Weekly Commentary, May 5,2023 Capital Markets, Economy.
VenkataRaghu K.
Registered Investment Advisor|Financial Planner|Financial Analyst|CPM?
The past week has been full of news stories about the debt ceiling and what would happen if Congress does not reach a consensus. Every time we are at this juncture, it has become a predictable routine, where negotiations almost always fail until the eleventh hour. It is not suitable for our country(or our credit ratings) to let the government fail in its obligations to bondholders, federal employees, contractors, etc., regardless of who is in power. There is plenty of blame on either side as to who caused the ballooning deficit and debt. Part of it can be attributed to the necessity of propping up the economy during coronavirus distress. Some more of it can be attributed to partisan pet projects. However, the ever-increasing deficit did not just start with Coronavirus economic distress. It has been in the making for the past two decades. Each side will try to extract as much political mileage from this debt ceiling crisis as possible, even to our economy's detriment. After a few more weeks of crisis drama, and possible wild stock swings, somebody will settle something, with some disagreement and political spin on both sides.
A quick research on past debt ceilings shows that it was routine for Congress to intervene in the government budgetary process. Since 1960, Congress has intervened about 78 times to change it somehow. In 2023, the Treasury has reached the debt limit of $31.4 trillion. To avoid breaching the limit, the Treasury has begun using extraordinary measures that allow it to borrow additional amounts for a limited time. The Congressional Budget Office estimates that the Treasury shall be able to finance governments operations until this summer without delay in payments or default. A consensus has to be reached before then to avoid a crisis of payments.
Economy:
The Federal Reserve has been hawkish about rate increases. They had another rate increase a few days back. Many institutions came away with the opinion that this might be the last rate hike for now. One can never be sure, as inflationary pressure is too much despite the consistent rate hikes for nearly a year.
Despite the rate increases, the economy has been growing slower. Adjusted for inflation, the real GDP increased by 1.1% over the first quarter of 2023. The Personal Consumption Index data shows that inflation is getting slightly under control. The bigger worry is our debt-to-GDP ratio. It is almost as high as during World War 2. If the economy thrives and the government can generate additional revenues from that growth, it may not be that worrying. We will probably have a soft landing if a slowdown happens in the short term. However, suppose policy squabbles persist, and we need help finding common ground to solve our long-term issues. In that case, we may go down the path of anemic growth and need some serious adjustments to alleviate the payments/debt crisis. The saving grace is that most significant economies are in the same boat as us, with a high debt-to-GDP ratio. So it is in the best interests of everyone, at least the major economies, to have a consensus policy toward overcoming persistent deficits.
Capital Markets:
Many companies have been reporting more positive earnings than analysts anticipated. Most companies' earnings per share were higher even with the inflationary and Fed rate hike headwinds. Inflation continues to be stubborn despite all the policy measures to tame it. The news cycle continued to be pessimistic about the food supplies being affected by the war in Ukraine and prolonged supply chain issues due to the pandemic.
Companies may have milked this situation, from analyzing their latest earnings reports. They raise the prices in tandem with other sector companies due to inflation, labor market tightening, etc. Still, they will not readjust the prices when costs go down, forcing the consumer to pay the higher costs unless another big shock happens in the economy.
Long-term investors are getting benefits from the capital markets. Even though several sectors had seen losses last year, many have been on a path to recovery. This is bringing some long-needed hope to the power of capital markets.
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Hypothetical Model Funds, Accumulation:
The hypothetical allocation is shared to show the power of compounding despite the volatile capital markets. The assumption is that $1000 is deposited into every fund monthly from 2008 till date, and dividends or interest earnings are re-invested quarterly. The slides show the hypothetical performance of each fund. ( Large, Mid, Small Cap Stock Funds and different duration Bond funds). The model or calculations do not consider tax effects, fees, or risk-reward ratios. Investors shall address these to have a balanced, risk-adjusted return portfolio. Model drift also happens in a portfolio, if it is left unbalanced. When market corrections happen, losses are more pronounced if the portfolio drifts toward risker stocks, which occurs in growing markets.
A short-term scenario is also shared,(same $1000 deposited into each fund over 1 to 2 years) to show how recovery is happening inspite of the drawdowns of last year or possible future short-term changes. From now on, we shall share long-term and short-term hypothetical models to compare and contrast what has happened over the long and short term.
Insigts:
There is a mixed environment when it comes to the news cycle and earnings reports. Even though the economy is showing some growth, it is not a place to say that the worst is behind us, and we shall start looking for a growth cycle. The Weekly Economic Index has shown a consistent downward trend in 2023. The job growth in some economic sectors has kept the economy growing. The tight labor market and economic development, albeit slow, have yet to lead to a panicky situation so far. Frequently, synergistic effects of 3 to 6 economic indicators and slowdown or losses in some stock sectors lead to a crisis. It is difficult for an average investor to time every move and trade based on that information. Combined with a proprietary analysis, that information is usually the forte of sizeable institutional hedge funds with multiple ways to profit from news. Investors who think long-term can tilt their portfolios to defensive and less sexy market sectors now to continue to benefit from the capital markets. Time and again, several analyses by seasoned CFAs, have shown the long-term benefits of compounding in capital markets. A commentary on that analysis will be an article by itself. In short, if you can think long-term, there are plenty of market opportunities despite the mixed news.
Contact:
Raghu Kumar Komari, CPM?, Candidate for CFP? Certification
www.iriswealthadvisory.com
Disclosures/Disclaimers:
The commentary is provided for educational purposes only. It shall not be considered Investment Advise, Financial Planning Advise, or a recommendation of specific funds. Fees and taxes are not included in any hypothetical model or fund analysis. Please do your due diligence.