RHP Market Talk

Staying The Course.

March 30, 2022 Royal Harbor Partners Wealth Management Episode 18
RHP Market Talk
Staying The Course.
Show Notes Transcript Chapter Markers

Yes. We are still on an economic rollercoaster.

Are we headed for dual supply chains and de-dollarization?

Glenn Royal, Natalie Picha and Jason Strzyzewski with Royal Harbor Partners Wealth Management Jason discuss the current federal rate hike cycle, recessions, supply chains and why we should all stay the course.

Get to know us at: www.royalharborpartners.com

Introduction:

You are 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 Picha:

Welcome to the RHP market talk podcast, episode number 18. 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. We're also joined today by our RHP Investment Analyst, Jason Strzyzewski. Hey Jason!

Jason Strzyzewski:

Thanks Natalie. Thanks for having me as always.

Natalie Picha:

I'd like to start by reminding our listeners that RHP strives to keep you informed about current markets in multiple ways. And we hope that you received our most recent Market Update sent out on March 10th, 2022. If you did not, please contact our office to update your email preferences. Okay. So, I always kind of start out by saying that we have so much to talk about. But I feel like I that's a broken record, because there's always a lot to talk about. Top of mind right now, of course, is the Ukraine crisis. The last two podcasts that we've done, we've spoke about the roller coaster ride and volatility and all those things. And here we are, right? We are definitely on a roller coaster. And I think it's probably gonna be that way the rest of the year. Glenn, I'd love to hear what you guys are thinking and what you're doing as far as shifting to being more defensive in the portfolios. And you know, where are we gonna go from here? What are your thoughts?

Glenn Royal:

Natalie...we have a very interesting setup in the market today. And it is growth, that we're seeing in terms of earnings growth. Analyst expectations that are driving the underlying market higher. That's cutting into a fed that's in a hiking cycle. What I think that is different about this hiking cycle is, that we're so used to the fed hiking into a deflationary environment, right ? We had that so-called fed put. Where wealth-effect started getting impacted. You see the fed come in and reverse course and lower rates. This time we're dealing with something for the first time in really about 40 years. And that's the fed that is fighting inflation. So, I think this time, the old saying was damned the torpedoes, right? I think that's the Fed's mantra on this. They're going to go through with their hiking cycle. Irrespective of what may be happening to equity valuations . They're more focused on getting inflation under control.

Natalie Picha:

Right. So. I actually heard an economists say recently that, they sort of missed the boat, right? They could have hiked last year. And kind of ahead of all of this, that there was no way to have a crystal ball. That the Ukraine Crisis was on the horizon.

Glenn Royal:

Well. You had Delta and you had Omicron in there as well .

Natalie Picha:

Exactly. Right. So they kind of missed the boat. They didn't, they didn't actually hike last year. Now we're kind of behind and we have to hike. This is the next big thing. And I think you've mentioned a couple of times is... in a typically in a hiking cycle, you're slowing the economy down. Are you moving into a recession? Is that what that hike cycle leads to?

Glenn Royal:

Yeah , so we kind of have to look at the track record of the fed in terms of avoiding recessions when they try to. Whenever in hiking cycles is so-called soft landing. Let's cool things down just enough to kind of touch and go. And take off again. Unfortunately, I've never seen them pull that off. Typically it ends in recession. Because you're braking the economy through monetary policy that has a lag effect. So, here we were a year ago and the fed was... Now we're saying you were behind the curve . Well , at that time, the fed was dealing with realities of the moment, that kept them to stay with cheap money. The Omicron came along. And that just... A lot of what the fed had been focusing on was what they call that transitory. That temporary inflation logistics. It was a cause of it. The Delta came along. That wasn't expected. That shut down regions of this country. Hard shut down again. And then you followed by, well today we have China, that's now shutting down their economy pretty hard. You're seeing it a little bit in energy price since today. But the fed , you know, their actions do take time to work through the economy. So, they are now agreeing that inflation has gotten ahead of their comfort level. Which is that average inflation target of 2%. It's now tracking 8%, 7.9, that is some pretty big inflation numbers coming out later this week. That'll tell us a little bit more about it. But that is what they're trying to get ahold of. And one of the ways they do it, is by raising rates. So, we've seen this already in the mortgage market. You've seen the 10-year treasury, which is the reference rate. The key rate , the most assets are priced off of. The 10-year... when Ukraine's war broke. There's the flight to safety trade, right? It's almost a Pavlovian response. But markets go by treasuries and when there's an event risk. But we took the yield down to 1.73 on the 10-year treasury from close to 2. We were already pricing in that higher rate cycle. Now today, post the Ukraine story and issues that we're seeing there with commodity pressures and precious minerals and gases and things like that. You've seen the treasury yield back up to 2.46%, that's a 42% increase in the yield of the 10-year treasury. But a matter of about three weeks time. For me , I would much rather have that rate change in a slower slope. That we can kind of bake into the cake. When it comes on so rapidly. I think there's consequences behind that. They are unknown. But typically it is values and equity markets. So, we are positioning the portfolio and trying to take these all into account. One of the ways we're positioning the portfolio is we are looking more at the fixed income. We had already ran this direction. We are, you know , active managers. We try to get ahead of the curve .

Natalie Picha:

We are forward looking.

Glenn Royal:

And so we, in our bond portfolios, we shorten all our maturities up. And by that, we just have less volatility in the portfolio because they're going to mature so quick. They don't deviate from par very much. Now, that we're getting in this setup, and I still see the fed with it'll be seven hikes this year. They've already hiked once a quarter of a point. Expectations on the street. I know Goldman is look for a half a point increase at the May meeting. Another half a point increase in June. In order to front-load this. And I do want to remind people, that when we went into this COVID , when the pandemic was first being discussed. On a Friday, Fed Chairman Powell was acknowledging the risk that we were dealing with. The WHO developed the pandemic, over the weekend. On Monday, the fed did a inter-meeting surprise 50 basis , half a percent cut to the federal funds rate. A week later, they cut a full one percentage point. So, to think that they're going to just come out this at a quarter of a pop , every meeting, I think is probably misguided. I look for them to take a lot of that up front and then slow down. If we get seven more hikes this year, the Fed's gonna push policy through what we call the neutral rate. That's the level equilibrium. Not too hot, not too cold. It's about call it two and a quarter two and a half percent on fed funds. It's their description of the neutral level. So, they're gonna take rates to restrictive territory. Maybe as high as 3% on the S& P funds rate. And they're going to keep it there a matter of time until they start to see that second order effect...that they're having some progress in buying inflation. And then they're going to try to lower rates back down again, for that touch and go. That soft landing. And in a way, we can know. The interesting thing about it this year, is my greatest risk is in the bond market, for the reasons we're discussing. Why we've shortened up our maturities and changes we're getting ready to do. But I have this equity market that's looking at earnings growth. It's looking at a very strong economy. And what you often get it in these kind of years, is kind of a roller coaster ride, a lot of volatility. With the flat return? My reference year. Kind of in my mind is the 1993 and 1994 market. S&P was up 1%, you know. 30 year treasuries were down...you know, 8% that year. The bond market got crushed that year. But what it did, is once we got through this, it set us up for extraordinary economy and a good support to have a really good years . We 1994 , 1995 , 1996 on up through 1999. The dot.com bubble...the market did really well. So, I'm optimistic with the underlying setup . I think this is the transition year for the fed to normalize rates, market kind of calms down and adjusts to that normalization. And then we set ourselves back up again to re-engage the bull market.

Natalie Picha:

Right. So, we talk about recessions and you've mentioned, around here that, you know, when the fed hikes, it's kind of like Chinese water torture. It's a constant...

Glenn Royal:

...that was Greenspan.

Natalie Picha:

...it's every, you know, it's a constant drip. And a recession is defined as two consecutive quarters of negative GDP growth. But we have a lot of consumer spending. We still have a lot of money in the system. People are still buying. We still have demand that's super high. But we've got a supply chain that we thought was going to get kind of ironed out. And then we have now the Russian Ukraine crisis. What do you see there?

Glenn Royal:

Jason and I...at the margin, we're starting to see improvement in shipping rates. They're coming down. Anything that was a good, a hard, durable good, people are now balking at paying those higher prices. At lumber. People are putting off projects. Delayed . That's what people do when rate prices get too high. They just start delaying their decisions. So, we're seeing that anecdotally at the margin. It's not enough to have a bottomline impact today. But it's encouraging, that some of those inflationary impacts are truly transitory. I know we don't use that word. It's a bad word right now, but , in terms of this eventually dissipating out of the system. Now, that being said, you know, my theory is that we're going into Cold War 2 .0 . And as a result, I see us with dual supply chain systems. You know, the east and the west type sort of situation. So, it has me looking at how do we invest to take advantage of that build out .

Jason Strzyzewski:

Sure. Sure. And that's a great point, Glenn. I'm starting to see more figures myself, of more re shoring of these supply chains. And even further diversifications within corporations themselves. To try and navigate through this mess. That's just been exacerbated by the Russia Ukraine conflict. And some , an additional cycle that's been also brought to the level of scope, is we have the commodity cycle that's already been ripping...red hot. And we have wheat,Russia Ukraine are the bread basket of Europe right now. So, you have Ag producers and all these commodities that are just getting hit with these higher unexpected pressures. What we're looking at? We're looking more internally. We're looking for companies that are going back to the U.S. Companies that are our manufacturing, heavy infrastructure, heavy...just looking to be a little bit more defensive going into this year to Glenn's point.

Glenn Royal:

Yeah . The agricultural cycle looks pretty good. We picked up some American machinery equipment. Ag mainly because of technology, you know , as cool as Tesla is well, that stuff's also getting out in industrial America. So precision Ag is something that we're pretty interested in. How to increase the...you know , the food basket and reduce costs . So, one of the things that was cool about this precision Ag is that a company that we own in the portfolio. They can tell their farmers where the weeds actually are. So, you just spray weed killer on that one spot, rather than having to spray your whole fields. Saving costs. Fertilizers. Things like that, which we know are rising.

Natalie Picha:

Both of you guys make a great point. And something I want to point out to our listeners is that when we talk about, I keep referencing the volatility and the rollercoaster and not getting off the rollercoaster in the middle of the ride. One of the things that makes RHP pretty unique in our active managed portfolio, is that we pivot. There's always going to be market events. They just are. You look back over history and sometimes history rhymes. Sadly. But there's always going to be some market event. In those market events, the difference between just getting off the rollercoaster and staying on the rollercoaster, can just mean a shift.

Glenn Royal:

Yeah.

Natalie Picha:

And that's what we're doing right now.

Glenn Royal:

Exactly . We're not abandoning stocks right now.

Natalie Picha:

It's just a shift. Because in every market event, opportunities are presented.

Glenn Royal:

...they are.

Natalie Picha:

...and you figure out where those opportunities go.

Glenn Royal:

So, we picked up energy and commodities in the fourth quarter. Because we saw opportunities there . Now, we didn't know Ukraine was going to happen, but that's been to our benefit with some of these stocks.

Natalie Picha:

Absolutely. So, let's talk about something else that's been out in the news recently. De-dollarization.

Glenn Royal:

Yeah.

Natalie Picha:

And what does that look like? I know that's probably a little bit of a longer term risk for the markets, but I think it's something we should address. Because, I know we've had some clients that have brought it up and it's in the news. So what are your thoughts?

Glenn Royal:

So, a couple weeks ago in the Wall Street Journal , there was an article that broke, that China wanted to pay Saudi Arabia and Chinese yuan rather, than U.S. dollars. So, we go back 50 years ago, post World War II order, the United States was able to put the dollar in as the petro dollar. So, everything in petro needed to be paid with U.S. dollars. Well , you can see that was problematic if you were emerging economy. With high inflation. Volatile currencies. You had to convert that to dollars and it was either good or bad, right ? Depending on what it is. Companies...countries like Saudi Arabia , the producer countries, what they would do, is they would buy enough dollars to offset the amount of their own local currency, the riyal, so they basically had a dollar backed currency. And they could trade the riyal just as though it was the dollar. Now what you're seeing is with this move know Russia, the other day said they wanted their contracts paid in rubles. Because of all the sanctions that were going on. Problematic to get that done. But, what you could see this start to see that shift in that movement towards the de-dollarization of the petro dollar. And we start to get a basket. I don't believe for one moment that it means the U.S. is going to be replaced. I think what you see is movement towards a currency. A basket of currencies. Could be the yuan, which is, you know, the Chinese currency. You see the yen. You see the Euro. And the dollar is something that is coming in. But we had to watch is, what are these countries like Saudi Arabia, these member, producer nations, what do they do with their reserves? Do they start pairing down and start bringing up yuan? Little things like that. This is a long trade. And what the implications are, is we've been in...a very, very good privileged , for the last 50 years United States, having that strong reserve dollar. Is we consume more than we produce in this country. And imports are greater than exports. The dollar would weaken as a result of us not being the reserve currency and would make our cost of goods go higher. Or imports go higher. So, our standard of living could adjust downward as a result of it. We've enjoyed a very strong one the last 50 years because of it. I don't see it happening anytime soon. But it causes us to look. And be aware of these things. And that's what Jason and I do. We're trying to look, you know, as much as we're trying to perform for you today, we're also looking around the corner to see what the potential is for, you know , next month. The next year.

Natalie Picha:

Absolutely. I always tell people, that our portfolios are really designed for 12, 24, 36 and 10 years. I mean we're looking at everything. All of it has to come under consideration. I like what you mentioned, actually, to someone this morning in a conversation, we're managing people's whole life savings here. So, when we look at the markets as a whole, and we're thinking about risk, what we're really looking at is how do we manage the risk in the portfolio?

Glenn Royal:

Yeah. That's still, you know, at the broadest sense, it's going to be your stock-spun cash allocation, which they work so well with you and Michele on the planning side of that, to determine what that is. And then we take it...the margin..we'll underweight, overweight. We're a little heavier cash now , going into this year. So, we'd have a little bit of opportunity cash. But you know , we were going a little bit earlier about how are we adjusting the portfolio in this environment? One of the things we're...I'm willing to step back in this type of market set up and not chase S&P performance. There's a time to do it and there's a time not. And right now we don't. I don't think it's the time to chase performance. We want to a give you a positive, real return. And we , think we can for the year. We are only down a couple percent. You know? Year to date. Feels a lot worse, but really the numbers aren't that bad year to date. So, we have the potential to get a return. A positive return by the end of the year. But what we're looking at doing, particularly in our bond side, that's my biggest concern. More than stocks. The bond side, we're looking at bringing in things like converts. Fixed incomes that be converted into equity for the kicker. We have floating rate instruments in there now. We're looking at bringing in the potential to do a little bit of alternative investment, if you will. The ability to shorts, fixed income securities things, like that. That take advantage of this market. A little more sophisticated trading and fixed income than we would normally do. On the equity side. I still go back to this strong underlying economy. You have this growth, that's there and I don't necessarily see that blowing up. So, it makes me want stay in stocks. But I want to pick the right one.

Natalie Picha:

Right. Well, I'm going to kind of go back to the comments that I've made. Like I said, I feel a little bit like a broken record. But comments that I've made in the last two podcasts about, staying the course for clients. Not jumping off the rollercoaster in the middle of the ride. It's going to be volatile. It was going to be volatile even prior to the Russia Ukraine conflict.

Glenn Royal:

Just the part of exiting the extraordinary monetary policy that was affected because of COVID. You have to expect that. It was rocky going in. It's really rocky going out.

Natalie Picha:

Right. But all in all, we want our listeners to know that we are here and we want you to give us a call. We want to thank you for tuning in to RHP Market Talk. And if you have questions or you just want to discuss today's topics, please contact us through our website at www.@royalharborpartners.com. And I want to make a little announcement. If you happen to live in the Houston area, we invite you to come out to the Sanctuary Foster Care Services 5k where RHP will be supporting the great work that Sanctuary does in our community. We have some clients that are going to be participating in this great event and we'd love to see you there also. At RHP, we are 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 work with the right advice?

Disclosure:

Royal 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.

Introduction
This May Sound Like A Broken Record
The Fed Hiking Cycle
Recessions and Water Torture
Dual Supply Chains
De-Dollarization
Managing Risk
Staying The Course...Again
Disclosure