By Maurice Stouse, Financial Advisor and Branch Manager
As 2022 ended, investors saw the year bring a 400% increase in interest rates and a $400 billion liquidity draw down by the Federal Reserve. Despite that, homeowner spending on mortgage payments, as a percentage of their monthly costs, was at a 60-year low. Housing makes up over 20% of the economy and accounts for about a third of inflation (based upon CPI). Stocks and bond values both saw significant drawdowns, or negative returns for the year. Housing has been in descent recently, but nowhere near the drawdowns of those. At least not yet. The demand for housing is as strong as ever; it is the affordability that brings values into question now. Finally, the U.S. Dollar (USD), had one of its strongest years on record. It had significant gains against almost all foreign currencies. Going forward, what might be on investors’ minds?
First, let’s look at some recent developments: The passage of the Secure Act 2.0 means that mandatory distribution ages will be extended from retirement accounts and contribution limits will be increased. This is to compensate for the burden of retirement saving moving away from the assurances of pension plans to the shoulders of the individuals to save and plan for their retirement.
Liquidity is slowly drying up. The Federal Reserve continues to slowly draw down all the excess or extra liquidity, or cash assets it created over the past few years. That means that there is not as much money chasing assets be they stocks, bonds, real estate, crypto, NFTs, or art. Perhaps the markets are coming back into reality where investors are paying for growth and profits more than from having excess or extra liquidity. That could prove to be a good thing for assets in the long run.
Contrarian investing for times like these: Does it make sense to be a contrarian investor? We think, given a particular opportunity, that clients might want to go against conventional wisdom or sentiment. That is what contrarian investing means. The institutions and the media don’t always get it right in our opinion. In this case, we examine higher rates and the impact on Financials: Many research firms and analysts (Raymond James among them) report they expect a lot of volatility in the sector (made up mostly by banks) over this next year. We note that some of the larger banks in the nation see higher rates as an opportunity for them to earn on their own cash assets even as they pay more for deposits. When the Fed raises the Fed Funds, or overnight rate, banks earn more on their excess assets that they park at the Federal Reserve or other banking institutions. Nonetheless many investors worry about shrinking margins on bank loans and of course if the economy goes into recession, that could increase the potential of losses on loans. We come down on the side that these higher rates will ultimately boost the Financials sector and suggest investors look to increase holdings in this area.
Innovations needed and therefore arriving in the Energy Sector. Take a look at what is emerging when it comes to cleaner energy. That means the nuclear sector. Professional investors are increasing their investments in nuclear technology, and it is showing in asset valuations. October was one of the strongest months for nuclear type energy stocks.
Next, consider the happenings with microprocessors, or computer chips. The drawdown on these stocks has well exceeded the drawdown of the broad market and we think they could offer some value for interested investors. The innovations being worked upon now are extraordinary (and might take years to be seen). We read and see things such as an entire data center (think the cloud) being placed upon one chip, one day. Most innovation and design work are done in the USA while the manufacturing is primarily taking place overseas, but not in China. China, as we understand it, is highly reliant upon the import of advanced chips to go into the things it assembles or manufactures for export. There is no design or manufacture of advanced chips there. The USA is taking measures – along with its allies – to limit China’s access to this technology. Taiwan is quite vital for China, and they may be reluctant to upset their supply chain (as well as their global business partners) by trying to overtake Taiwan.
The case for cybersecurity and defense stocks (in the Industrials sector) is something we are taking note of as well. The advances in technology provide for higher standards of productivity and living but also the risk of cybercrime and cybersecurity. There are companies that are leaders in this technology through their innovation and creativity. We think investors should have a look there.
There are two types of investors: Institutional investors and individual or retail investors. On any given day institutional investors make up the bulk of trading both in dollar and share volume. Institutional investors are typically mutual funds, pension funds, endowments, banks, insurance companies or other similar type entities. When the media talk about what investors did on any given day, they most often are talking about institutional investors. The retail or individual investor is the person, or anyone acting on their own for their own account. It is interesting to note that as 2022 came to a close, individual investors were more apt to buy stocks or bonds vs institutional investors. Institutional investors were somewhat bearish late in the year. The big question is: Do institutions get it right? The world is replete with reports and opinions. Institutions would seemingly have the edge with vast research resources and perhaps lower costs. We leave it up to the reader to decide. However, our opinion, with some historical input, is that individuals can do just as well or perhaps better.
Other things to watch as 2023 progresses:
We suggest investors (individual investors that is) keep an eye on the strength of the dollar. Might foreign central banks (and the Bank of Japan being one recent example) be raising their rates and therefore become more competitive with the dollar? Will foreign central banks start to decrease their U.S. dollar holdings? International investments can benefit when exchange rates lead to a cheaper dollar. Should the dollar get cheaper by the way, that is what typically makes gold and other precious metals rally. U.S. companies who rely at least in part on overseas sales or revenues would most likely see an impact should the dollar decline in value vs. other currencies A weaker dollar makes them more competitive. The dollar’s strength, however, has proven beneficial for the U.S. as it has not been forced into raising rates more aggressively.
Inflation waned in the 4th quarter of 2022. We see that disinflation is accelerating and expect that trend to continue. Supply chains are opening again. There is little to no back up in cargo off the U.S. coasts now. The Federal Reserve has stated that it needs to get inflation to 2% (that is based upon PCE vs CPI by the way). We wonder if that is attainable in 2023 and if the Fed will be satisfied, at least for the time being, with a moderated rate of inflation closer to 4-5%. If so, we think interest rates are likely to stabilize. We see inflation and rates in that range.
Wage inflation has proven to be one of the most resilient factors of the cost of living over the past couple of years. Fewer and fewer workers have been the main culprit. Worker participation rates were reaching decades low levels in the last two years. Prior to the pandemic, worker participation rates (we see that as eligible workers 18-65 years old) were reaching significant highs. That was in part due to many Americans working longer than the retirement age of 65. The Social Security Administration now sees Full Retirement Age (FRA) closer to 70 than 65. During the pandemic the number of more senior workers who were retiring almost tripled. We see that as temporary as the number of older workers is beginning to increase again. Many Americans are choosing to work beyond age 65 or perhaps they have retired from one career and now are having an encore career. That, too, can have implications for investors.
The rise of technology and affluence drive some people to work longer as they seek to build their assets through income, increased saving and investing be it in stocks, bonds or real estate (second homes being one example). Also, younger workers are on the rise again. Many of them stayed home or extended time in college and many are now out and in the work force. What this all adds up to is greater labor supply and less pressure on wages, that key driver of inflation. In other words, the economy might solve for inflation just as quickly if not quicker than the Federal Reserve. So, as we see it, disinflation is accelerating in goods, in services and in wages.
To sum it all up for our readers, these scenarios would prove to be beneficial to stock and bond values. We suggest investors, regardless of how 2023 unfolds, always take into account the big three: 1) Investment objective – IO, 2) Time Frame – TF, and 3) Risk Tolerance – RT. Once those are defined, we suggest you then begin to put together that combination of investments for you to reach for and to attain your goals in this life.
Maurice Stouse is a Financial Advisor and the branch manager of The First Wealth Management/ Raymond James. The main office is located at The First Bank, 2000 98 Palms Blvd., Destin, FL 32451, phone 850.654.8124. Raymond James advisors do not offer tax advice. Please see your tax professionals. Email: Maurice.email@example.com.
Securities offered through Raymond James Financial Services, Inc., Member FINRA/SIPC, and are not insured by bank insurance, the FDIC or any other government agency, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risks, including the possible loss of principal. Investment Advisory Services are offered through Raymond James Financial Services Advisors, Inc. First Florida Wealth Group and First Florida Bank are not registered broker/dealers and are independent of Raymond James Financial Services. Views expressed are the current opinion of the author and are subject to change without notice. Information provided is general in nature and is not a complete statement of all information necessary for making an investment decision and is not a recommendation or a solicitation to buy or sell any security. Past performance is not indicative of future results.