in when Greenspan was appointed. So, I've watched this under Greenspan , which we didn't know what the Fed was going to do. They didn't announce it. You ju st h ad to watch their actions in t he market and figure it out afterwards. It was much more reading the tea l eaves. So this time around, they are announcing. They want clarity. They don't want any market su rprises. They don't want to t ighten the financial conditions so much th at i t tips us in to r ecession. But, let's go back to when this started. Chairman Powell on a Fr i day in tha t February of 2020. He sa ys , hey , everything looks okay . W e u nderstand the COVID. It was first coming on the scene. And then on Monday, the Fed did an emergency 50 basis point cut to the Federal funds rate. So, t hey started out with 50 basis point s and they went a ser ies of quarter. If I go back to big economic periods under when Greenspan w as c hair, the dot com blow ups and stuff. It wasn't unusual if they gave a bunch of credit. Flooded the system with money. Liquidity to repair it. That the first hike was 50 bips. Or even moving interim meetings. That's not something we've seen. And that's another possibility, as you see an int er im hike. But let's talk about the hike cycle too. Where rates are expected go ? T h e Fed, this Federal funds rate trains in a range of zero to a quarter percent. So we'll refer to the top end of that range of a q ua r t er of a point is whe re we are today. So each hike, if i t's a quarter of a point, if I get that interim or that 50 bips, that puts us from a quarter of a point Fed funds rate to 2%, by the end of this year. That's what the market, through all this year, has priced right into it. We can follow that and track it through interest swaps, interest rate sw aps in the future market. And we're seeing it. So, everything's baked into th e ca ke for Fed fun ds to go. You know. What I don't know is, what that end ter min al rate will be. Will they be able to get there? That's always a question and the y s truggle with that. I'm not sure if they w o n't happen again. There's bigger picture issues that come back in with the deflationary forces. Demographics. We had issues with tariffs. We put tariffs onto som e th ings there with the sup ply chain earlier on. But th e demographic story and the n ati on's moved about i mm igration is possibly i mpacting our labor force participation rate. So th ere' s things like that, that are in the system that, you know, h as t o be worked out.
Jason StrzyzewskiAnd that's what I'm seeing Glenn. It's going to be real difficult for the Fed to really thread the needle for this soft landing. It always is. When we have these inflationary pressures. Some of which are becoming more entrenched into this market. And then to your point, we have others where, you know, they've been , products have been supported by this extreme demand, for goods rather than services. Where those levels of demand, supply chain constraints, labor constraints have been elevating those prices and supporting these levels. So, we expect to see a lot of these figures, that aren't typically inflationary pressures, those to roll off a little bit. But this could stay around longer than we would be comfortable for. You know, we were talking transitory for the longest time. Everyone feels a certain way about that word at this point now in the markets. But here we are. Here we are.
Glenn RoyalY ou know.....Natalie, I think Jason makes some really good points on that. Part of the components of inflation, if I look at just simply, used car prices, right? You know, they're up with 43%. Year over year. That's about 5% of the o f the CPI index. That's a pretty big chunk of that index f or that kind o f high rate. That we don't think sustainable. Right. You're just not going to see that. So some of these big... shelter probably is sticky. That's a big component of it. An d w e've se en p rices he re. They don't roll back down that quick. Also I think with the wage gains that we're seeing. T h e tight labor market. There's issues there. That won't go back so quick. They may not be...we are seeing signs tha t wa ges aren't increasing anymore. Which a big inflationary pressure. But , t hey are, you know, firm. So those things coming together gives us...while these rates may be sticky, they are looking like, t h e y 'll start to roll over in the sec ond half of this year . Th at's where this transitory nature originally it c am e in the word bec ause we thought it w as the short term iss ue. Supply chain logistics and all that. Thought that was going to get corrected. But then we didn't know about Delta wave . An d the n tha t came along then , ri ght. As soon as we were kind of recovering from that, we got slapped with Omicron. So now we're back at this point today, we're back kind of p as t the Del ta wave and that little nice spot peop le are going...and, you know, hopefully we'll see if t hi s pandemic becomes endemic at this point. Now kno c k on wood it does. Right?
Mortgage Rates
Natalie PichaSo, when we talk about the markets, maybe front running the Fed. Right. It's interesting that in the second and third quarters of last year, we had clients, you know, refinancing their homes. Mortgage rate less than 2%. We actually have people now coming in are already up at 4%, 4.5%. Almost 5%. Fed hadn't even raised rates once.
Glenn RoyalThe invisible hand. It works . It's the market doing it for you.
Natalie PichaThe market's doing it for you!
Glenn RoyalThe Fed...one of the greatest tools that Fed has is just jawboning, right? The jawbone of an ass. Remember that? And that's what they do all the time . They just got to get out and imply. And the market will react to it.
Natalie PichaRight. So what gives you confidence that, with where we've been here the first couple of months of the year, that this isn't going to get worse?
Glenn RoyalWell, we're seeing, anecdotally, you're starting to see little things start to come over. The CEO of Maersk, one of the largest shipping companies in the world, they're starting to see pressures come up. It's at the margin. It's still sticky, to Jason's point. That you're just starting to see little signs of it lower . No longer necessarily going higher. At different little indicators, we see logistics improving a bit. Right now, the Chinese Lunar New Year, you know, that's passed. All that, shipment of goods, back to manufacturing. Offshore...Long Beach is slammed again with goods. You know. It's continuing. Some companies like Apple and Walmart have figured out how to deal with a supply chain that's less than optimum. And so, you've had two years to figure it out. So we're finding those companies that are doing well. And those that aren't.
Unpacking The U.S. GDP
Natalie PichaSo , another indicator that, often, clients look to...is they look at the U.S. GDP. Either our growth expectations, they look at the strength of the U.S. dollar and things like that. Let's talk a little bit about how all of this plays into that. Our so called deficit. The GDP. The U.S. dollar. Strengthening. Weakening. How does that look right now in the current situation?
Glenn RoyalThere's that...boy, that's a lot to unpack.
Natalie PichaSorry. Just put it all in there together.
Glenn RoyalYeah. As far as GDP growth, we are still expecting growth, just shy of 4%, like 3.8 , 3.9 in there. Which is twice historical average. I do have higher inflation. We do expect those things to come down. Components of it in the second half to be less of a stiff wind in our face, right. More , easier to deal with. And then my corporate profit growth is still strong as can be. I mean, corporations are coming in. You had about 80% for first quarter.
Jason StrzyzewskiStill had an excellent earning season to your point.
Glenn RoyalWhat you seen on the top line there , Jason?
Jason StrzyzewskiTop of the line, you know, earnings, net profit margins, much better than expected. 12% over 11.5 estimates. Still a dip from third quarter of 2021, but growth. We still have growth. We still have companies that are protecting those margins. Keeping free cash flow available. And that's what we're really looking for. In these earning periods, we're looking for companies that, like you said, Apple making their own supply chains. Navigating that themselves with the size to their aid. Being able to do that is a big plus for them. Companies available to preserve their pricing power. And then also to be able to navigate at the labor shortage and labor issues. And by doing that, you know, we're looking for high-quality companies. Stable balance sheets. Just really going back to fundamentals. And looking back into January, we had a real , it was healthy in my opinion, evaluation adjustment to a lot of the growthy names out there. Bringing a lot of these high flyers down to reality. And as a result of the liquidity that Glenn was talking about. Being sucked out of the system a little bit. So, we're starting to see the effects. Everything's starting to get baked into the cake. And Glenn and I we're still very bullish going into latter half of the year. It will be a little bit discomfort going into this hiking cycle. We're not sure how that's going to look like. And how it's going to unfold. And then Russia Ukraine. But like to Glenn's point, it's going to be shorter. Shorter term.
Glenn RoyalYou know , we'll see , you know, every market's different, but yeah, I really feel like some o f the things that we're doing in the portfolio, were , you know, technology was the end al l f or everybody for so long. That was in an e nvironment where we had quantitative easing and real le ast p a r g rowth as a result. I think of that, you know, th e F ed controlling the economy now that the Fed's stepping away, you start ge t t hings going again. I'm pretty, you know, I l o ve that. I mean, if I can start getting Fed funds back to 2%, I can start getting paid in mo ney markets. I can start getting rig ht. A n o rmal as fu nctioning economy and to me, I kind of had the se triple threes in my mind. We were talking about this, that if I can get inflation trending down, it's got a three handle three point, what if I can get unemployment to the thr ee handle, which is r ig ht there, righ t. Th ree now. And if I can get GDP growth at 3%, I'm pretty happy about that. And if we stepp ed back in the context of, yes, we're used to, you know, a two and f ive eight s mort gage or auto or whatever, okay. Maybe this thin g s need to double. Maybe we need to go below five. I, on some of these things, I six on an au to loan, but that's not going to stop this economy. I think it still continues. We're not in any hyperinflation. We're not anything like in the seventies. We're in a period where a little bit of inflation can drive real wage earnings, that c an d rive productivity. And as ano t he r thing we always talked about, the biggest concept , I hear this a lot where clients are looking, Hearing advisors or readi ng online about past financial conditions, And t r yi ng to extrapolate that to today. Pa rticu larly the deficits,
Low Debt Load
Glenn Royalright? The deb t load servi ce is incredibly low. It's when you add the interest expense and the debt. Everyone refied. We were talking about this. If you had a mortgage, you refied. If you were a corporat i on, a CFO, you refied your corporate debt. Everyone has gone through a huge refi cycle. A benefit o f this. So, we're starting to see municipalities refi. We w ere start ing with the very l ow debt service obligation. Coverage ratios with healthy balance sheets. It's a whole different environment. And I think the biggest thing, it's rea ll y ha rd for me to quantify, but we haven't had the internet, but for wh at, 20 y ears in business or less. And the fir st was trying to figure out how to use an email, right. Right? I mean, and then we went to Web 2.0, which wa s the move away from your deskt op t o cloud. You know, now the web's advancing. Even further, maybe these Metaverse and things th at we are hearing. But, I thin k th ose are hugely defla tion ary forces that we had to cont end with. That are productivity. That's a re sult o f that. Think about this work from home. If I 'd have been s tuck in my house the last two years without the internet. Business? W e really be in bad shape. We didn't skip a beat. So, th e Fed , you had a te mpo rary hit. The Fed put in the money . N ow the Fed's taken it bac k and we are right back to where we wer e, kin d o f pre-19 levels. For the most part. And we do want to talk one th ing about inflation. Maybe I can make this easy to understand. We heard this from a Goldman por t f olio manager. And this is kind of also wha t 's happened. This a hundr ed d o l lars bill
The $100 Explanation
Glenn Royalanalog y. This is a simple way to explain. If I had a hundred dollars and before the pandemic hit, I'd spend half of that on goods. Lumber. Autos. Clothing. TVs. And I spent the other 50 bucks on services. Restaurants and Disney World, cruise ships and all that. When the pandemic hit, all of a sudden, I s pent my who le hu ndred dollars spen ding on goods. And our demand for goods was 1 4% higher than before the pandemic. Now we're starting to see things change. But that had impacts on supply chains, that were already decimated because we have this jus t i n time inve nt o ry s ystem, these days. Another ev ol ution i n the business community th at I think, you have a Mi tski moment. You s aw where the fail ings were. A pandemic ju s t destroyed just in time accoun ti ng. So that's being fixed. Right. We're get back to t h at. It's just goin g to take a little time. I see no reason to not have optimism about the economy. Really for so me time now, we don't see a recession on the horizon. And that would b e another thing. We do want to t alk abou t cr e di t s. W e were talking a little bit earl i er about, how do we monitor for risk in the market? What is our key thing? And Jason and I are big, big advocates of the bond market. We are looking for risk that's evidence by basically, riskier bond s e ll ing off. Right? Comparable to treasury. So there 's a con cept that we l ook at, that's called spread. And all it is, I take the difference between the yield on an investment grade corporate bo nd, a nd compare that to a like maturity, U.S. Treasury. Why do a treasury? Well, that's kind of the risk free gold standard. Right? I t ak e more risk in corporate. Corpo ra te investing bonds. That spread, y o u k now, in my lifetime, it was 138 basis points. You know, my trading career in the past, 140 stayed in that ran ge. During this period when rates came so low and the demand for yie ld got so tight, that spread got down to about eight tent hs of a percent or so. Really, really tight. Well, now it 's ba ck to 1.15%, 1.12% , 1 .15% above treasu ries, comparable treasuries. That's not stress. That's absolutely still very, very positive. If I take that same analogy, I look at high yiel d bonds. They're paying me about three and a half percent above trea suries. T hat p articular sector, during the 2008 crisis was paying me 26% above tre asury.
Jason StrzyzewskiIt was l ooking hist or i cal ly. Those spreads were much wider.
Glenn RoyalMuch wider. And so we are seeing effect that the spr eads a re fine. We're loo kin g also, it's something c al l ed t he shape of the yield curve. Which is basica l l y, if I buy a two year treasury, it's goin g to yield me less than a 10 year treasury beca us e of the time v alue. It 's going to b e yielding less than a 30 year, right? So the further out, higher yields are. We l l, som etimes those curv es can do things you don't anticipate. Which one of them is called a flattening of the curve. And it's when t he Fe d is i n th i s ra te hiking cycle and they're pushing up . T hey only control short maturities. Two years and in. They keep pus hin g on that. The longer end maturities kind of st ay where the re a r e, because the y sen se the Feds raising rates to cool things off. That means we might head in a recession. I' m n o t going to sell my duration. So I hang on to my longer bonds. So they're hanging onto th at and we're get ting the flattening of the c urv e. I got to say, the negat iv e a bout a flat...an inverted yield curve...when short rates are higher than long rates, is it's got about a 100% accuracy of calling a recession. It i s very, very accurate. We are watching that. W e've seen these credit, this difference between the yield curve. The slopes spent a bo u t e ight tenths of a point, higher rates familiar. That's co me do w n to jus t over four tenths of a percent. It's collapsin g down. We still have a ways to go. We may not g o there. You know, if I can get the bond market to change and what have you. But that's o ur tell-tale. If I see the yield curve flat. I f I see those spreads...that extra...the risk in the credit, in t he bond market, in the credit market...you'll see us raise c a s h. You'll see us increase our bond e xp osure over on t he fixed income si de. O ne of the things we're looking for is when interest rates are above inflation. That r eal return is positive. It's not there. It's negat iv e about a half percen t. If th at goes positive? You know, backup the pickup truck, we are loadin g up th e bed with bonds. Because it'll b e a g oo d ti me . And t hat de-risks the portfolio. Particularly for, you know, many of our client s a r e in balanced portfolios.
Tie It All Together
Natalie PichaRight. So, I guess that's a great way to kind of tie it all together. Is that what we're doing here. I mean, and the work that you and Jason are doing all the time. It's really looking at the macro. The micro. All of those things. And bringing it in and actually executing it on the portfolios.
Glenn RoyalYeah. So, you know the way Jason are working as a team on this, is I'm handling macro. The big picture. The economy. The focus. The portfolio strategy. Where we're going with that value. The value and the growth. And Jason's coming in from a bottom-up side and helping me with stock security selection for different areas. So it's a pretty good team how we're doing. He's so focused within the sectors and what's going on at that micro level. And I'm looking more at what's happening in Ukraine. What's happening in China. What's happening in Washington, DC. And how we invest in that.
Natalie PichaWell, thank you both for all that you do. I tend to have a lot more of the one-on-one conversations with the clients. So, I get to hear how confident they are in knowing that they've got somebody that's watching it on a day in and day out basis. We want to thank all of our listeners for tuning in to RHP Market Talk. That's a great way to kind of wrap up this conversation with how Jason and Glenn are really putting all that we've talked about, to work in the portfolios for our clients. So, if you have any questions, please contact us through our website at www.royalharborpartners.com. At RHP, we're passionate about planning for your financial future. We're devoted to our relationships with multi-generational families, for the creation of successful legacies through our one-on-one conversations. We can help you navigate your personal wealth management and investment journey. How different will your life look with the right advice?
Disclosure
DisclosureRoyal Harbor Partners is a registered investment advisor and the opinions expressed by Royal Harbor Partners on this show are their own. All statements and opinions expressed are based upon information considered reliable. Although it should not be relied upon as such. Any statements or opinions are subject to change without notice. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investment, or investment strategies. Investments involve risk, and unless otherwise stated are not guaranteed. Information expressed does not take into account your specific situation or objectives and is not intended as recommendations appropriate for any individual. Listeners are encouraged to seek advice from a qualified tax, legal or investment advisor to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.
