No doubt about it, the economic outlook is a bit concerning, at least to me. We’re seeing real stock market volatility and with it drops in the Dow Jones, NASDAQ and S&P 500 that give most observers heartburn. But why?
It Begins with Inflation
Inflation is coming down. Year-over-year comparisons bear this out. That being said, inflation is going to continue to be with us for the foreseeable future, particularly in light of labor costs given certain demographic movements that will keep forcing these costs to increase.
What is especially troublesome is the fact that as the cost of labor continues to rise, but overall inflation rates ease, companies will not have pricing power. The net effect will be labor costs becoming an even larger pressure on corporate earnings over the course of the next six to 18 months.
Additional Concerns as Winter Approaches
Economic worries do not end with inflation. European energy prices and interest rates are concerning as well. Likewise, there is a very high percentage of the corporate bond market that has moved into floating rate debt over the course of the last few years. This means that corporate debt will be subject to interest rate adjustment upwards to the extent interest rates float with the market.
Put another way, as interest rates go up, debt payments rise along with them. Bottom line: the companies issuing debt will have larger liabilities (read: larger cost for their interest payments), which creates a cloud over corporate profits.
Geopolitics continue to create their share of issues too. Events in Russia, Ukraine, China and the South China Sea—not to mention a hundred other variables around the world—translate to instability and the opportunity for a lot to go wrong in the short term.
The Canary in the Coal Mine: Bond Default Rates
Bond defaults are rising, which is a real problem. Remember, bonds are debt instruments and represent loans made to issuers. When issuers default, bondholders lose capital on their balance sheets. And this has a domino effect. When one company defaults, another has assets that evaporate off of its balance sheet, which puts that company’s bonds at risk of default. On and on this process goes—the dominoes falling (one company after another) in slow-motion over many quarters. Or maybe not so slow. In our view, there is a significant risk of some of these dominoes falling even more quickly over the next six to 18 months.
Hunkering Down for Prolonged Slog
We could be in for more than just one negative year without a significant upswing in the stock market, and we are preparing for that. How?
First, we look to work with large, well-protected businesses with wide moats and a relatively low debt load. And second, by protecting your cash flow. This is especially true if you are retired—or getting close to retirement. In that instance, we want to shield at least three to five years of cash flow at all times.
Of course, if you have questions about the economic outlook, or know someone who may be uncertain as to how best to navigate the economic headwinds, please feel free to contact us at Vizionary Wealth Management. We are always happy to have a no-obligation conversation and offer our perspective for the decisions ahead.