Do Policymakers Care About Your Portfolio?

Please note: This update was prepared on Thursday, September 1, 2022, prior to the market’s close.

It has often been said that the Federal Reserve doesn’t care about your portfolio.

Last Friday’s comments from Fed Chair Jerome Powell may have proved the point.

Powell’s much-anticipated speech in Jackson Hole, Wyoming, while short, was dissected for every bit of nuance. Wall Street traders came to a bearish conclusion: Powell & Co. will combat inflation at almost any cost. As a result, major stock indexes fell 3% or more on the day.

And they continued to fall this week. The S&P 500 index closed August with a 4.2% decline for the month, after having jumped 9.1% in July.

Traders reading between the lines are concerned that Powell and his colleagues appear to have abandoned hopes for a “soft landing” in favor of a “growth recession” that stymies economic advancement to corral inflation. This is less painful than a protracted recession, but it’s a potential headwind for stock investors who’d been expecting less draconian interest-rate hikes.

Here’s what we’re watching and why it matters:

• Job openings rose in July and remain near record highs. The persistent strength in the labor market and consistently low unemployment appear to have emboldened the Fed to try to cool inflation without causing widespread layoffs. Friday’s August unemployment report will further clarify the jobs picture.
• Shipping prices are down significantly from a year ago. The Drewry Hong Kong-Los Angeles container-rate benchmark fell to $4,052 per 40-foot container, a drop of 49% from August 2021. While still above historical norms, this is one sign that inflation may be cooling.
• Also on the shipping front, port congestion in Los Angeles has fallen dramatically this year, from a high of 109 ships in queue in January to just eight as of Monday. While this is partly due to shipping traffic being rerouted to East Coast ports, it’s another indicator that the supply chain issues driving higher inflation are unsnarling.
• Rumors of the demise of the U.S. consumer have been quashed thanks to some August confidence measures rising to their highest levels since May, when inflation and high gas prices dimmed Americans’ outlook heading into the summer. Optimism about the next six months also rose, as did plans for purchases of big-ticket items like appliances, cars, homes and vacations.
• One contributor to U.S. consumer optimism: Increased earning power. Powell’s belief that “the burdens of high inflation fall heaviest on those who are least able to bear them” aside, the bottom 50% of households have seen income growth of around 45% since April 2020, and they’ve experienced inflation-adjusted wage gains of 2.8% in the first six months of 2022. This improved earning power may help keep spending afloat, especially as inflation slows.

Fed Turns Hawkish

What a difference a year makes! In 2021, Fed Chair Powell was firmly in the “transitory” inflation camp—using the word five times in his annual Jackson Hole speech. This year, Powell was out to send a strong message intended to restore the Fed’s inflation-fighting credibility.

Here’s a key excerpt:

“Restoring price stability will likely require maintaining a restrictive policy stance for some time… The historical record cautions strongly against prematurely loosening policy.”

In plain English, that means we can expect the Fed to keep the benchmark interest rate higher for longer, even at the risk of pushing the economy into a recession.

Fed officials presented a unified front this week amid the stock sell-off. Minnesota Fed President Neel Kashkari said he was “happy” about the market’s reaction and that “people now understand the seriousness of our commitment to getting inflation back down to 2%.” Federal Reserve Bank of New York head John Williams backed that sentiment in an interview with The Wall Street Journal, saying that achieving the 2% target will require the central bank to hike interest rates above 3.5% and leave them there through 2023.

Of course, talk is one thing. Now policymakers have to back it up with actions—something bond and stock traders anxiously await.

Chart of the Week: Profits at a Record

 Interim Chief Investment Officer Jeff DeMaso: 

While Jerome Powell stole the show in Jackson Hole last week and had onlookers reevaluating the probability of a recession ahead, the most recent data on corporate profits flew under the radar.

In fact, U.S. companies were more profitable than ever in the second quarter, according to the Bureau of Economic Analysis. But it’s not just the absolute level of money coming in that matters; it’s also what companies keep after taxes and expenses—aka “profit margins.” Through June, profit margins improved compared to the first three months of the year, and they remain near record levels.

This tells us two things. First, if we are in fact heading for a recession, companies are starting from a position of strength. Second, so far, major U.S. businesses have been able to pass higher input costs on to customers in the form of higher prices. While that’s not great for consumers, it’s a positive for investors. We’ll be keeping an eye on profit margins in the quarters ahead, as we don’t expect companies will be able to keep raising prices forever. That said, if inflation is in retreat, input costs should also abate a bit.

Strategy Activity Update

Please see below for a summary of the trades we executed over the week through Thursday and our current tactical strategy allocations.

Dividend Income

Buy Cash

Sell iShares Biotechnology ETF (IBB)

AIQ Tactical Defensive Growth

AIQ Tactical Multi-Asset Income

Buy iShares TIPS Bond ETF (TIP)

Sell iShares iBoxx USD High Yield Corporate Bond ETF (HYG)

AIQ Tactical High Income

Buy Cash

Sell iShares iBoxx USD High Yield Corporate Bond ETF (HYG)

Sell iShares 0-5 Year High Yield Corporate Bond ETF (SHYG)

Sell Xtrackers USD High Yield Corporate Bond ETF (HYLB)

Sell Invesco Fundamental High Yield Corporate Bond ETF (PHB)

Adviser in the Media

Jeff DeMaso spoke to Ignites about a new portfolio manager on two Vanguard funds overseen by subadviser Wellington Management.

In this week’s Adviser Takeaways, Senior Research Analyst Liz Laprade explained the S&P 500’s recent slide, while Manager of Financial Planning Andrew Busa demystified student loan forgiveness.

Looking Ahead

Markets and Adviser’s offices will be closed on Monday in observance of Labor Day. We’ll be back at our desks and ready to assist you bright and early Tuesday morning.

A number of key reports come out next week, including reads on the service sector, consumer credit, wholesale inventories and the Federal Reserve’s “Beige Book” of anecdotal reports from around the country. 

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser wish you a safe, sound and prosperous investment future.

About Adviser

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.