Update on the Economy and Investment Markets 5-7-22

Welcome to the Stearns Financial Special Mother’s Day edition of the Chat.

We are dedicating this Chat to all mothers who through their tireless devotion, nurture us, love us and teach us the meaning of family and community. We are grateful for this celebration and raise our glass to all mothers on this special weekend!

In case you’ve ever wondered, the very first American Mother’s Day was the result of efforts made by Anna Jarvis, daughter of Ann Reeves Jarvis. In a great act of service, the elder Jarvis created “mother’s day” events during her lifetime as a way to bring women together and offer training on good “mothering.” Following her mother’s death in 1905, Anna Jarvis conceived of Mother’s Day as a way of honoring the sacrifices mothers made for their children as well as a way of recognizing the contributions made by women to society at large. Her efforts resulted in the first official American Mother’s Day in 1908, though the tradition of honoring mothers goes back to ancient times around the world in various iterations. Difficult as it may be on this Mother’s Day weekend, we must now turn our attention to the current state of affairs both here at home and around the world.

Sadly, the phrase “when it rains, it pours” seems especially relevant in today’s environment. A war in Ukraine, a pandemic, rising interest rates, high inflation, supply chain issues, labor pressures and stock market volatility all have consumers feeling nervous. In fact, consumer confidence, which has averaged around 86% from 1952-2022 is now at 65%, demonstrating that Americans are, by and large, nervous. Given all the uncertainty surrounding both markets and geopolitical events, we are dedicating this entire edition of the Chat to our most frequently asked questions. In addition, we are hosting two separate events, each focused on various aspects of the current environment.

UPCOMING SFG AND HIGHTOWER LIVE CHATS

• Inflation, Stock Volatility and other wealth topics – Join Hightower’s Chief Investment Officer Stephanie Link on Wednesday, May 18 at 4 pm ET as she discusses the latest on inflation, investment volatility and economic trends. This session is a good companion webinar to SFG’s Live Chat (below) on May 24 which will focus on some of these same trends, but focus specifically on SFG’s adaptive strategy plans. CLICK HERE to register.
• SFG Investment and Economic Update – Join senior members of our investment team and moderator Haleh Moddasser, CPA on Tuesday, May 24 at 4pm ET as we explore the issues discussed in this Chat’s FAQs including the latest trends surrounding inflation, the economy and investment markets. To register CLICK HERE.

SFG’S RECENT MOST FREQUENTLY ASKED QUESTIONS

Q: The U.S. economy shrank in the first quarter and recession talk is becoming more frequent. Are we headed for a recession?

A: Americans are increasingly worried about the economy, with about 6 in 10 concerned that a major recession is “right around the corner,” according to a recent survey conducted by AllianzLife. Their reasons are clear: Economic activity shrank in the first three months of the year, inflation is at a 40-year high and the stock market is sliding.

While many economists are predicting a mild recession in 2023, we don’t believe the factors giving rise to the first-quarter downturn increase the odds of a recession now or in 2023. These factors include a sharp drop in U.S. exports; slower restocking of goods in store and warehouses; and decreased spending by federal, state and local governments.

However – and this is important – consumers continue to spend, businesses continue to hire and wages continue to rise. The labor market also remains in good shape, with two jobs available for each potential employee. There has never been a recession following this combination of factors. Accordingly, credit rating agency Fitch forecast that the U.S. will have recovered all of the jobs lost during the COVID-19 pandemic by the third quarter of 2022.

Strategas (recently voted Wall Street’s top macro research firm for the fifth year running) has similar recession odds (35%) for 2023 to Goldman Sachs and other top firms. They believe a slowing economy has a 50% probability and a surprise upside scenario has a 15% likelihood of occuring.

Deutsche Bank economists are among the outliers, predicting “a major recession” in late 2023 or early 2024. They reason that high demand and supply chain shortages will persist into 2023, perpetuating higher inflation. This, in turn, would force the Federal Reserve to raise interest rates higher still while tightening policy further than currently forecast.

SFG’s Take: While we don’t totally discount the grimmer inflation projections, we feel a mild recession in the U.S. is possible in 2023. With that said, we think it’s also possible the positives outlined above may potentially help avoid a recession altogether. Further, we feel a slowdown in GDP growth rates to pre-pandemic levels of 2-3% is likely.

Q: Not long ago you had a special piece in your Chat about buying iBonds (government sponsored inflation bonds). Other than the limits on how much can be purchased, are there other negatives?

A: As inferred above, iBonds have an annual limit on purchases of only $10k per calendar year per individual. In addition, iBonds are not particularly useful for purposes of short-term spending. You can cash your Series I bonds any time after 12 months from the date you purchase them. You will receive the original purchase price plus interest earnings. If, however, you redeem an iBond within the first five years, you’ll lose your last three months interest. Not the worst outcome, but not optimal either.

SFG’s Take: We support our clients buying iBonds. Because they have to be purchased directly, we cannot facilitate such purchases nor can we custody these assets at our third- party custodians.

Q: Is the current stock market decline a predictor of tougher times to come?

A: Not necessarily. Corporate earnings have generally continued to grind higher with companies managing through inflation shocks and continuing supply chain bottlenecks fairly well. With that said, valuation multiples have contracted significantly, especially for growth stocks whose valuations are based on the anticipated growth of future earnings, now worth less when discounted back to 2022 dollars by higher inflation and interest rates.

SFG’s take: We believe stocks have declined for reasons other than tough economic conditions and expect valuations to stabilize. Why the decline? We believe the stock market has overreacted to the Federal Reserve’s aggressive interest rate hike plans, even though the terminal rate (projected at the end of their tightening) still leaves us at relatively low interest rates.

Q: What’s new on inflation predictions?

A: Despite the factors discussed in our last Chat about Russia/Ukraine and supply chain inflationary pressures, there is growing evidence that inflation will become less of a worry as 2022 progresses.

BCA Research: “… the peak in inflation has probably been reached in the U.S. For one thing, base effects will push down year-over-year inflation. Monthly core CPI growth rates were 0.86% in April, 0.75% in May, and 0.80% in June of 2021. These exceptionally high months will fall out of the 12-month average during the next few months.”

BCA Research: “More importantly, goods inflation will abate as spending shifts back toward services. The following chart shows that spending on goods remains well above the pre-pandemic trend in the U.S., while spending on services remains well below.”

SFG’s Take: While it appears inflation will moderate as the year progresses, we believe inflation in 2023 will level off at 3.5-4%. The majority of client budgets we have analyzed are subject to lower inflation than the artificial Consumer Price Index. We are still considering additional steps to protect portfolios in the event inflationary pressures remain elevated.

Q: I haven’t heard much about the U.S. federal budget deficit lately other than concerns about government printing presses magnifying inflation effects. What’s the latest?

A: There is some positive news that offsets concerns about the impact of higher interest rates on debt costs. From Strategas: Deficit reduction in the first quarter of 2022 was nearly four percent of GDP, the second largest quarterly deficit reduction going back to 1960. The deficit fell by nearly $500bn in March alone as COVID-19 aid runs off and inflation boosts tax revenues.

Over the course of the past year, the deficit has declined by $2.2 trillion and is down 58 percent from its peak in March 2021. We expect further declines in the deficit in Q2 due to very strong April tax collections.

Much of the deficit decline recently is due to 2021 stimulus spending rolling off. There is not much celebrating in spending money one year and then claiming victory the following year when the spending rolls off. But the deficit decline is important because it makes it easier for the Fed to wind down its stimulus (new phase is called quantitative tightening, rather than easing).

Still, as inflation remains elevated and interest rates rise, the Congressional Budget Office expects interest and spending costs to increase faster than tax revenues. With the tight political balance, any spending increases that would bring deficits back up is unlikely. Both parties generally agree the infrastructure spending bill passed will have a positive economic impact – they agree on little else.

SFG’s Take: Federal debt and U.S. budget deficits are still manageable in the near term. The ratio of federal debt to GDP has climbed to over 100% which begins to put pressure on the annual government budget as interest rates rise. SFG would like to see a larger safety margin.

Fortunately, politicians of all stripes who couldn’t be bothered with debt and deficits five years ago have begun to realize the need for more constraint, although the debate still rages over which proposed spending programs will grow the economy versus simply add to the already inflated debt. The slowing U.S. economy and slowing deficit add-ons are projected to maintain (rather than skyrocket as some feared) the debt-to-GDP ratio over the next five years.

SFG COMMUNITY OUTREACH

• One of the ways that SFG Wealth Advisor Shira Katsir, CFP^® gives back to the profession and her community is by being the Pro Bono Director for the Financial Planning Association of the Triangle (Raleigh/Cary/Durham/Chapel Hill), helping those who can’t afford financial planning to increase their financial skills. Shira launched a new pro bono partnership with Habitat for Humanity in Sanford, NC. FPA of the Triangle Members, and members outside of the triangle, can sign up to volunteer their time and expertise to the families HFH serves. Volunteer opportunities will be available at various times and days throughout the year to ensure easy access for all involved.

The focus of these financial coaching sessions is on budgeting, cash flow management, debt and the financial implications of being a homeowner.

CYBER TRAINING

The second cyber training module focuses on how Lookalike Websites Trick Users.

Be on the lookout for “lookalike” websites and links in emails, social media posts and online ads that mimic authentic sites. Attackers create lookalike websites that use known, trusted brand names, logos and images to fool users. Please CLICK HERE to access this brief (two-minute) module that shows how these lookalike sites are used for malicious purposes, like selling counterfeit goods, stealing passwords for legitimate websites and spreading malicious software.

SUMMARY

Our belief is that recession risks are low this year but have elevated for 2023 – they remain more a possibility next year than a likely scenario. Many factors are still positive for a slow growth scenario for the U.S. and global economy.

Reading or watching the news is making some of our clients more anxious these days. Inflation and the Russia/Ukraine war remain issues, with further complications from the Omicron surge and zero COVID-19 policy in China creating additional supply chain problems. Many of these issues are expected to show improvement in the coming months, but stress fractures will persist.

Wildcard risks (low probability, high possible impact) discussed in this and previous Chats remain, including Putin’s future actions, suggesting some caution. 

SFG is balancing numerous opportunities and threats in our portfolios, customized to meet our clients’ unique circumstances.

In growth portfolios, we are leaning into a variety of short- and intermediate-term asset classes and trends that we believe have favorable forward-looking risk/reward relationships.

In more conservative growth and income portfolios, we are maintaining good diversification while striving for positive real returns over inflation.

Our “Sailing in Uncharted Waters” investing approach can be summed up by six themes:

• Diversification with a balance of offensive and defensive measures, depending on the desired risk tolerance of our clients,
• Underweighting, or avoiding areas of higher future concern,
• A focus on higher-quality investment themes,
• Identifying and implementing buying opportunities that may be appropriate for more growth-oriented portfolios,
• A more defensive stance using different portfolio tools for more conservative growth and income portfolios, and,
• Utilizing select alternatives to traditional bonds and stocks.

~ Dax, Dennis, Glenn, Jason, John and PJ
(the SFG Investment Committee)