This Week in Review:
Earnings Impress Early,
But Fed Hikes Weigh On Markets
This week followed a familiar bear market pattern of big up days followed by smaller losses as the S&P 500 rose a whopping 4.3% over Monday and Tuesday before taking a breather on Wednesday and Thursday.
Of course, that’s just a few days. We’re not sounding the all-clear or saying we’ve seen a bottom. Nobody knows in real time when bear markets end and bull markets begin. But the markets’ flip-flop (bonds also rallied) certainly puts the lie to those who think they can predict ups and downs.
A generally strong start to earnings season has buoyed stocks in recent days and lessened recession concerns, though upcoming reports from major tech companies could shift sentiment—the beleaguered NASDAQ 100 index of large tech firms is currently down 32% for the year.
On the monetary front, Federal Reserve Bank of St. Louis President James Bullard, described by Bloomberg as Wall Street’s “Fed guru,” says he expects the Fed’s aggressive interest-rate-hiking cycle to end early next year as inflation falls and the central bank returns to “ordinary monetary policy.” Despite this optimism from one of the Fed’s more hawkish figures, we’re not there yet. The Federal Reserve has telegraphed a fourth consecutive 0.75% hike at the bank’s Nov. 1–2 meeting, and markets are increasingly pricing in another one at the Fed’s December confab.
- Disarray in the U.K. Yesterday morning’s abrupt resignation by Prime Minister Liz Truss after just six weeks leading the government leaves chaos in her wake amid worries that Britain is headed for a rough recession. The U.K. is a major U.S. trading partner and the world’s sixth-largest economy; the fallout from the ministerial musical chairs remains to be seen.
- Imports to the Los Angeles and Long Beach ports—the country’s two largest—were down 15% and 11%, respectively, in September. These venues typically see an autumn rush of holiday goods pouring in. The culprit? Not the supply chain this time: Concerns about labor negotiations at the California ports prompted shippers to reroute deliveries to the East and Gulf coasts.
- In response to inflation, the IRS announced this week that top marginal tax-rate income thresholds will increase next year by 7% from 2022’s level. The standard deduction will also go up by 7%. Along the same lines, Social Security recipients will receive an automatic 8.7% cost-of-living adjustment starting in January 2023—the largest increase since 1981.
Chart of the Week: When Do Rate Hikes Start Working?
If you’re not frustrated, we definitely are! Since the Fed’s crusade to lower inflation began, it has raised interest rates from near 0% to north of 3% in a matter of months. These moves have lowered returns for both stocks and bonds and sent waves of volatility crashing across financial markets.
But are they working? The purpose of interest-rate hikes is to slow the speed at which money circulates in the system. Increasing borrowing costs slows the spending splurge in America, and it should help curb rising prices. All those market ups and downs may be turning traders’ stomachs today, but the Fed’s strong medicine is intended to heal the economy over the longer term.
The chart below explores potential paths for inflation vs. interest rates over the next 12 months, and it can help us tell whether and when hikes are finally doing their job. Here’s the good news: As early as February and as late as May, interest rates, as measured by the federal funds rate, should finally eclipse the inflation rate.
Why is this important? It means bond investors can earn a positive rate of return on their investments when adjusting for inflation. In other words, those lending money will benefit from doing so. Once this inflection point is reached, we expect bond market turbulence to ease. Interest rates higher than the inflation rate are also indicative of a stronger financial outlook and economic stability, both items equity markets are begging for. If current trends continue, that crucial moment could arrive next spring. The short-term outlook remains cloudy, but there is sunshine appearing in the distance!
Signal From Static: Valuing Growth or Growing Value?
The growth vs. value debate is in the news again. A well-known hedge fund manager has claimed that true value investing is dead, slain by the ETF juggernaut and those who have switched to computer-driven algorithms to choose stocks, labels be damned.
This comes at a time when “value” strategies have been outperforming “growth” strategies. Traditional value stocks like oil producers and utilities have taken the lead from their growthy tech and consumer-discretionary cousins. And Wall Street pundits are now claiming that value is poised to outperform into the future, while growth remains moribund.
If only it were that simple.
While the labels are an easy out, the trouble is that there are many definitions of what constitutes a growth or value stock.
A simple definition of a growth company is one where profits are growing faster than the markets’ overall. Of course, this ignores the fact that, for instance, biotechnology companies often show no earnings for years as they burn cash to discover the next great therapy. Amazon, one of the best-performing growth companies of all time, had zero profits to show for its growth for years. Still, I don’t think anyone would consider either Amazon or the typical biotech to be value companies, which typically see their shares selling for lower valuations relative to their earnings or book value, and which often pay a dividend.
Here’s where it gets tricky, though. Apple is certainly a growth company, but it pays a dividend. Many of the largest U.S. banks were, and still are, considered value companies, yet for years they paid no dividends at all.
Over the almost 45 years that the Frank Russell Company has calculated returns for large growth (Russell 1000 Growth index) and value (Russell 1000 Value index) stocks, neither one has outperformed the other.
Value stocks and growth stocks have traded leadership and, as the chart so clearly shows, the points when style preferences turn can be swift. Attempts to time the changes are fraught.
Yes, there’ve been periods when growth beat value—such as the 26 months from December 1997 through February 2000 (up 31.8% annualized vs. 4.2% for value). Equally, there have been periods when value outran growth. Yet, at the end of the day, after more than four decades, growth stocks and value stocks have come out at the same place.
When assessing the state of the markets and the state of your portfolio, I believe it’s important to ignore—or, at a minimum, be highly skeptical of—attempts to use simple labels to describe more complex investment strategies.
Instead, continue to focus on core investment principles including diversification and controlling risk in the furtherance of meeting your objectives and long-term goals. Don’t let the noise of the growth-vs.-value debate distract from the signals of smart portfolio management.
Register for the Polaris Wealth Quarterly Outlook on Oct. 26!
On Wednesday, October 26th at 1pm PT we will continue our popular quarterly Market Outlook series. We’ll be addressing key investment themes expected to impact markets over the remainder of the year.
We look forward to discussing the markets with you. Register now!
If you are unable to attend, a replay will be available the following week.
What’s the State of Your Estate Plan?
It’s National Estate Planning Awareness Week—yes, there is such a thing—yet less than half of all Americans have an estate plan in place. What gives?
One common misconception is that estate planning is only for older or extremely wealthy individuals. We disagree. Here’s why almost anyone reading this needs to get on the estate planning train.
- Protect your wishes. The most important reason to put a plan in place is to ensure your wishes for the settlement of your estate are carried out. A will alone is not enough to protect how, when and to whom your assets and possessions are distributed upon your death.
- Avoid probate. When no solid estate plan is in place, individual states rely on a probate process to sort things out—and offer varying ways to avoid it. With probate, decisions about all of your assets, all of your belongings and even who would have custody of your minor children could go through a public and potentially lengthy court process where a judge ultimately makes the call. Obviously, this is something to avoid like the plague.
- Reduce taxes. Suffice to say, no one likes to pay taxes. Depending on which state you live in, your assets could be taxed at both a federal and state level. A well-crafted estate plan, completed in alignment with your financial plan, can help ensure you don’t pay more to the government than necessary.
- Protect yourself and your beneficiaries. An estate plan does more than protect your assets. It allows you to determine guardianship of minor children and clearly establish who can make medical decisions on your behalf if you are unable to do so.
- Get peace of mind. A thorough estate plan should clearly lay out your wishes before you are unable to do so. The goal is to minimize family conflicts down the road while making an emotion-laden process easier.
- Even if you are young and single, putting an estate plan in place is a smart move now
Next week brings an abundance of informative reports. We’ll be looking at reads on manufacturing, the service sector, home prices, durable goods, consumer sentiment and spending, disposable income, inflation, wages, and the first estimate of third-quarter GDP.
If you’d like to learn more about our tactical or fundamental strategies, please contact our team at
800-268-9046 or email@example.com.