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
Looking For A Silver Lining
Use Left/Right to seek, Home/End to jump to start or end. Hold shift to jump forward or backward.
In Market Talk Episode 23, Natalie Picha, Glenn Royal, and Jason Strzyzewski talk about the impact that this hiking cycle by the Federal Reserve has had on our real wealth.
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
Introduction
Natalie PichaWell, welcome back to the RHP Market Talk Podcast, Episode 23. Brought to you by Royal Harbor Partners Wealth Management, located along the beautiful Gulf Coast, Houston, Texas, serving families across the country. I'm Natalie Picha, Founding Partner...
Glenn RoyalAnd I'm Glenn Royal, Founding Partner...
Jason StrzyzewskiAnd I'm Jason Jason Strzyzewski, Investment Analyst.
Natalie PichaGlad to
"That ain't mud on your boots."
Natalie Pichabe back here guys, again. Once I feel like, every time we're in this room having these conversations, it's, another big story to talk about. I mean, we have no...we're not missing enough information to talk about. That's for sure. There's always a lot going on. We're excited to say that we're going to be putting out a Quarterly Newsletter. Glenn, thank you very much for penning that. I know this one was a big one. And you kicked it right off with "Don't look now pardner. That ain't mud on your boots." So, why don't you tell us a little bit about what you mean by that?
Glenn RoyalYou should be able to pick that up on your own, Natalie. Our readers should. That was a research report I saw in the eighties from a short seller that I just absolutely loved the title of it. And I've always wanted to find a reason to use it. Unfortunately, I think I found one.
Natalie PichaWell, I have to ask, what are you referring to?
Glenn RoyalWell, what we're talking about is the impact the Federal Reserve has had on our wealth. Whether it be homes, stocks, bonds, crypto. Our personal wealth has taken a hit because of the Federal Reserve's hiking cycle. That's the mud on your boots.
Natalie PichaGot it. Got it. Okay. I know that they are really focused in. And very data dependent right now. And it's all about inflation. It's the inflation story. And we're looking at another 75 basis point hike coming up. Feels a little bit like...I think you just mentioned damn the torpedoes. Right? It's no matter, what we're hiking when there's a lot of other things going on out there.
Glenn RoyalI call it more navel gazing. When you're so fixated on one thing, you can't see the forest for the trees. So, that's kind of in my mind what the Feds more or less doing is they're so hyper-vigilant and focused on inflation. That we're getting to a point in the Fed hiking cycle, that you could see a policy mistake occur. You start to see unintended consequences as a result.
Jason StrzyzewskiSure. I mean, we saw a delay in these rate hikes. We...the economy was able to have this cycle started a lot earlier. And now as a consequence, the Fed, like you said, is so ultra-focused on squashing inflation that they potentially will go too far, too quickly.
Natalie PichaYeah. Let's talk a little bit about like, the velocity of the rate of change. I mean, you noted in your paper, that's going to be coming out this week , it's an 1126% increase in yield for the two-year note just in this year. That's crazy.
Glenn RoyalIt is. And that's a big determinant of the risk-off we're seeing in the markets. Is when you get that swift of a move off of basically zero interest rates, like 5,000 year lows in history of markets. It's a measure called convexity. And that's what I'm most concerned about the Fed. One of the reasons I've probably taken a liken of the mud on your boots is that rate of change off of zero interest rates, 75 bits a clip, is so swift that it's, causing unintended consequences. We saw it last week...week before last actually...out of the UK. This is your first sign that things are happening. Here in the US, by our central banks that have a contagion effect around the world. What was that...the UK incident?
The UK Incident
Jason StrzyzewskiYeah. I mean that's a whole mess, if we wanted to get into it. But really, you saw the current parliament have to pivot a little bit on their tax plan. Where they were loosening up policy a little bit and they had to go in and purchase their 30 year gilts. And to essentially save their pension funds from seizing up. And that's opposite policy of what they're trying to do. What anyone's trying to do, to attack inflation. So, it doesn't make sense. But it's in conflict...it's a result of...
Glenn RoyalIt's a result of politicians getting involved in economics.
Jason StrzyzewskiExactly. Yeah. So, that's a whole another story. But here, you know, we're still seeing liquidity. We're definitely seeing things tighten up. And conditions getting a lot tighter. Which is positive. And we're seeing, you know, areas where these hikes are working. 30-year average fixed mortgages above 7.2%. But in other areas, the core headline inflation, all these other metrics, it hasn't quite happened yet. So, that's why it leads us to believe there could be an issue on the back-end of that convexity with these hikes.
Glenn RoyalYeah, Right. I...and you know, politically, I'm going to take a little spin on that. Part of what the UK was doing was supply side tax cuts. They came in to cut taxes. There were increased fiscal spending, little supply side as well. At a time when you're looking at 40-year highs i n inflation and the Bank of England is raising interest rates to fight inflation. You c ome i n with that kind of r ight growth metrics, which there are times, but this wasn't it in the economic cycle. As a result, you saw the pressure on gilts. The pension funds that a re heavy investors i n 30-year gilts o n with leverage in the UK i s how they meet their pensioners' needs. They basically got crushed on that. T he bond m arket sold off, i t crushed a nd the Bank of England had to come in with a back stop and start buying gilts. That's the unintended consequences that can come. It happened over in the UK, but it had the potential having liquidity effects i n global sovereign debt. Well, things we have to be careful about.
Jason StrzyzewskiAnd that's just another portion of this volatility that we've been seeing lately. I mean, you have the Russia-Ukraine story. That's been going on for quite a bit. More impacts with energy and OPEC on that side of things. But the tax reversals in the UK, we're seeing money flows across global markets as well. And then our inflation print. Last Thursday, October 13th, we saw the core rate increase, larger than expected to 6.5%. Headline was decreasing. But, we really saw a huge, what they called bear hug rally intra-day. Crazy , buying activity where the S&P reached a 50% retracement level from the highs. 3,505 on price. And that just triggered huge algorithmic buying and quantitative programs that we're seeing more and more on the market on these data points and these other metrics.
Glenn RoyalAnd I...you
Algorithmic Buying & Volatility
Glenn Royalknow...I get to use these podcasts for my pet peeves. And one of those is the removal of the uptick rule. The plus tick rule that happened in 2007. So, what that means is if I wanted to sell short a stock. A stock I did not own. I wanted to sell it to try to profit on it going down. Is I needed the prior sell to be higher. A plastic tick than the self-preceding that. That was removed by the SEC big lobby. And it happened in 2007 to occur. Since then, we've had well over 20 documented incidents of an up 1% day, followed by a down 1% day. Or vice versa. Extreme volatility. You're hearing other portfolio managers talking the marketplace about it, but it's the volatility that's coming from algorithmic trading. Program trading. So, we're in a market where investors are basically sitting on the sidelines. There's confusion. A lot of what we saw in the UK, what Jason has been talking about. When I'm confused...I sit on my hands.
Natalie PichaRight. So don't do anything. But the computer trading doesn't matter.
Glenn RoyalBingo!
Natalie PichaComputers are trading it anyway,
Glenn RoyalWhether the market is liquid or not. And so you tend to get increased volatility. The result of automatic trading. We're well aware of that. We can see when it's going on. We as...when we're investing in our portfolios, Jason's really good about knowing when to step back. Or when to take advantage of that. So, we do use that. But be aware of a lot of what you're seeing... with this enhanced volatility...is from algorithmic trading. Yeah.
Jason StrzyzewskiAnd with volatility, comes opportunity and we're starting to see that in the market. Especially ahead of this earnings season. Plenty of pockets of value within large indices . But looking at S&P in general, still pretty rich in areas of it. So, we're looking within certain sectors of the market. But another thing to point out is, back in June, analyst expectations for earnings per share year-over-year growth was 10%. And now that's all the way down to 2% year-to-year. Growth.
Glenn RoyalSo
Lowered Earnings Expectations
Glenn Royalthe analyst are really taking a hard pull and driving down earnings expectations. They hadn't been. But they caught up and is what you're seeing.
Jason StrzyzewskiExactly. So, hopefully, you know, this is a lower bar to meet. And this earnings period should be a little bit better than anticipated.
Natalie PichaSo, that's a great point. Why don't you talk a little bit about, that for our listeners. About what it means to the markets to what you're seeing. When you get someone that beats the earnings estimates. So, if you bring that estimate down now, right? It's a whole lot easier to beat. What does that do?
Glenn RoyalThe market is savvy enough to kind of pick up on a little bit of manufactured beats. We understand that. But the other side of that is you can use a quarter like we're in...which is really , expectations for a negative quarter. I call that the kitchen sink quarter. So, there are companies that you can clean out finances. Bad paper. Over things. This is the time to do it. You don't want to do it when everybody else is doing great. You know. So this, you could start to see little things like that. Reorgs in businesses. Different things that go on in this timeframe and taking some earnings hit under the guise of a bad economy. But one of the things that's happened because of the Feds strong h and at raising rates, is it has strengthened the dollar. The U S Dollar goes hand i n h and with interest rates. So across the board, globally, a strong dollar is causing problems. We're seeing it in commodities. Different prices that are purchased only in US dollars. The area that we're looking at...and this has happened before...is when you have such a strong dollar, the companies that have a large multinational business. Which tend to be large technology companies in the US. They get impacted on that currency conversion back to dollars. Because they're sold in which go down in value. That's an issue that we're really, really keeping an eye on. It's probably our...my biggest risk. As I'm looking at is the strong dollar with the international currency conversion for these big, big cap tech stocks. Which is your S&P 500. It has me as a PM starting to focus more on stocks because evaluations that are attractive after this bear market is small and medium-sized businesses here in the US. We're seeing a lot of attractive valuation in small caps. They've just gotten their teeth kicked in. To levels where as a value person you're starting to say, hey, there's an interesting opportunity. And we're starting also to move that into the mid-cap space. We're...and that's something we wrote in this newsletter, to caution what may have worked well for the last decade, in an era of very cheap low interest rates and being the Fed, having your back. Won't work in the future. And so we are looking more towards domestic oriented companies that I just mentioned. And also companies that pay us large dividends and interest payout. I want what we call carry. I want that income to carry me through this market. That's been a big focus of ours and how we're structuring right now. Not so much S&P 500. Which is almost blasphemous if you've been in the market the last decade. Because that's where it's all been at. Right. I'm here to tell you...that playbook is changing because of higher interest rates by the Fed.
Natalie PichaRight.
Changing Leadership in the S&P
Natalie PichaWell, we can even talk about, I think we touched on this last week about the composition of the S&P 500 and who the leaders are. The leaders being...that leadership has changed a little bit just in the last couple of years. Can you guys touch on that a little bit?
Glenn RoyalYeah. More defensive sectors for one, everybody goes to Staples, utilities, healthcare , what else? You else do you see Jason?
Jason StrzyzewskiExactly the , the staple names like you're saying. Then obviously the big push for energy, the only gainer on the year. So, there's plenty of potential for shake up in, you know, the FANG stocks, the top names in the S&P composition. Again, to that strong dollar, if they have brought down that exposure as multinationals. But still it's a large portion of their bottom line.
Glenn RoyalDifficult to hedge out that risk.
Jason StrzyzewskiSo, if that plays out to be a larger risk. And that materializes. Then, you know , you could see more of a shake up in the composition.
Glenn RoyalWhich would affect your S&P 500 headline numbers. Because that's market cap weighted towards its biggest tech companies. But other indexes, Russell 2000, you know, more equal weight S&P 500. Those indexes ought to start performing on a relative better basis. If I look at the valuation of the market and I take away those tech guys, those big five, the rest of the market's trading below a historical multiple of 15 times. We're pretty cheap.
More on Inflation
Natalie PichaRight. Right. Well, let's talk a little...I want to go back a little bit to inflation because I know we've said this in past podcasts about this is the inflation...the inflationary pressures, really had a lot to do with covid and supply chain and things that we had never experienced before. And we're fighting, we're still fighting inflation the old-fashioned way. It's a little bit different, but the inflation continues to remain very elevated. But you continue to see a lot of consumer pent up demand. You're still seeing a lot of spending. I was just listening to an analyst this morning, talk about people are still booking trips and doing, I mean...it's crazy. Restaurants are full of people. It's still...the spending is still happening and not sure consumers are still strong. When that inflationary piece starts to really roll over.
Glenn RoyalIt's a very good point. And underneath this inflation story that you, you know, in the press headlines is your point, a very strong economy. A strong consumer. The balance sheet of the consumer, governments , a nd i n c orporations, a re really, really good shape right now. So, debt is not an issue at the moment. It can be. Particularly with higher c osts o f capital, but not right now. Because we a re coming off, a decade of very low interest rates and everyone's had a chance to refinance their balance sheets. Be it individuals or corporations. Including the governments. So we're good shape. I'm not worried about financial stability in that regard of debt. M ore so than policy mistakes b y t he Fed.
Natalie PichaSo we've been, you know, we're really in a cyclical bear market. It's a bear market that's being paused because of the Fed's rate hiking cycle. And I, again, I keep referencing our past podcast. But I know the question that I get all the time is, are we there yet? When is it done? Where is the bottom? What's the, you know, what are the signs for the change? When are we going to be out of this? Are we headed for recession? Not a recession? You know, everybody would love for us to have a crystal ball. Right? And we just don't.
Glenn RoyalI wish I had that. I wish I had it everyday. So you have to basically then go back to your o ld p laybook. Right. It's basic blocking and tackling. Which is valuations. And that's where we are. Valuations have come down t o much, much more reasonable l evels. S o, I think in this piece the S&P as a whole i s a t 18 times earnings. We were 31, you k now, a year ago. So, the valuation is a big story that we have to correct. But I think to give an answer, we do try to take a stab at that. Are we there yet i n this piece? And it's a basically looking at if I take earnings to flat. I don't, we don't grow S&P earnings next year, flat year-over-year. And I use that figure 208 b ucks. I 'm like that. And then I tie a historical low multiple o f 14 times. That gives me that 3,100 level S&P. But I w ant t o point out, I think this is really key is markets a re discount the future. We're always six months ahead of ourselves. So, even though the Fed may still be in the last few phases of hikes, meetings of hikes, doesn't mean the market won't rally before that. In all likelihood will. Once it sees that end g ame.
Jason StrzyzewskiThat's what we were seeing a couple months ago. Where the market was trying to price in pivots. And it just wasn't there. And then that's where we had those bear market rallies.
Glenn RoyalYes. That's every one of those bear market rallies is on the belief that we're near that pivot. And away we go. We know the Fed's not going to pivot to bale us out. They're more focused on inflation. If they do pivot to bale us out, it means there's some considerable issues.
Natalie PichaSomething else. There's some more pain somewhere,
Jason StrzyzewskiThere's something else that we don't know.
Glenn RoyalThere's an unintended consequence that's manifested itself.
Natalie PichaRight. Right.
Q3 Earnings Update
Natalie PichaWell, I mean...like I said, so much to digest. So much going on. Where are we, by the way , in earnings periods, Jason? Can you kind of give us an update, timing wise ? What going on in the markets?
Jason StrzyzewskiI mean , JP Morgan kicked things off officially last Friday. So really this week. Next week. When things really start going for Q3. And like we were talking about before, expectations were brought down a little bit. Well...more than a little bit. But , we'll see how it shakes out so far so good.
Glenn RoyalBank of America released this morning, and one of the things that was great is they are really a snapshot of the US consumer. And corporate as well. They're the banker of the United States. They're not seeing any problems with consumers. So they feel pretty good. And so that's a message that I think i s being well received in the market today. What I want t o hear next? What does Microsoft have to say? What does Apple have to say? What's the health of the consumer that we hear from these, some
Jason StrzyzewskiSome of those other discretionary names as well to see...
Glenn Royal...Amazon.
Jason StrzyzewskiYeah. How they are hit with consumer demand or not hit.
Glenn RoyalRight. So we're data dependency is probably the word du jour, this year. And it's true. We're all watching the same data points. The Fed is watching for some clues that the other thing is when will you know that , when's it over? Are we there yet? Is when we start seeing signs that the Fed is calming down on the rate of Fed fund increases. Instead of 75...they start going to 50. They start going 20. They're starting to see that exit ramp.
Natalie PichaRight.
Glenn RoyalBam. Market
A Silver Lining to this Horrible Year
Glenn Royalgoes.
Natalie PichaRight. Well , before we close this one out. Do you guys have anything else you want to touch on?
Glenn RoyalYeah , I think that the main thing that I see...and I've been harping on this thread for a while now...about the Fed being too supportive of the economy. In essence, we've had the Fed as the 800 pound gorilla, since 2008. Great financial crisis. We needed a catalyst for the Fed to be able to get away from supporting the market and let the markets function on their own. I didn't know it was going to be inflation. We hadn't seen it in 40 years. But inflation has caused the Fed to go through this aggressive rate hike. And what that's done, is that's made bonds attractive. That's the main message I'd like to leave in this podcast. Is we are taking advantage of fixed income at rates that we've not seen in 12 years or longer. And we're getting in something called the real rate. Which is our earnings after inflation. What do we really earn in our pocket? How we grow our wealth is that real yield. We're picking up real yield at 1.6 on the 10-year. I just haven't seen that in a dozen years. And I'm really, really excited. So, our opportunity that's come out of this, is we've overweighted fixed income by 5%. And now that I can get four and a half...five...6% out of the bond market, I can de-risk in essence. The equity side. The more volatility, particularly for our clients that are looking more towards retirement. And they want a little bit smoother ride. That's the end result of this whole horrible year. Is that I've got a bond market that's normalized. And as an investor I can de-risk my portfolios with fixed income.
Natalie PichaThat's an awesome way to close this out. I mean that's the...that is the silver lining in all of this. You know, and I think going forward it's going to be, it's a great outlook for the future. Well, we want to thank our followers for listening to RHP Market Talk. If you have questions or would like to discuss today's topics, please feel free to 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 our 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 adviser and the opinions expressed by Royal Harbor Partners on this show are their own. Registration of an investment advisor does not imply a certain level of skill or training. 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, investments, 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 adviser to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.
