The Financial Advocate: Summer 2023

“Time to be Optimistic?”

Three to Six Months?

A year ago, investment markets were selling off severely under the assumption that a recession would hit the U.S. economy “three to six months out.”  This “three to six months out” slogan has been the drum beat of many economists and analysts going all the way back to the fall of 2021.  Now, in the middle of the summer of 2023, we see economic growth when we were supposed to be in the midst of recession.  Some analysts are even arguing that the economy is accelerating.  At the same time, others are still doggedly warning to expect a recession in … “three to six months.”    

In the latest FOMC meeting announcement and subsequent press conference with Federal Reserve Chair Powell, the Fed acknowledged that they believe risks to the economy are subsiding.  That does not mean those risks have gone away completely. While inflation is cooling (remember that inflation was the primary reason that the Federal Reserve started the current rate-hike cycle), labor markets remain tight and there is much debate as to whether a 2% inflation target is achievable.

We are in the middle of earnings season and most earnings and revenues are beating expectations.  Corporate earnings were supposed to be falling off a cliff.  Traditionally, stocks are valued on the profits they reap.  A more stable earnings picture than expected should be a positive for equity investors.  After 2022, more stability is welcome.

Could we be entering the best of both worlds?  Are we in a period where inflation falls, everyone keeps their job (plus a raise), corporate profitability is even and predictable, and interest rates move lower?   It would be nice, but this scenario is unlikely. 

We expect interest rates to remain around current levels and we do not expect a cut in rates from the FOMC in calendar year 2023.  (That would be a serious reversal of policy). Housing will continue to cool; 7% mortgages feel expensive compared to recent history.  Labor markets may remain tight partially because of the undefined immigration approach of the U.S. The United States has historically relied on immigration to expand its workforce.  We need foreign workers, both skilled and unskilled.  While we have appropriated trillions of dollars to new plants and infrastructure, we do not have enough qualified people to build and staff them.  Taiwan Semiconductor, one of the world’s finest semiconductor manufacturers, has committed to building a new, $40 billion dollar plant in Arizona. The project has been complicated by not having enough skilled workers to run the plant – whereas they are sending 12,000 employees here to help get the plant up and running.  Without a forward-thinking immigration policy, this chokepoint on the American economy is likely to persist.

Second Half Threats

There are two notable threats that loom as we enter the back half of the year: continued above-average inflation and geopolitical conflict.

As you know, the Federal Reserve is committed to reducing inflationary pressures to their stated target of 2%.  Inflation is comprised of the rise in price of goods and services. While services inflation appears to be coming down, goods inflation appears to be accelerating.  Oil prices are rising, other raw materials are in an uptrend, and food prices are “sticky.” High (above 2%) inflation will cause the FOMC to keep interest rates elevated – a policy that will eventually have a dampening effect on the economy.

The double threat of inflation and geopolitical risk can be summed up in the conflict between Russia and Ukraine.  Russia recently pulled out of the food deal they agreed to last year and has been actively targeting grain supplies in Ukrainian port cities like Odessa.  Those policies will undoubtedly destabilize the immediate region and create the potential for a widening/exacerbation of food shortages, inflation, and further military confrontation. We do not know how this will play out, but we must keep the threats in focus to guard capital.

Now, Some Optimism

An article in The Wall Street Journal by Greg Ip noted a piece of interesting recent history. Expansions in the post-1980 period have lasted 8.6 years on average. If the Fed manages the “soft landing” it is looking for, and this average were to hold, then the expansion we are currently in could last another four to five years.  That is a big supposition.  But remember, many of the recent periods of economic expansion have been peppered with continued pessimism and non-believers.  8.6 years is a long period of time to stubbornly hold onto pessimism (and sit on the sidelines as an investor) if the economy is in expansion and markets are rising.   

We have not had a labor market this robust in the post-1980 period.  The strong labor market could be a double-edged sword.  It could cause wages to remain “too hot,” keeping inflation elevated, thus forcing the Fed to keep interest rates high which could ultimately lead to a recession.  Or, a healthy consumer, confident in a strong labor market, could shift spending away from goods (more of a pandemic trend) back to services.  Recall that inflation is usually caused by excess demand leading to higher prices. This recent bout of inflation was primarily caused by pandemic-disrupted supply chains.  At present, supply chains are mostly functioning normally.  Vehicle production is back up, used car prices have fallen, and semiconductors for most products are available.  Workers continue to return to the workforce – helping somewhat to ease the terribly tight labor market. With prices rising, consumers of all income levels are proving resourceful.  While some analysts believe that inflation is “stuck” at current levels, there are convincing arguments that it could continue to drift lower over the next year.

And when labor is tight, you can bet that industry will look to technology to try to solve part of the problem. Can you turn on the television and not hear a reference to Artificial Intelligence (AI)?  We believe that the recent published gains in AI are history making, not hype. Productivity growth is key to growing prosperity. If we can do more, better, faster, we ultimately create more wealth and higher living standards.  For the past twenty years, productivity has

been running at gains of about 1.5% per year.  It is projected that AI can double that productivity to 3% over the next several years! This should lead to increased profits while reducing inflation. Threats to the economy like worker shortages, a rapidly aging population, and deglobalization may be offset by rapidly rising productivity.

There are some very profound examples of AI being used to increase productivity. In a recent Goldman Sachs report, it was noted that 44% of all legal services could eventually be handled by AI programs. Software developers reported that with the use of AI, their development time decreased 55%. NASA said that AI improvements to their instrumentation was accomplished in 1/10th of the time of human counterparts, with higher accuracy. Think about the possibilities in engineering, drug development, architecture…the list goes on. 

What’s Next?

So – what is next for the economy and the markets?  The answer is everyone’s least favorite it answer: “It depends.” 

“Sticky” inflation, an overly aggressive Federal Reserve, and waning business and consumer confidence could still spell recession.  Do not be surprised if you hear continued calls for a recession in the months ahead.  Remember – we have been collectively listening to this drum beat for close to two years!  Many analysts believe that even if we have a recession, it would likely be shallow.  A shallow recession could produce a more moderate market pullback than some would expect as significant discounting was already done in 2022. 

Do not be surprised if you hear continued calls for a recession in the months ahead.  Remember – we have been collectively listening to this drum beat for close to two years!  Many analysts believe that even if we have a recession, it would likely be shallow.

Continued disinflation, a healthy consumer, upticks in productivity, and de-escalation of geopolitical tensions could allow for the “soft landing” that the Federal Reserve has been desperately trying to engineer.  The pesky drumbeat of recession has been softer lately, but it has not gone away completely.  If equity markets were to further recover and investor excitement about new developments in science, technology, and AI were to ramp up, we could be looking at a revitalization of the “Roaring 20’s” theme.

“Economist’s Corner,” by Roger Klein, PhD

The Federal Reserve began increasing its target interest rate on March 16, 2022. The initial increase was 0.25%. Including the initial increase on March 16th the Federal Reserve has hiked its target interest rate 11 times. The most recent increase of 0.25% occurred after the meeting of the Federal Open Market Committee (FOMC) on July 22 and July 23. The cumulative increase in the target increase rate is 5.25%. The current target federal funds rate is between 5.25% and 5.50%.

The Federal Reserve’s policy of increasing its target federal funds rate is designed to bring down inflation. Is it succeeding? The answer is “yes.” At its peak, in June of 2022, the consumer price index (CPI) was increasing at an 8.9% rate when measured year-over-year. In June of 2023, the CPI was increasing at a 3.1% rate when measured year-over-year. Inflation has been decelerating, and decelerating inflation is good for financial assets, stocks, and bonds. The Fed has an inflation target of 2%, and there is some concern that the Fed will keep monetary policy too tight too long as it tries to get inflation down another 1% to meet its 2% target.

Soft landing or trouble ahead? The “soft landing” scenario is one in which the Fed achieves its inflation target without a recession. Nobody knows if this will happen, not even the Federal Reserve. Meanwhile, the economy continues to grow at a respectable pace. In the second quarter of 2023, real GDP grew at a seasonally adjusted annual rate of 2.4% and this followed an increase in the first quarter of 2.0%. Remember back to the first two quarters of 2022 when real GDP registered two consecutive small negative numbers and the crowd roared “recession.” Those two negative GDP quarters were followed by a 3.2% growth rate in Q3 and a 2.6% growth rate in Q4.

Fed Chair Jay Powell said at the press briefing, after the July FOMC meeting, that going forward the Fed will look at the incoming data to make its rate decisions. The next FOMC meeting date is September 19 and September 20. There will be two more employment reports and two more inflation reports before that meeting date, so the Fed will have a lot of data to chew on.

The economy continues to get a lift from the fiscal side of the equation. According to Charlie Bilello of Creative Planning, government spending over the past 12 months has increased by 14%, while tax receipts over the past 12 months has declined by 7%. The result is a ballooning federal deficit which is now $2.25 trillion. The Treasury has been selling securities by the boat load to finance this deficit. The rating agency, Fitch, just lowered the credit rating of the United States to AA+. The rating agency S&P had already lowered it, so now Moody’s is the only rating agency maintaining a AAA rating for the United States.

Managed Model Strategy

Global Alpha

Global Alpha is currently in a fully invested stance. Notable concentrations are evident in semiconductors and software capitalizing on the AI revolution.  We believe that AI is transformative to our country’s productivity and prosperity.  The field of artificial intelligence is in its infancy and will play into our lives for years to come. On the opposite end of the spectrum is a concentration in materials and industrials: components for highways, bridges, and other basic infrastructure.  Three major pieces of legislation will fuel America’s “rebuilding” for years as well.  Reshoring jobs and factories, rebuilding roads, highways, and even harbors and airports, bode well for the building industries. We maintain investments in the health care, consumer discretionary, and communication industries. These are currently in a “market weight” position. We are underweight financials, real estate, consumer staples, and utilities. The model is currently unhedged.

Global Balanced

Global Balanced maintains a quality focus across asset classes.  The portfolio has participated nicely in this year’s uptrend.  We attribute strong performance mainly to being well-diversified and multiple asset classes recovering from the selloff of 2022.  The concept of shifting supply chains has been a central theme to the portfolio and continues to be developed.  As companies reduce their reliance on China, we have incorporated ETF holdings in India, Vietnam, and South Korea.  Additionally, the “old NAFTA,” now USMCA, is back in vogue.  We have included ETF holdings in Mexico and Canada in an attempt to capture this trend.  The strategy has been nimble in its fixed income holdings as we continue to add individual Treasury bonds opportunistically.  Alternatives are performing nicely but retain defensive characteristics.

Moderate Allocation

The Moderate Allocation portfolio has continued to benefit from a non-defensive posture. Healthy weightings in the technology, consumer discretionary, and communication services sectors have allowed the portfolio to participate in the growth company rally this year. At the same time, our quality, dividend paying holdings in other sectors have provided sensible diversification. We closed out our tactical trades in international holdings (iShares EAFE ETF and Vanguard All-World ex-U.S. ETF) for a profit. We continue to hold a position in emerging market bonds (iShares JPM Emerging Markets Bond ETF), as we anticipate further relative gains. Should the U.S. economy enter a recession, we will take defensive actions. As of now, the portfolio is appropriately positioned, in our opinion.

Milestone360

• Clients that custody at Pershing Advisor Solutions:
  • PAS is instituting a new set of fees for clients that have not selected paperless delivery.  These new fees are slated to begin as of August 31, 2023.
    • Paper statements and trade confirms will cost $2.00/month/account starting 8/31.  This fee will increase to $3.00/month/account in January 2024, and $5.00/account/month effective June 2025.
    • There is a $10/year/account tax document fee which will be assessed in March 2024.
    • Existing paper statement and confirm surcharge fees will be discontinued.
    • Pershing will directly debit these fees from your investment accounts in the month following the date the fee is incurred.
  • If you have partial e-delivery (for example, you receive paper tax statements, but paperless statements and trade confirmations) you will be charged the full monthly paper subscription fee.
  • Our team is happy to help you with the e-delivery / “paperless” process.  If you have any questions about going paperless, please let us know. 
  • Important note: VWM does not benefit from these paper processing fees, nor any other fees charged by account custodians.

• Clients who custody at TD Ameritrade Institutional:
  • Charles Schwab is set to fully integrate TDAI into Schwab over Labor Day Weekend. (Schwab completed the purchase of TDAI in 2019 and has held off full integration until now).  Schwab has created an online client information hub at welcome.schwab.com/alliance that provides helpful information and addresses FAQs.
  • VWM will have the same authorizations on your account at Schwab as we did at TDAI.
  • Key Dates:
    • In the next week or so, you should be receiving a “Key Information Packet” directly from Schwab.  This packet includes your new account numbers.
    • You will no longer have access to AdvisorClient (TDAI’s online platform) starting 8:30PM ET on Friday, September 1.
    • Account information will be unavailable from 8:30PM ET on Friday, September 1 to 5:00AM ET Tuesday, September 5.
    • On Tuesday, September 5, your Schwab Alliance online platform will reflect your current account values.
  • Account Movement:
    • Your accounts will automatically move to Charles Schwab.  There is nothing you need to do to facilitate the transfer. 
    • You will be receiving a new Schwab account number.
    • You will be receiving a letter in the mail from Schwab the first week of September stating that your accounts successfully transferred from TDAI to Schwab.  You will receive one letter per account.
  • Online Access:
    • From this point forward, you may create a Schwab Alliance Login ID and password to access your accounts once they transition to Schwab.
    • To create a Schwab online account, go to schwaballiance.com.  Click New User, and create a Login ID and Password. 
      • If your username qualifies, you may be able to use your existing TDAI credential.
        • Once you have established a username and password, you may elect to go paperless.
      • Direct Deposits, Standing Money Movement Instructions, Checks, and Debit Cards:
        • Any instructions that we (VWM) has set up on your behalf at TDAI will automatically transfer to Schwab.
        • For 60 days, instructions that you would have provided other institutions (payroll deductions, banks, other custodians) will be honored.  However, these instructions should be updated promptly.  Please contact our office for assistance.
        • For clients that have used debit cards and checks on their TDAI accounts in the past 24 months, replacements will be provided for you.
      • Account Information History:
        • Your account history will not be lost in the transition from TDAI to Schwab.
        • For your next statement period, you will receive both a TDAI statement and Schwab statement.  Please note and do not be alarmed: your TDAI statement should reflect a $0.00 balance.
        • Many documents will be available to you upon request to your team at VWM:
          • Statements will be available for 10 years in PDF format.
          • Tax documents will be available for seven years.
          • Trade confirmations will be available for two years.
        • Cost basis information will carry over from TDAI to Schwab.

Our goal is to help clients at both custodians traverse these changes.  If you have any questions at all, please do not hesitate to contact us.  We are happy to help.

As always, we appreciate your business and continued support. We are here to answer any questions you have about the economic environment, portfolio strategy, financial planning, or changes at the custodial level.  Enjoy the rest of summer!

Nick Ventura, CFP® CPWA®

President / CEO