With unprecedented rate hikes and inflation this year, was 2022 all that bad?
Natalie Picha, Glenn Royal, CFP®, and Jason Strzyzewski look back at 2022 and what economic conditions are waiting for us in 2023.
And how about a year-end Santa Claus Rally?
www.royalharborpartners.com
Experience the difference of working with a firm that empowers your life—a firm that focuses on what matters most—you.
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https://podcasts.apple.com/us/podcast/rhp-market-talk/id1538051530
With unprecedented rate hikes and inflation this year, was 2022 all that bad?
Natalie Picha, Glenn Royal, CFP®, and Jason Strzyzewski look back at 2022 and what economic conditions are waiting for us in 2023.
And how about a year-end Santa Claus Rally?
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 number 25, brought to you by Royal Harbor Partners Wealth Management, located along the beautiful Gulf Coast of Houston, Texas. Serving families across the country. I'm Natalie Picha, a founding partner...
Glenn Royal:And I'm Glenn Royal, a founding partner...
Jason Strzyzewski:And I'm Jason Strzyzewski, an investment analyst.
Natalie Picha:And here we are, the last podcast of the year. Guys, I like to start out I should say...Hey, well, what do you think? Where are we going from here? But that might be getting a little bit old. So, we're going to start by doing a quick review of 2022 and then go ahead and start talking about, I mean, January, right? The big news this year, 2022. It's all about the fed rate hike. Six times from March to November, taking us from a fed rate of 0.25 to 4%. Unprecedented.
Glenn Royal:Pretty steep isn't it.
Natalie Picha:Yeah. Yep. They're calling it the hockey stick. If you look at the graph,
Glenn Royal:I'd call it something else. It's not PG rated.
Jason Strzyzewski:Yeah. I'd call it a lot of things at this point.
Natalie Picha:I feel like, you know, I hate to keep repeating. But that rate of climb has changed the market significantly in a very short period of time.
Glenn Royal:Yeah. Coming from zero, 5,000-year historical lows and interest rates to four in such a short, high-velocity period of time is largely what we see as the damage in the markets. Had we gone from three to seven, you'd had that cushion effect, right? It wouldn't have been as steep. Oh, lots of consequences. I you're seeing it too Jason.
Jason Strzyzewski:And the speed of it as well. Essentially the Fed is just going ultra-aggressive to play catch up. They relate to the game, and here we are. That being said, you know, there, there are some positives to where we're at right now. We had one of the worst years on record for the 60-40 portfolios, but now we have yield. We have carry. We have paid on cash. And I know we keep saying this over and over, but it's true. It provides other alternatives in 2023 and going forward.
Glenn Royal:Oh yeah. A year ago, we were seeing historically high valuations in both stocks and the bond market. Whole different setup today from last year.
Natalie Picha:Right. And we are looking at probably another 50 basis point hike here in December.
Glenn Royal:That's on tap.
Jason Strzyzewski:That's pretty baked in. Yeah. We see that potentially based on economic data. Powell came out the other day; they're very committed to their path to squashing inflation. That being said, they are slowing down the pace of hikes. Powell believes we can still achieve a soft landing. Now the definition of soft landing is coming into question.
Glenn Royal:It sounds like landing a space shuttle on the moon.
Jason Strzyzewski:Exactly. So it...you know, two consecutive quarters of negative GDP. If we are in recession, it's shallow at this point. And then then, but really what we're looking for next year is more of an earnings recession, to see how corporations across all sectors start to really cut back in spending—more defensive measures to insulate themselves for 23.
Natalie Picha:You make a great point about the 60-40, though, and I think we mentioned this in the last podcast, but I'm going to say it again. There's a big difference between being paid zero on a money market CD or your bond portfolio and getting paid anywhere from three to 5% on your bond. That is the difference, which is that the makeup of your portfolio is going to be different going forward.
Glenn Royal:It has, it's made to 60-40, you know, this reset this year. attractive
Jason Strzyzewski:Now. Right.
Natalie Picha:Right.
Glenn Royal:So, I know there was a lot of discussion in the past year about the death of the 60-40 balance portfolio. Sixty stocks, 40% bonds. Nonsense, you know, rates of normalized and 60-40s are back, and it'll serve its purpose.
Jason Strzyzewski:Yeah. And we're seeing that institutionally as well. Rebalancing out of equities to take advantage of the the bonds now.
Natalie Picha:Yep. Absolutely.
Glenn Royal:Hey, one thing too, like we saw this market action, big surge the last day of the month in November. There's some, you know, trading going on, and I don't want our investors to understand that the market is re-engaged, and off we are to the races. A year or two years ago, retail traders came to the market doing the meme stocks. Right? We saw them drive the AMCs and the et cetera of the world. Now they've taken that same option strategy toward the indexes. And they do far out-of-the- money calls right on the expiration day. And what you're seeing is the dealers that have to hedge and all that, that type of options activity. It creates this artificial lift based on this options trading. When you had those days, and you think the market is on, give us a call, and we'll tell you if this is out. You know, we like to blame everything on algorithms, but we may do that, but we'll give you an idea if this is for real or not. And that was kind of a head fake.
Natalie Picha:Okay. Well, that's a perfect segue into something that sometimes gets talked about in December; it's called a Santa Claus Rally.
Glenn Royal:Ho, ho ho!
Natalie Picha:Yeah. Are we going to have one? Are we not going to have one? And for clients that might not know the term. That gets thrown around. You know, as you get towards the end of the year, there's some tax loss harvesting and things like that that can go on. That can help create the environment, what we call Santa Claus Rally, which happens around December. Do you think we're looking at something like that?
Glenn Royal:I hope so. So this is a year where we've had tremendous tax loss selling. We have...you know, the big mutual fund houses that are at us daily with their marketing machines telling us tax loss selling. And, of course, trying to steal assets from one shop to the other. That sort of thing. But we are probably getting set up for that little year-end closure of books and then looking for the new start of the year. Historically, it's been in the small and medium midcap names that we talk about. Less than 10 billion in total market capitalization. And so that's a big area in the portfolio that we've gone long this year. We liked that space a great deal, mainly because it was so cheap.
Jason Strzyzewski:Valuations. Yeah.
Glenn Royal:Yeah. And valuations matter. Particularly with normalized interest rates.
Natalie Picha:another big headline that came out today as we're recording this in December the second payrolls rose in November, and hourly earnings jumped particularly in leisure and hospitality, which is a carryover from, you know, we're still in a post-pandemic world. Some of this is absolutely tied to the pandemic and what we saw in 2020 and 2021. What are your thoughts?
Jason Strzyzewski:Yeah, we're still in that renormalization period of zero-interest policy and all the stimulus we had this year. So these data points that continue to come out are going to remain patchy. And the market wants to be hopeful. They're pushing for that pivot and the slowdown of the Fed. But we're quickly reminded just how strong the economy is. You have spending, I mean, the most recent Thanksgiving spending period, black Friday consumers broke records at their levels, and you know, they're still staying relatively strong. You know, credit card utilization they are increasing. But delinquencies are below pre-pandemic levels. So that's encouraging to me for the U. S. Consumer. But then, when you look at that, conversely, that lets Chairman Powell do a little bit more.
Glenn Royal:Yeah. Those financial conditions as they, you know, get a little easier. That's not what the Fed wants. They want to tighten financial conditions, and when you get market rallies. And people spending money and all that, that kind of eases these conditions contrary to what they're trying to do. It doesn't mean the fed's through. They're going to keep raising rates. One thing that we keep hearing about is the seventies, which is the last time we had inflation, and frankly, we haven't had a fed that's had to do with this in 40 years. They've always dealt with their other mandate, which is full employment. The economy looks a little bad; they cut rates or vice versa to maintain that. So they got a little bit surprised by this inflation. Obviously, they were late to the game, a couple, you know, a couple of quarters on, on their increases. But during that period of the seventies, when we had hyperinflation that was wage driven. That's a little bit of the concern today. You saw continued strong wage gains. But in the seventies, we had such strong labor unions that were driving that demand, and that kept inflation going for a long time in that decade. These wages that we're seeing now are more carryover from the extraordinary stimulus that we saw coming into the system through the covid relief programs. And the consumer's still in pretty good shape. Their jobs are still out there. The economy's doing well. That kind of, it's a tough market because you see the good, but you see the increases in fed rates. Trying to slow things down. It gives me a little bit of reason to be more optimistic later into next year. I mean, we can talk a little bit about that.
Natalie Picha:Well, why don't we jump right into the 2023 expectation? The Fed has already said that when they do get there, they're not sure when they get there to that terminal rate, but they're going to it there for a while. So we expect continued rate hikes. Smaller ones, obviously. And it's interesting; Jason just mentioned that Chairman Powell still thinks we could get a soft landing; what does that mean?
Jason Strzyzewski:He has to give the U. S. some sort of confidence.
Glenn Royal:You don't see him talking recession.
Jason Strzyzewski:You're leading the boat right now. And you're going to predict driving into a big iceberg. I mean, what does that say about things? To prepare for next year, what we've done so far in the portfolio, taking a look at the names, you know, moving away from those higher duration equities. This means Tech companies that rely on the growth premium, I'll call it. So their valuations are elevated with the assumption of high sales growth. Strong margins and promising results. We've seen, you know, the past decade almost in a lot of these corporations post tech bubble from the emerging companies, the FANG stocks. Now you look at it this year; we've seen a rotation from those growth names into value stocks. You know, your old economy dividend payers, stable corporations. That'll continue as many of these tech names will be under sales growth pressure in a slowing economy. Even though we've had quite a bit of earnings revisions to the downside, we believe there's more in that space.
Glenn Royal:Another thing where we are with this fed hiking cycle. So they've gone really strong three-quarters of a point, you know, I think they did a half, and they went a quarter and a half and three-quarters successfully last three times. We're getting to the point of the hiking cycle where unintended consequences happen. Things can break. And the Fed is aware of that. So they're going to start slowing down that pace of increases. We talked about half a point and then subsequent quarter point, maybe three following that. Right now, the market's priced at a terminal rate of about five and a quarter percent. And to your point, they will stay there. They're not going to back off now. Hallelujah. For bond investors, that's the greatest thing I've heard, you know? In a couple, well, in a decade in 2008. We now have really tremendous opportunities in the bond market, which allows us as portfolio managers to de-risk the overall profile of our client's portfolios.
Natalie Picha:Exactly.
Glenn Royal:And get a rate of return.
Natalie Picha:Well, and for those people out there that have really, since 2008, they've been indexers, right? Passive investors. Just index it and forget it.
Glenn Royal:That's the smart thing to do.
Natalie Picha:I want to make a note of what the tech market share of the S&P 500 was at the high of about 24%, and where we're sitting now is about 18%. So you're talking about considerable change to the overall index. So if you were sitting in the index all this time, kind of a passive investor. You've probably felt some pain.
Jason Strzyzewski:You know, we're active managers at the end of the day, but you can't argue efficient markets and indexing to an extent. Still, really with this setup that, we see the almighty S&P. You look at it just performance-wise compared to the Dow Jones 30, and you have significant outperformance in the Dow Jones. So it's a revaluation. A cut down to that premium that was in tech for quite some time, and we expect that to continue.
Glenn Royal:Yeah. What benefited tech so much was a zero-interest rate environment. You know, most tech companies are all about the future earning stream. And so, as interest rates go up, we tag that as a discount rate and do a present value analysis of future earning streams. That's what's hurting technology stocks so much is this increase in interest rates. Suppose I look at the S&P 500 from an equal weight basis. Or the 500 stocks have one 500th representation. That's outperforming the S&P 500 index as a whole, which is weighted towards that tech stock group.
Natalie Picha:Right. Okay. So I know that we always say around here we don't have a crystal ball. We can look at the information. Digest that information and really look at the overall economy. And that's what we do. We're really fundamental investors. There's some discussion at times about momentum, and I know even in 20 and 21, there was a lot of momentum behind a lot of stocks, like you said, even the retail investor jumping in and the meme stocks and things like that. But at the end of the day, we're fundamentalists. Like we really dig into the numbers. We want to understand why we own what we own. We want to own good companies that have those good valuations. So the shift from growth to value is what we've done. But everybody's kind of, again, the conversation is, okay, hard or soft landing. Recession, no recession. If we look out to the six-month mark mid-year, is the Fed going to pivot? They're going to pause on these rate hikes. Because that seems to be what the market is waiting for.
Glenn Royal:Right now, the biggest thing we're going to be dealing with next year is decreasing volatility, and interest rates as the Fed calms that down. But increasing uncertainty in corporate earnings as we get into this latter phase of the hiking cycle; we expect corporate earnings in the S&P 500 to be relatively flat next year. If I throw an average PE multiple of 17 times on this year's earnings, which is roughly 2.30, 2.35 with what we're expecting next year, that puts our year in target next year around 4,000 on the S&P. Where, where are we today? 4,060. But how we get there will be an interesting ride. Most of the damage likely comes in the first quarter. As those first-order effects of these fed hikes, they've been doing or finally felt in the system. And that could see a 10% decline or so in the first quarter. Should we go into a recession? Then you could see as much as a 20% decline. And in that area, I'd probably put a 14 multiple PE multiple on these earnings, which puts us down about that 31-50 level on the S&P 500 downside. We're not expecting a recession. I think the base case right now is more for that flat market environment because of their earnings decline. What we'll be doing, though, is, this is the last bite of the apple, if you will, if you have cash. Or you're waiting for a buy point in the market as we get into that first or second quarter. I get that sell-off; what the market's going to start focusing on as we get into the second half of the year is the growth recovery and the fed pivot or pause or what have you. The Fed will stop, you know, raising rates; markets look good. So I feel really good about 24, and on late 23, I just got to get through this earning slow down in corporate profitability. That's the lag effect of the fed.
Jason Strzyzewski:Exactly. For those reasons, and not to mention geopolitics. And all the uncertainty with Russia and China. It's pretty murky waters for next year. You know, it's a dangerous game the fed's playing right now, but it's necessary. You know, it's been painful, and you know, I can't say we're expecting all the greatness for next year, but as Glenn said, 24, 25, it really sets us up for a much better environment.
Glenn Royal:Yeah. We come to this year knowing what the setup is looking like by increasing investments in companies that pay dividends. So we call this carry in our parlance. We have shifted our portfolios to generate almost four times the income we were getting last year. I noticed the other day we had a big position paid out of dividend distribution into our client's base. It was basically a quarter of a million dollars that came into the portfolios for everyone to share in, and that comes in monthly. A year ago, that would've been, you know, 30 or$40,000, now it's increased that much. So I'm really comfortable with how we're positioned for this year. But that growth trade probably kicks in, and in the latter part of next year, 24, you get these big tech companies that actually make money. That's probably when I will start leaning into that group. More than the value we're all hanging in right now. What carries you for the first half of the year.
Natalie Picha:Well, I made this comment, and I know it gets kicked around. Bull markets don't last forever. Bear markets don't last forever. It's business cycles. Right, and you ride those business cycles and adjust along the way. And that's how you really manage to, again, we'll go back to our planning background. You manage to your goals; you manage your time horizon. Because the environment is always going to be changing, and you got to move with it.
Glenn Royal:Yeah. Its long time in the market is what we really need in order to meet those goals. Day to day, month to month, quarter to quarter. Yeah. That's just normal volatility. So please don't plan on that, but give us the long- term horizons we'll dial you in.
Natalie Picha:Exactly. Well, I want to thank our listeners for following RHP Market Talk and for following us in 2022. This is our last episode of the year. I want to wish you all a very happy holiday season. I hope you get to spend some time with your family and friends. 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'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:Royal Harbor Partners is a registered investment adviser, and the opinions expressed by Royal Harbor Partners on this show are their own. Registration as 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. The 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. The 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.