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Understanding our Economic Environment

By Wayne Wagner Jr.

Anyone paying attention to our commentary of late will recognize a recurring theme in this most recent quarterly update. While we enjoyed a great month of performance in October, this was on the heels of a rather ugly August and September. Taken together, Q3 2022 was another down quarter.

 Allow me to begin with the challenging state of affairs facing the investment community, which I’ll follow more optimistically with what can be expected going forward. Make no mistake, we’re in a bear market, down 20-to-30% year-to-date with a trend line showing lower highs and lower lows. Meanwhile, global markets are on the decline as well; for instance, the Chinese stock market is now trading at 14-year lows, leading that country’s central bank to step in an attempt to stabilize the stock market by purchasing equities.

 Concerning Data Points Are Shaking the Economic Landscape

 The U.S. Federal Reserve continues to raise interest rates to stem inflation, and it doesn’t appear that the Fed will be rushing to rescue the stock market by cutting rates any time soon. 

 Rising interest rates are rapidly cooling the housing markets, with principal and interest payments on a median home rising over 60% this year alone. Without question, interest rate increases will slow people from moving (at least those who don't have to move), will keep people from cashing out equity in their homes to spend elsewhere, and will delay folks from buying bigger, more expensive homes given the cost of higher mortgage payments.

 Bond Defaults are rising as well. This is because a high percentage of the corporate bond market has moved into the floating rate debt portion of the marketplace over the last three-to-five years. Consequently, profitable businesses carrying a lot of debt with adjustable-rate loans (read: bonds) are seeing profit margins quickly evaporate as interest rates spike. This causes a number of these companies to go into default and those defaults, in turn, impact the markets as banks carrying the bad loans aren’t able to issue as much new debt as they work to clean up troubled loan portfolios. 

 There is more! Wage inflation (the amount people earn over time) is real, it’s here to stay, and it hasn’t been fully factored into corporate earnings. What this means is that these earnings will be hit over the next couple of years as headline inflation falls, prices stabilize, yet labor costs climb. This is an illustration of the "earnings recession" to be expected over the next six-to-24 months.

 We’re also expecting ongoing volatility in the equity markets and, with it, repeated whipsaw reactions: "yay, the market had a great week” followed by "ugh, I can't look at my statements anymore." Rest assured, we understand how you may be feeling and it's our pledge to continue providing sound investment guidance and management without the tug of these emotions.

 Here's What We’re Doing

 Our approach to wealth management in a down economy is both strategic and measured. In times like these, we make it a practice to do all of the following:

•  Maintain generally higher levels of cash within portfolios.
•  Manage toward near- to intermediate-term cash flow needs, doing all we can to avoid selling stocks at depressed prices to get there (in our view, liquidating shares only to spend the proceeds, all the while foregoing the opportunity to realize increases in a stock’s value once it rebounds, is an unpardonable sin).
•  Harvest losses in non-retirement accounts (if you have one, don't be surprised to see us selling positions this quarter, sitting those funds in cash for 31 days, and then buying those same or similar positions back again—this process allows us to harvest losses within portfolios to use against future gains).

 In terms of bonds, we’re being very strategic. As a rule, we don't own broad bond indexes or large funds that mirror indexes. Instead, we’re picking bond sectors only when we believe we can do a better job managing downside exposure in what we expect to be an ongoing challenging environment for debt securities.

 Along those same lines, we continue to reduce overall bond exposure in favor of fixed index annuities. Rising interest rates are improving the risk/return profile of these kinds of assets, which add a level of protection not found in traditional investments.

 Finally, when it comes to equities, we continue to lean toward dividend growing stocks that’ve been more resilient than the broader markets. Historically, these kinds of equities have weathered market storms much better than others.

 Where Do We Go From Here

 There's a lyric from an old country song that resonates these days: "When you're going through hell, keep on going, you might get out before the devil even knows you're there."

 And so, we’ll keep on going. Yes, we’re expecting ongoing volatility in the markets, but we don't cry "chicken little" or run to perceived short-term security in assets like precious metals. Nor do we sit idly by on the sidelines praying  for better days.

 What we do is take advantage of opportunities to harvest tax losses, rebalance portfolios and buy more shares of stocks after they’ve fallen in value, and we proactively protect cash flow needs for the near and intermediate term.

 Bigger picture, things still look great! Our economy and society are experiencing some of the most radical and positive changes not just in our lifetimes, but in the last 150 years. Technology is constantly advancing; new discoveries in medicine are curing diseases and extending life expectancy; transparency in our public sphere is helping to keep the power hungry and politically minded from hiding their backroom deals; equality and dignity for every member of our society is front of mind; and the way we generate and deliver power and data globally is evolving. Bottom line: our world is resilient and amazing, as is our economy.

 The future is bright indeed. Our grandchildren will live longer, better lives than we and our parents could ever imagine. But we must remember, progress isn’t a straight line; rather, it comes with seasons of lows . . . just like the current stock market, which is sure to recover.

 As always, anytime you have questions, need reassurance or see opportunities, don't hesitate to reach out. We’re always here with perspective for the decisions ahead.

 Here’s to a wonderful holiday season. 

Wayne Wagner Jr.
President