Hi. This is Michael Joyce from Agili, Your Personal CFO. And I’m pleased to share with you our thoughts and viewpoints for the Summer of 2022.
Not a Great Year So Far for the Financial Markets
As I’m recording this at the midpoint of 2022, I think we can all agree that this has not been a very good year at all for the financial markets. In particular, the past several weeks, since the beginning of April, have not been good. It’s almost been like Chinese water torture where you get the “drip, drip” of down days, seemingly every day.
And there’s really been no place to hide. I mean, traditional safe havens like bonds are also down a lot as interest rates have risen. The US Aggregate Bond Index is down over 10% for the year, so far.
Now you may recall, last quarter, I did a little tutorial on price/earnings ratios or P/E ratios. And a lot of things that we talked about then have come to fruition. The price/earnings ratio, as interest rates went up, the price/earnings ratios on the stock market have come down a bit. And that’s been quite rational.
But we were also, at that time, starting to see a little softening in some of the economic data and we were worried that that would start to bleed into corporate earnings – and lower the “E” part of the price/earnings ratio. And while corporate earnings have held up relatively well so far, it is widely expected that there is going to be some softening in corporate earnings – and, in some cases, some stocks are being priced as if they are already in a recession at this point in time.
Concerns about a Recession
And there is a lot of concerns about a recession. And our base case right now is that there’s not going to necessarily be a recession. It wouldn’t surprise us to see a little slowing in the economy. Indeed, the parts that have been slowing — the parts of the economy that have done the best since the beginning of the pandemic, where people bought a lot of “stuff” – that’s slowing. You see retailers with excess inventories and so on.
But the service part of the economy, which is a very big portion of the economy, which hadn’t risen so much since the beginning of the pandemic, we expect that to be pretty stable and it will provide some ballast to economic activity. And, if there is a recession, we expect it would be a pretty shallow recession.
Inflation at a 40-Year High
But we’re also still battling inflation which remains at 40-year highs. Now we do expect inflation to moderate at some point. You know, we’re already starting to see some improvements in supply chains. As I mentioned, there’s been a little bit of softening in certain parts of demand, somewhat caused by the Federal Reserve’s tightening. But inflation is still a big problem and until it shows in a sustainable way that it’s going down, we don’t think there can be a great deal of improvement in the financial markets.
The last couple of downturns that we’ve had have been pretty short. You know, there’s been a pretty quick recovery from the beginning of the recovery. But that’s really an anomaly. The average bear market lasts for nine or ten months. And that’s not been our experience with the last couple downturns. So, we’re about six months into it and we don’t know how long it’s going to last, but we do caution investors to be aware that this could last longer than the past couple downturns.
Encouraging Labor News
Now there are some positives as well. The employment market — employment is very strong. We are starting to see a little layoffs being announced in some corners of the economy, but there are still two job openings for every person available to work. So, we do expect that the job market will remain strong.
There’s also plenty of liquidity. Households are holding more money in bank accounts – much more money in bank accounts – than they did prior to the pandemic.
Michael Joyce’s “I-95 Economic Indicator”
And last, there’s my favorite economic indicator – and that’s called the “I-95 Indicator”. And based on my travels up and down I-95. And it’s been very accurate over the years. You can see when things slow down — you can see when things start to pick up — based on the car and truck traffic on I-95. And based on my recent travels on I-95, it shows that, at least at this time, the economy is still pretty strong.
Overall, with the stock market, we believe that based on where interest rates are and based on where earnings are, that the prices on the markets are pretty fair right now. But that would mean that interest rates can’t spike up more or that there can’t be greater deterioration in earnings than we have modeled in. Right now, it’s pretty fairly valued, so we wouldn’t expect that things might move up a lot in the short-term. But every day, we do see more and more opportunities than we did before.
Short-Term Bonds Perform Well
We haven’t talked a lot about the bond markets in the past couple quarters, but the bond markets are much larger than the stock markets. And as I mentioned, they haven’t been a safe haven this year. But it’s also created opportunity for us. I mean, I’d hasten to add that while the bond market indices are down 10%, our clients haven’t experienced that at all because we’ve been investing in mainly short-term bonds, which have much less interest rate sensitivity. So as interest rates have moved up and we have bonds that are rolling off, we have extra money to reinvest in a higher interest rate environment. And that’s a good thing.
Right now, investing, going out two or three years, in corporate bonds, we’re commonly finding yields of 5% or more. And this is much different than it was three months ago, or six months ago, or certainly a year ago.
Municipal Bonds Taking a Hit
We’re also starting to see some values in some odd lots in the municipal bond market, which have been very rich over the past couple of years, especially last year. Municipal bonds moved up because individual investors thought the tax rates might be going up. But that didn’t happen. And as a result of that and a couple of other reasons, the municipal bond market is really taking a hit this year. That’s created some opportunities.
Opportunities in Foreign Markets
In foreign markets, I think we could safely say that foreign economies are going to have rougher sledding than the US economy. If you think about Europe, it’s much more closely tied, or much more impacted by the Russian invasion of Ukraine. You know because, again, a lot of their agricultural and energy commodities are from that area.
China’s slow down, somewhat self-induced by their Zero Covid policy, has impacted most of the emerging markets, with the notable exception of India. So, the economies might struggle a little bit, but from a valuation standpoint, foreign markets are very cheap right now. You know, if you look at them relative to US stock market valuations, foreign valuations are at a 20-year low relative to US valuations. So, they’re very cheap. So, if we’re underweight in some foreign markets, we’re now averaging into those markets – not putting all of the money in at once, but rather, a bit at a time.
Overall, we don’t think this is a time to run away, nor do we think this is a time to back up the truck and load up. This is not like the Spring and Summer of 2020 where we saw opportunities everywhere. But we will see more and more opportunities as time goes on and we are still optimistic about the long-term. So, for short-term cash flow needs, we’re making sure that we have the liquidity to meet those needs and we are still invested for growth for your long-term goals and objectives.
If you have any questions on these thoughts and viewpoints, feel free to contact your financial strategist at Agili or to contact me. Thank you very much and have a great day. And have a great summer!