What a difference a month makes.   After a strong June and July, the S&P 500 is down about 3% this month so far with the NASDAQ 100 down about 4%.  Small caps are down about 6%.  So, while we may have seen a broadening of the market, unfortunately it has been to the downside.

Corrections are a normal and unavoidable part of market life.  They are always painful in the moment, but they usually heal pretty quickly and after the fact are quickly forgotten.  The key is rest.  Early this summer, the stock market had gotten ahead of itself.  The S&P 500 and NASDAQ traded at consistently overbought levels from Memorial Day through the end of July, and the NASDAQ 100 traded as much as 25% above its 200 day moving average.  These were all unsustainable paces.

U.S. investors still have many issues and unknowns to deal with, including a weak Chinese economy, higher interest rates, an inverted yield curve and mixed signals from our economy.  Countering those issues, earnings results are improving, the Fed is likely on hold, and the worst of the rate hike cycle is behind us.  Our economy is an unknown, but there are more pros than cons.  The longer-term bull market uptrend remains intact, and August feels more like a pause than the bull market exiting stage left.

The yield curve has been inverted for about 10 months (which means short-term interest rates are higher than long-term interest rates). So where is the recession?  Although it is tempting to dismiss the yield curve in this cycle, history has shown that recessions haven’t been quick to arrive after the yield curve first inverts.  While it has been about 300 days since the first inversion of the current cycle, it has taken an average of 589 calendar days for a recession to arrive after the curve first inverts.  This would put off a recession until early June of next year.  Although the U.S. economy is still reasonably strong, we are not yet out of the woods.

Many investors (including us) are concerned about the valuation of the S&P 500, which trades for an elevated 21.4x trailing earnings.  We came across a recent study by Bespoke Investment Group that showed the premium valuation is very top-end loaded.  While the ten largest companies in the index have a trailing median price-earnings multiple of 27.5x, the median multiple of the remaining 490 or so companies is more than ten points lower at 17.0x earnings (or about 15.2x 2024 projected earnings).  The average P/E for the S&P 500 over the last ten years is 17x so maybe the valuation for the S&P 500 isn’t as stretched as it appears at first glance.

WHY POWELL IS STILL CAUTIOUS:  WAGE INFLATION

COULD THWART 2% INFLATION TARGET

The Fed is looking for labor market weakness to confirm that its tightening is cooling inflation.  But today’s labor market remains strong – with more job openings than job seekers and rapidly increasing wages.

Meanwhile, there are structural shifts in labor market dynamics that continue to constrain the supply of qualified skilled workers at a time when demand for those workers remains high:

  1. More women are leaving the workforce. Women’s labor force participation peaked around 2000 and has fallen since.  McKinsey and Company reports women leaders are leaving corporate America at the highest rate in years.
  2.  More Boomers are retiring. The number of retirees is growing much faster than the number of new workers.  This has decreased the supply of labor and, perhaps more importantly, removed much-needed skilled workers from the economy.
  3. Small businesses are challenged to find qualified skilled workers. Over 40% of small business owners have reported that job openings were hard to fill, a historically high level.  The National Federation of Independent Business (NFIB) has cited labor quality as the most frequently identified business problem.
  4. Labor has the power in an inflationary environment. In a low inflation environment with ample qualified skilled labor, management has little incentive to increase benefits and wages.  But in an inflationary environment with a shortage of skilled labor, workers can demand greater benefits with increased pay.

Labor unions make up a much smaller portion of the U.S. labor force today compared to their heyday of the 1970s, but they have been flexing their muscles lately.  That is a notable departure compared to the last 25 years.

 

As a result of structural changes including the four listed above, wage inflation is likely to remain elevated and the job market strong, making it increasingly difficult for the Fed to completely defeat inflation.  Inflation as measured by headline CPI has been cut from 9% to 3% year-over-year over the last 12 months.  That last 1% reduction to achieve the Fed’s 2% target is going to be tough.  Our expectation is that it will take another year or longer to go the last mile.

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Are you prepared for the next market correction or financial crisis?

Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

Knowledge – Results

Experts in Risk Management

Are you prepared for the next market correction or financial crisis?

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Richard Furmanski

Richard Furmanski

CFA

has been a portfolio manager and analyst for over 35 years. He manages conservative, tax-efficient portfolios for both pre-retirees and retirees. His lower risk approach appeals to investors who want less volatility and competitive risk-adjusted returns.

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Frequently Asked Questions

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Do you manage both stock and bond portfolios?

Yes. We build a portfolio of conservative, high-quality stocks and hold them for the long-term. The average holding period is 4 – 5 years. Our focus is on stocks that are suitable for retirement portfolios.

Our high-quality bond portfolios are designed to provide both income and stability of principal. Bonds provide the anchor for balanced accounts (those holding both stocks and bonds).

What is your investment philosophy?
We take great care in purchasing only high-quality stocks and bonds intent on a multi-year holding period. Portfolio turnover and taxable realized gains are modest in comparison to other active managers. We do not time the market but will become more defensive, in terms of stock holdings, when market conditions warrant.
Will the portfolio be managed in accordance with my financial goals?
Yes. Each of our clients has a custom-tailored portfolio. These custom portfolios are designed to meet specific client objectives with a thoughtful approach to specific constraints such as risk tolerance. And as each client’s situation changes, the portfolio does as well. There is no cookie cutter approach.
What kind of expertise do you have and how can that help me in difficult markets?
We have been working with high-net-worth clients like you since 1982. Over that time we have helped them to navigate several bear markets and financial crises (including the stock market crash of 1987). We hold the Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP) designations.
Are you sensitive to taxes when managing portfolios?
Yes. Our holding period for an individual stock averages 4 plus years which means our turnover is low and realized gains can be carefully managed. Further, where possible, we tax loss harvest small losses as a way of offsetting gains taken elsewhere in the portfolio.
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Results will differ by client and the level of customization but we have provided competitive investment returns for many years.
How do you charge for your services?
We charge a management or consultant fee based upon the size and level of customization of the account. As the account grows, we benefit together.

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