Natalie Picha, Glenn Royal and Jason Strzyzewski discuss all time lows in consumer sentiment, record inflation and the Federal Reserve's largest interest rate hike since 1994.
How does this all affect the average investor? Well you wouldn't be human if you didn't fear loss.
The old economy is back!
Get to know us at: www.royalharborpartners.com
Experience the difference of working with a firm that empowers your life—a firm that focuses on what matters most—you.
Whether you are beginning your financial journey now or have already taken steps toward your ultimate life goals, we are here to guide you.
https://podcasts.apple.com/us/podcast/rhp-market-talk/id1538051530
Natalie Picha, Glenn Royal and Jason Strzyzewski discuss all time lows in consumer sentiment, record inflation and the Federal Reserve's largest interest rate hike since 1994.
How does this all affect the average investor? Well you wouldn't be human if you didn't fear loss.
The old economy is back!
Get to know us at: www.royalharborpartners.com
Experience the difference of working with a firm that empowers your life—a firm that focuses on what matters most—you.
Whether you are beginning your financial journey now or have already taken steps toward your ultimate life goals, we are here to guide you.
https://podcasts.apple.com/us/podcast/rhp-market-talk/id1538051530
Welcome to the RHP Market Talk Podcast, Episode 20 brought to you by Royal Harbor Partners Wealth Management, located along the beautiful Gulf Coast of Houston, serving families across the country. I'm Natalie Picha founding partner...
Glenn Royal:...and I'm Glenn Royal founding partner.
Jason Strzyzewski :... and I'm Jason Strzyzewski Investment Analyst for the firm.
Natalie Picha:Well, I'd like to start our conversations out today, by recognizing that our team just celebrated the three year anniversary of the launch of RHP as an independent advisory firm. And I just wanna say, we attribute our ongoing success to the families we serve, and the trust they put in our team. So, to all of you out there listening to today's podcast. Thank you. And congratulations guys, because here we are, after three years and quite a historic three years that it's been.
Glenn Royal:Understatement of the year.
Natalie Picha:It really is. That is an understatement. We were just preparing to do this recording and we were talking about... Well, what are we gonna talk about? And Jason said, there is not a shortage of things to talk about today. Today's recording comes just after a historic federal reserve interest rate hike yesterday of 75 basis points. That is the highest hike we've had since 1994. Glenn, you've seen this before. You've actually been around.
Glenn Royal:I was a young man back then. Yeah. You know and part of what we're seeing with this hike, if we go back to last year, we were expecting only a quarter of point increase in federal funds rate this year. That was what was baked in the cake. Well, we've seen things change. Obviously things have changed a lot. And the increases that the fed has done recently, I think is interesting, because it's they've increased the fed funds rate by a total of one and three quarters points over the last three hikes. That takes us the fed funds level right back to where we were when the pandemic started. So they haven't really started the path of tightening beyond that. We're just starting to get into that this year and what I think the catalyst was, we were looking for a half a point increase. This last go round, but then that Michigan Consumer Index came out. And sentiment came in at like 14 year lows. And then if we look at the actual indicator, it was showing, consumer sentiment. At levels lower than we saw in 2008, the.com and even lower than the late seventies during that inflationary period. So I don't know what the catalyst is for people feeling so poorly? Politics. Coming out of pandemic. You know, you name it. There's a number of reasons, but we're responding so much quicker, so much faster. These market news. In this case, it caused the fed to raise rates a full three quarters rather than that half. What we have on the table going forward, is expectations of either a three, another half a point, most likely three quarter of point increase in September excuse me...July. Then in September, you'll look at a half a point increase. And then subsequent quarter of point increases. So we'll probably finish the year where we started at a quarter of a point on the federal funds rate. We'll finish this year at three and a quarter percent is the estimate that we see right now.
Natalie Picha:Right? And that is just such a fast pace. It's just the pace change that we're seeing in these markets kind of going back to Jason's point...so much to talk about. There is a lot baked into these markets. We'll talk about markets being forward looking, but the sentiment, the market being so far ahead, inflation being so far ahead fed, having to kind of play catch up with that 75 basis point hike the speed. And to your point, the kind of the anxiety in this market is literally off the charts from a historical point of view.
Glenn Royal:There's also some other things going on. Jason, we've talked about The Tick Index. Why don't you tell us what that is and what you're seeing there?
Jason Strzyzewski :Yeah, we're taking a look at The Tick Index and it really shows volumes of inflows and outflows of trading on the day. And just watching it and the drastic moves that it'll make interday. I know I've talked about this before. Seeing sector rotations, but just looking at the inflows and outflows on a daily basis. It almost feels excessive. And that a lot of that can be attributed to algorithmic trading. Which essentially runs the market. You know, it's what 40, 50% roughly trading sometimes. Some given daily basis. And then when we have very important data releases. Fed meeting. Jerome Powell speaking yesterday, I mean on every last word, the market was all over the place trading wise. And it's been very interesting to see the past several fed meetings when Jerome Powell spoke, we've gotten a strong equity lift. Post speak and during speak. And then the day after, kind of gives it all away. Fed giveth. Fed taketh. And what we're kind of concerned about a little bit now, is one of the points that Jerome Powell brought up is he's going to start addressing headline inflation as well. So, that's including more volatile pieces of CPI. So energy, food prices as well. And that's going to take a lot more hikes and a lot more pressure which might put us into...let's just say a scenario we don't want to be in. But they're trying to thread the needle. And I think it's becoming more and more difficult as these figures, and as things develop. So, what we're trying to do, we're really hyper focused on the consumers and what actual consumption levels are. You know, we have sentiment at all time lows. It's kind of shocking to think that we're below 2008...1980. But here we are. So for this next earnings period, we're looking to see if that consumer sentiment corresponds with actual consumer behavior. And we're seeing, you know, bread crumbs in certain pockets of the market. Riskier parts. The tech that we've been talking. This rotation. Tech to value, well, free money period's done. So we're seeing a rotation out of that area. So where's the first place to, you know, take away investment from these large corporations. It's from that free money parts of the market. So, Glenn, what do you think about that?
Glenn Royal:You know, what I'm seeing is... I think up to the last couple of sessions and we're have a pretty hard down day today, it was all about interest rate adjustment. How with those rates move. When the market was pricing that. Now we've shifted towards possibly pricing in a recession. And I think the market's really starting to focus in on that. There's some things that we look at in the earnings estimates. So, you know, when the PE multiple onto that price earnings multiple. Right now, wall street, consensus estimate... all the strategists out there. What's your consensus? Consensus is for us to end this year at$227 on earnings per share in the S&P 500. If I put a 20 multiple on that, which is historical average, that puts the S&P about 4,617 on the end of the year. It's currently 3,652. So that's a thousand points higher. So we are seeing, I think this between the volatility that we're seeing in trading through algorithmic trading... a buyer strike if you will. When you get these kind of markets, people sit on their hands. They don't do bids. So you see that program trading just take off and reset prices. My concern is that if the recession develops, the fed is doing this rate increase. They're data dependent. They're seeing the same things we're seeing, but if I start to see corporate earnings roll over, that's my big concern. Does the fed policy mistake happen when they push too much on fed increases to fight inflation while earnings come down. And we cross that point. If I take S&P earnings down to 200 bucks. Low on the streets...205. Which is interesting on a 19 multiple, which is our historical average fee multiple, right. That takes us to 3,900 on the S&P okay. We're 3,651 So we can still finish the year with some gain from those levels. Not maybe not a calendar year gain. Right. But it's things that we're watching very closely. And we'll talk a little bit about how we've shifted the portfolio and some of the things that we've seen.
Natalie Picha:I also want to touch on something that Jason just mentioned and that's the strength of the consumer. Something that I've been seeing a lot of and kind of kicking around lately is, you know, Economics 101. In some ways, people are trying to connect a lot of different dots in this economy. Right? So, pandemic, we had supply chain instability that supply chain's demand and supply that fed into the it's still feeding into the inflation story. The Fed's action to inflation is let's raise interest rates because we're trying to slow down the consumer. But the health of the consumer and where are we right now? So it's something we've mentioned in some past podcasts, but the consumer drives this economy. And the fed is trying to get them to slow down. And the consumer's also the person that has the job. Or does not have the job. So these are all really simple Economics 101 things. That I think people just need to be reminded of this is all that's going into this. Right.
Glenn Royal:So what kind of brought this in place on was our demand for goods and we all worked from home, right? Yeah. Right. 14% higher than before the pandemic started, got a lot of money thrown your away from the federal government. Interest rates have come down drastically during that period. But now we've shifted away from those goods. You've seen that in Walmart. You've seen it in Target and their recent reported company announcements. It's not that the consumer's not buying. We've just shifted our interest in things we want. So all that inventory they built up the leg in a lot of inventory. All that stuff. Nobody's buying it. So they're over inventory. They're stuffed. And part of that reason too...they are the two biggest retailers in the country. If I'm a supplier, I'm going to make sure Walmart and Target is taken care of. Right? Yeah. So they had inventory. Others did. And, uh, but the shift now is going towards services. And we see that clearly in air travel. So airlines people aren't balking at paying up for the surcharge of higher fuel prices that airlines are having to pay. They're buying the tickets. They're going to the beach, you know? Yeah. They're outta here for the summer. We've been cooped up for two years. So that pendulum of consumer behavior swings from goods to services, and it's, you know, it's like listing from one side of the ship to the other. Fast. And we're still trying to get back to that center ballast in here between these two. But we are...it is whip sawing us surround on economics.
Jason Strzyzewski :I think what we're really seeing is just this giant reset in policy. In the market. In consumer behavior. Just everything. Altogether. And it's incredibly painful in a lot of pockets. In a lot of areas. But it's something that we need to have done to get more normalized rates historically. You want to talk about more historical figures that we're expecting to see due to this. What do you think?
Glenn Royal:You know coming out of 2008, I think this is a big sea change that's going on. That we're all having to deal with. Coming out of the 2008 period. You had a period of low and falling inflation combined with low interest rates. You know, fed was expanding its balance sheets. Things like that. That really fed into the last decade. So the sea change we're seeing...and I call this the revenge of the old economy...is you're starting to see what worked the last decade, no longer working. So, innovative technology companies. The non-earning technology companies. Hard to invest in that kind of business, when you have no earnings because of the cost money going up. Through higher rates. It's made us shift the portfolio over towards value. Companies that pay us dividends and cash flow. As well as keeping with the tech that are established technology companies that do make money. So, we're kind of, barbelling this portfolio. Heavier weight towards the value the dividend players. But we're adding in that portion of the tech. We maintaining it. That makes money. All those companies on com. That new economy. That benefited from this very, very cheap money. The last decade. That's turned against them. You're seeing venture capital firms like Sequoia, one of the largest in the country, that's telling their investment pool to have a year's worth of operating earnings on hand. You know, start cutting back. Layoff workers and all that. And you're seeing those in the numbers. So, we've seen the housing prices come up as a result of the fed increase. A sharp swift move that we talk about. This rate of change. A couple of points in mortgages. And the next step will be unemployment will start to go up.
Natalie Picha:So, let's talk a little bit about that fed hike as a result. I mean, again, they're trying to cool off the economy. And we're seeing all these different things happen all at the same time. The rate of change is just astounding. We've mentioned before. Compressed market cycle. Pre-pandemic. Post pandemic. I mean, we've never been in this world before. And you're seeing all the other financial markets, global bankers, they're also increasing. So that's another piece to this puzzle, you know.
Glenn Royal:It is. Today we saw the Swiss National Bank...
Natalie Picha:...Swiss National Bank...
Glenn Royal:... went positive by half a point. You saw the Bank of England go by half point. So this is not just a U.S. phenomenon. Inflation, it's a global issue. The war in Ukraine. You have issues with climate that's causing destruction of food crops. Or weather related issues. There's all kinds of things a foot. You know, the question is, is how long does this last? How much can the fed actually control by raising rates? How much of this is out of the control? But to Jason's point, if they're focusing on top line on gasoline, how much can the fed, you know? We know that higher prices is the cure for high prices, right? But what that implies is demand destruction.
Natalie Picha:Right?
Glenn Royal:And we saw today, Kroger made announcement, this morning on the earnings call, where they're seeing shoppers with a smaller basket of goods. And they're substituting for brand names. Away from the higher, you know, national brands.
Jason Strzyzewski :Yeah. Swap into those store brand names to...you know, save on the extra little bit. But I think we could do a whole podcast on energy. And we're in a tricky situation with the fed facing this large inflation number. Energy prices that don't have any end in sight with the fundamental supply shortage. Russian invasion. Blocking things. Other pipelines, Gasprom, halting. Flow. There's a number of things you could go on and on talking about. Where the proposed solutions don't exactly align with the solution that would actually help energy.
Glenn Royal:From the timeline, you can't build a gas refinery plant. It takes 30 years. All the plant expansion we've seen is this area, all been for plastics and specialty chemicals. Not for refining gasoline. So one of the things that Jason and I watch is that the 3-2-1 crack spread. If I take three barrels of oil, I refine it in the two barrels of gasoline. Dollar worth of distillate jet fuel or diesel. That spread is now...it was up to about 60 bucks a barrel. It's 58 or so. Look, you look at that over the last 15 years, it used to be like$15,$16. So it's exploded on the margin. The plants, they're running it full capacity. They're 90% capacity. But again, we've switched from goods to services. But some are drivings of services. That summer driving season, you know. All that's lifting that demand for gasoline and it's driving up these costs. For$5, a little over five bucks, national average, my guess is it's six bucks a gallon national average for gasoline. You're gonna start seeing demand destruction.
Natalie Picha:Right. Right. But you're still seeing profitability by refiners.
Glenn Royal:Yeah. And they're not going to stop. That's one of their...you know, we see the whole oil complex is structurally...it just doesn't have the ability to meet our needs. We've under invested in it. ESG. Different reasons. That we've seen. Actually a lot of loss of capital by investors that weren't in the energy patch the last decade. They've lost a ton of money. So you had this structural un-investment, under investment, and you're starting to see that turn a little bit. But it's gonna be...you know, it's a five year life cycle, per you know as Jason said, before they're able to get where they are. You do the little things. You release a little bit on strategic petroleum reserve. That is a drop in the bucket.
Jason Strzyzewski :It's a bandaid on the issue.
Glenn Royal:But what it does do is it creates a bid by the government to replace those lost reserves, at these higher prices of oil down the line. And then I see this of one of the senators that wants to propose a windfall tax on these oil and gas companies. And all that in my mind does is that raises prices. Or it creates under investment. Which raises prices. So they come and meet those caps. So some of the policies we see are still really out of sync with the economic reality of the oil patch.
Natalie Picha:Yeah. Well, so I saw a great article this week from American Funds. And I love this quote."You wouldn't be human if you didn't fear loss." Right.
Glenn Royal:And that the truth.
Natalie Picha:And, we've been kind of saying over the last few months is, you know, on the it is a roller coaster ride. You don't jump off the roller coaster in the middle of the ride, then where do you go? And we've already been making some major changes. Some major shifts. Markets are made by greed and fear. And typically what you see is people jumping ship on the low end and then jumping back in at the high end. And the name of the game is not to buy high and sell low. But to buy low and sell high.
Glenn Royal:Yeah. Right. Right. And really the only way you can do that is just time in the market not timing the market.
Natalie Picha:Exactly. I was going to say, not timing the market, but time in the market. And then. And then knowing, like you said, where energy, I mean, energy's going up right now.
Glenn Royal:Well, you know, we had negative$30 of barrel in the pandemic. We're at one$120 today. Right. That's a big swing.
Natalie Picha:In a very short period of time.
Glenn Royal:Yeah. And you know, part of that, I hear energy related to Ukraine. Putin's tax. Whatever, all that stuff. But energy was hitting 90 bucks a barrel before the Ukraine War. It was because that structural underinvestment in that energy patch. So, you know, I see that...one of the things that, so there's silver linings, you know, you have to be an optimist or this business will put you in your grave. Right. But what we see....and it's something I've harped on, off and on. The normalization of monetary policy. That's, what's happening so fast underneath our feet. Took inflation to do it. But the fed is bringing rates to where...at the beginning of this year, if I a 10 year real yield, what I get the 10 year return that I got over under inflation, was negative 1%. Today, or just a few days ago, it was positive by eight tenths of a percent. So when we saw that real yield where I was getting paid to own a bond over inflation, it caused us to take a look at, you know, three year investment grade debt. And you're getting yields in there of you know, 4.4%, which is a rapid increase in yield. So, the exciting thing is I look at tax free municipals. I look at debt. That is the area that's coming our way for our investors. Where we're going to be able to get a return above inflation. As the fed pulls that down. And keeps pressing on those rates higher, they're going to cross that path. We're gonna take advantage of that slowly. We're very short maturity. So for the most part, we call this shorter term. The term is duration. It seems to be price and where you're seeing things like the 20 year treasury down 25%. You're seeing the AG index down, you know, 14, 15%. You know, we're not in that part of the market. We're in the areas that mature fairly quickly. So they don't deviate much from par. Of these shorter maturities from maturity level. But what we're waiting for patiently now...we've been patient on this...maybe a little too long, but I'm waiting for that point. When those real yields start even going in my life. I've seen 2% above inflation. Maybe it's one, one and a half. We get there. Then you'll start to see us move out. Start buying 10 year governments, corporates, and maybe a little bit longer in treasuries. I have less investment grade risks. If I go treasuries out longer. Would call that extending that duration out the yield curve. And what that's going to do is it's going to allow us in our balanced portfolios, where I can get 5, 6% locked into that portfolio. And I can kind of take a de-risk from the equity side. I don't have to get it. There was no...remember tina? There is no alternative to stocks. That term has now changed to tara. There are reasonable alternatives to stocks. And so that's the exciting thing that I see that wakes me up. I get up every morning, I come here and look at this stuff. And, you know, once I get out from underneath my desk on these days like this. I start to start to see that.
Jason Strzyzewski:An internal pep talk going!
Glenn Royal:Somebody says, hey, you sound muffled. Well, I'm underneath my desk.
Natalie Picha:I think the... finally getting something for the fixed income or the bond side of the portfolio.
Glenn Royal:It's been in a drought,.
Natalie Picha:I think client clients are going to see, wow! I actually get my savings account, actually earn something.
Glenn Royal:Yeah. Your money market. Start paying that end basis point you were getting on your checking account? We were seeing...I was looking at three year CDs the other day at 2.9%, 3%. How long's it been since you've seen that?
Natalie Picha:A long, long time.
Glenn Royal:So that helps. You know, our clients that are, you know, in the retirement life cycle. And then for the young folks though, I do wanna stress that we are...I okay I'm gonna show my old side...and go use... you ever heard of a Foley's Red Apple Sale? I mean, this is like, you know...we are looking at a sale on stocks that comes around every decade. Once a decade. And so if you're young and your investment case is out 20, 30, 40 years. Or if you're investing for your grandchild that has that same stock. You wanna buy stocks. They are on sale today. You know, we're gonna guide you through it and get you through all that. But don't let the fear...which we understand. You remember your loss greater than your gain. It's just the nature of, you know, the human mind. The way it works. But now's a time we talked about fear and greed. How the pendulum swings, you know. You want to be greedy now. Now is the time. And then for those that, like I say, are in the twilight years...like I'm getting to be with the gray beard and all that stuff, you know...I'm seeing finally some opportunity. Like down fixed income. Where I can go to the beach and not have to take the equity risk.
Natalie Picha:Right. Exactly. Well, and I mean, again, I think the compressed cycle. Pandemic. Just whatever that fear is, has really...because you mentioned it...It's our sentiment levels are at historic lows. But we haven't seen a normalized interest rate environment. This is not pandemic conversation. This is 2008 and even further.
Glenn Royal:It's the exiting of zero interest rate...
Natalie Picha:...policy.
Glenn Royal:Yeah. Around the world. Everything's now positive. And with that comes associated volatility. Like a reentry in a space capsule coming back to earth.
Natalie Picha:It's normalization. Not just from the last three years, but like you said, the last decade.
Glenn Royal:So, the thing we look at too, is how much further on rate increases. So, there is the market is starting to try to price in 4% on fed funds, which would let us go up a little bit higher next year. And then it starts to see the potential for this recession, that the fed may cause. And then the Fed's starting to have to lower rates out in'24. So this compressed cycle we've been talking about is likely to fall over in that fixed income space. I'm well aware of that. I don't know how long that window's gonna open. But we want to be nimble. We want to be able to take advantage of it as that opportunity opens up in bonds before it closes on us again. And did that in'18 when the fed was last raising rates in 2018, that real rate got positive by 1% for like a month. And then immediately went collapsed and went down negative 1%. I don't know. I think we'll have a little bit bigger of a window with the fed, you know, raising rates like they are, but, and also don't expect this so-called fed put that's what we're trained. Every new investor and the vast majority of investors are new. They've come in since 2008, they've experienced nothing but easy money coming down. And whenever the market got a little too turbulent... like it is now...The fed would come in and lower rates. Which would kind of protect that down. So call that the fed put. That's over. That's not happening. The fed at this point is more focused on inflation than they are about asset prices. I would...
Jason Strzyzewski:...don't fight the fed.
Natalie Picha:Don't fight the fed!
Glenn Royal:Don't fight the fed. Don't fight him. We said that in a podcast years ago. Don't fight the fed. That was it, you know. Here we are now saying the same thing, but on the other side of that trade. It goes both ways.
Natalie Picha:Right. Okay. Well, before we wrap up, do you have any last thoughts for our listeners? I mean, I feel like with this podcast was a little late in the release. Part of it was all that was going on in the markets. And then knowing that the fed meeting was happening yesterday. We kind of try to time our information around some of that.
Glenn Royal:I do have one little thing to note. And that's the way indexes are comprised. Behind indexes.
Natalie Picha:Something we need to say.
Glenn Royal:So, the S&P 500 is what we call market cap weighted. The largest companies have the biggest percentage point value changes in that index. That happens to be the big technology companies. The so-called FANG, Facebook, Amazon, Apple, Netflix, Google, and all that. There is an index called the FANG plus, includes Alibaba and Badu are the Chinese companies. The big global tech companies. That index is down 35.5% year-to-date. If I look at the S&P as a whole, it's down about 22.91. If I take the equal weight S&P 500. 1, 500 through each representation, you're outperforming the S&P declined by about four percentage points, here to date. So, we're seeing still high valuations, in those big tech companies in like 17, multiple for the rest of the market. So, a lot of the damage has been done. We're probably closer to the capitulation phase. Something like 20% of the stocks on the S&P 500 are treading below 10 times earnings. You're seeing the market breadth is just completely collapsed. So there's a number of things that makes us feel that we're kind of at that phase of capitulation. You're seeing it in these indexes. And just something to understand. So S& P 500 could be more impacted. Vice versa. Yeah. When it's on the upside, like it was the last decade. That was the place to be. I'm not arguing active or passive. That's not the purpose of this. I believe in both. But there are times. Right now. And so we're gonna advocate for stock picking and like, we've done.
Natalie Picha:Well you mentioned it before. Revenge of the old economy.
Glenn Royal:Yeah. Exxon-Mobile is 30 bucks a couple years ago. 120 today, you know? You know, being able to kind of look at those and see those changes of where we're going. The shift in interest rates. The feds movement, what it does to value versus growth. That active managers can move in and take advantage of that. Doesn't mean we're not going to have it down here. We still are kind of in and out with the tide in that regard. But we always talk about the 90, 80, we're looking to, you know. I just want to perform down markets. So we're doing our job to try to do that outperforming in these down markets. So we don't have to work so hard when the market's turned up. We just want to participate.
Natalie Picha:Well, I want to thank all of our listeners for tuning to RHP Market Talk. If you have any questions or you'd like to discuss today's topics, please feel free to contact us through our website www.royalharborpartners.com. At RHP, we are passionate about planning for your financial future. We're devoted to our relationships with multi-generational families for this 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? Thank you Glenn. Thank you Jason.
Glenn Royal:Thanks Natalie.
Jason Strzyzewski:Thank you.
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.