SWMG Economic and Strategy Update
October 12, 2022
Today we got the much-anticipated Producer Price Index for September. This index measures wholesale prices or the input costs for manufactures. The number came in slightly higher than expected (8.5% vs 8.4%) and had both good news and bad depending on your perspective. Supply chains seem to be getting a bit better as are most commodity prices, however, the service sector is still dealing with more than 1 million unfilled jobs. Higher interest rates have a significant impact on purchases we tend to finance but limited impact on services. Job openings have declined from 11 million in August to 10 million in September (a significant decline) and shows the Fed’s actions thus far are having at least some impact on demand.
Tomorrow we will get the September CPI (consumer price index) numbers. We expect markets to react/over-react accordingly. If the number is less than expected, markets will rally while a hotter (higher) number than expected will lead investors to conclude the Fed will have to keep interest rates higher for longer. Higher rates for longer periods increase the risks the Fed will over shoot their target and plunge the US economy into recession.
You can’t open a single website or newspaper today without someone predicting the markets are going to crash and it will be the worst recession we have ever had. It seems everyone wants to have their prediction in print so they can say I told you so if it happens. We still view the risk of a major meltdown as a possibility, but not a probability. US households are still in very good shape financially. I do think the risk of a recession next year has risen with each hot CPI number but I think a lot of the damage to stock and bond prices has already been done. Indeed, fixed income is starting to look attractive compared to 2 years ago.
Our strategy has adapted with each phase of this downturn. We have limited our exposure to Growth stocks which tend to have earnings far out in the future in favor of Quality and Dividend paying companies whose earnings are now. We remain under-weight the entire equity sector and have built somewhere around a 20% cash and cash equivalents position, depending on the model. We currently have close to zero direct exposure outside the US (other than US multinational companies) which helps with a strong dollar vs the rest of the world currencies. We stand ready to be more defensive as needed.
Many of you have asked “why aren’t we all cash?” As I have shared with most of you many times, market timing will almost always lead to poor portfolio performance. According to FactSet, missing the 10 best days in a given decade since the 1930s would have seen 70% lower returns over the course of that decade on average. And it works both ways. With the US stock down around 25% since January, 9 single days make up that entire decline according to DataTrek’s Nicholas Colas. Without them, the index would be up 8.6% YTD.
With that said, if you have a need for funds in the next several years, those funds should not be invested in either the stock or bond market. Long-term, inflation and longevity are the biggest risks for most of us and cannot be managed or mitigated with cash or CDs.
As I look to the future, this will end at the first sign the Fed is going to pause raising rates. Just as we saw markets fall triple digits on high inflation and employment numbers, markets will zoom to the upside on a pause by the Fed creating an opportunity to put funds to work at nice discounts. In the meantime, I expect the US stock market to trade in a range until we have more visibility and I expect interest will have to stay higher for longer than we had hoped.
Christen Sanchez, CFP®, AIF®, CFS
Sanchez Wealth Management Group, LLC
A Registered Investment Advisor
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