May 2021 | Equity Commentary

Published on June 2nd, 2021

May 2021 | Equity Commentary

Marketing Overview

U.S. equity markets moved slightly higher in May but rising inflation concerns led to more volatility during the month. However, there is little doubt about the momentum of corporate fundamentals heading into summer. As of the end of May, nearly all of the S&P 500 companies had reported Q1 2021 earnings, with 87% posting positive earnings-per-share (EPS) surprises. That is the highest percentage beating estimates since at least 2008. European equities produced better returns than U.S. equities in May, as daily vaccination rates in Europe passed the U.S. for the first time. The ‘rolling’ global economic reopening that started with China and moved to the U.S. is now approaching Europe, which we believe bodes well for global economic growth forecasts in the quarters ahead.

Inflation took center stage as a headline risk in May, driving elevated volatility in the middle of the month, before Federal Reserve governors shared their views that inflation was likely transitory, and these comments appeared to calm markets. U.S. consumer prices jumped in April by 4.2% from a year earlier, marking the biggest 12-month increase since 2008. To be fair, April 2020 was early in the pandemic, so the base effect (comparing last year to this year) is a big reason for the steep jump. The more telling data point, in our view, is the 0.9% increase in core inflation from March to April, the biggest rise in monthly inflation since 1981.

Many readers have likely noticed signs of inflation in the economy. The national average for a gallon of gas crossed $3 a gallon for the first time since November 2014, lumber prices have more than doubled in 2021 to date, and copper prices are over 30% higher. For the first time ever, the average price paid for a used car rose above $25,000.

The housing market has also seen pronounced price pressures. The S&P CoreLogic Case-Shiller National Home Price Index jumped 13.2% from March 2020 to March 2021, which is the highest annual rate of price growth since December 2005. The U.S. Commerce Department reported that the median price of a new home sold in April was $372,400, which marked a 20.1% increase over the last year. That’s the biggest annual surge in new home prices since 1988.

Supply and demand imbalances in the housing market may ultimately correct themselves. Data over the last few months indicates that lack of inventory and higher prices are causing home sales to cool off – existing home sales have declined for three straight months and fell 2.7% from March to April. The share of consumers who said they plan to buy a house also fell to its lowest level since 2013. The pandemic catalyzed many structural changes in business and the economy, and it may have also fueled a rapid wave of migration that could abate in the coming quarters and years.
The Federal Reserve and the financial media seem to be in a tug-of-war over the inflation narrative. The Federal Reserve has been leaning into the ‘inflation as transitory’ narrative while some in the financial media have been framing long-term inflationary issues as a foregone conclusion. Both sides offer valid arguments, but investors may be better served to sidestep the debate and simply keep an eye on the 10-year U.S. Treasury Breakeven Inflation rate. This measure has seen a significant rise over the last year, but stalled in May at around 2.4%. We would attribute the pause to the rate of increase in previous months, a softening of long-term inflation expectations, and strong continued demand for government securities.

The U.S. economy continues its rapid recovery, supported by the reversion to normalized pre-pandemic activity, monetary accommodation, and fiscal stimulus. A key metric in U.S. labor markets, initial unemployment claims, fell to a new pandemic low at the end of May. Claims came in just above 400,000, better than most economists estimates and confirming a steady downward trend. Initial jobless claims are now at their lowest levels since the pandemic’s onset. Consumer confidence also remains on a upward trend, and while it has yet to reach pre-pandemic levels, appears poised to do so perhaps later this year.

Internationally, Europe appears to be turning a corner on the pandemic, with 30% of adults now vaccinated compared to about 50% in the U.S. Europe reached a new milestone in May, however, surpassing the U.S. in daily doses administered. As the E.U. emerges from recession and joins the U.S. and China in its return to growth, we expect the global economy to gain momentum as the year progresses. Overall, while we continue to keep a watchful eye on the risks posed by rising interest rates and inflation, we still believe the most prudent course for equity market participants is to remain broadly invested to capture the benefits of global reopening.

As of May 31, 2021

7 Financial Planning Lessons for Life Following COVID-19

Published on May. 25, 2021

April 2021: American Funeral Director “7 Financial Planning Lessons for Life Following COVID-19” by Tim Hermann

COVID-19 disrupted many aspects of our everyday financial lives, whether in business, personal finance or estate planning. Many of us would prefer to forget the challenges and losses of the last year and just move on. I get that – but before you wipe the slate clean to start the new year, I think it’s useful to consider what lessons we can walk away with. For savers, spenders and investors, I’ve got seven lessons to share.

Read the Full Article Here

Source: Published in American Funeral Director Magazine

The Great Inflation Debate

The Great Inflation Debate

Published on May 17th, 2021

The S&P 500 declined 4.0% from May 10 to May 12, the largest three-day selloff in five months. The Nasdaq composite declined 5.2% and the Russell 2000 index of small capitalization stocks declined 6.0%. We believe investor concerns about inflation sparked the pullback.

On May 12, the U.S. Bureau of Labor Statistics reported that its widely followed Consumer Price Index increased 4.2% in April as compared to the year ago period.1 The CPI increased 0.8% as compared to the prior month, seasonally adjusted. These price increases were higher than expected.2 They were also an acceleration from the growth rates reported in March. The annual increase was the largest in twelve years.

Investors had been bracing for higher inflation to show up the data. One reason is that prices in the year ago comparison period were depressed by the pandemic, a phenomenon known as the base effect. But growth in the April price index as compared to the prior month also accelerated, which cannot be attributable to the base effect.

Most observers believe that inflation is picking up in the U.S. The great debate is whether this increase is transitory. Investors and policymakers typically pay little attention to one-time changes in the price level. But a persistent inflationary environment can be pernicious. It can grow out of control if left unchecked, eroding both consumer purchasing power and corporate profitability. It could weigh on the U.S. dollar, reducing the allure of the U.S. capital markets for foreign investors. And if monetary or fiscal policy is tightened to address runaway inflation, it could choke off the economic recovery.

We divide the current drivers of inflation into three categories. The first is the post-pandemic economic reopening. In April, airline fares increased 9.6%, hotel room rates increased 8.1%, and car rental rates increased 82.2%.1 These were driven by the base effect as prices were depressed a year ago. We expect travel and similarly impacted service industries to increase supply and catch up with demand in the coming months, suggesting this category is likely a source of transitory inflation.

The second category is the knock-on effect of supply chain bottlenecks. Winter Storm Uri shut Gulf Coast chemical plants in February. The Suez Canal was blocked for six days in March, distorting global trade flows. A fire at a Japanese semiconductor plant in March exacerbated a pandemic-induced chip shortage. We believe events like these contributed to a 21.0% increase in used car prices in April, as supply chain constraints prevented automakers from sufficiently replenishing new vehicle inventories at dealers, increasing the value of used vehicles.1 While there is a litany of supply chain issues, we expect most to be resolved in the coming months, suggesting this is another source of transitory inflation.

The final category is labor cost inflation. We believe this is the area of greatest concern, because wage increases tend to be sticky, and increasing labor supply may be more challenging than other inputs to production. Recently there have been signs that labor supply has not kept up with demand. On May 11, the Bureau of Labor Statistics reported that U.S. job openings in March reached 8.1 million, a record level.3 This occurred despite surprisingly anemic nonfarm payroll additions of 266,000 in April, also reported by the BLS on May 7.4 The increase in average hourly earnings in April was a meager 0.3%, but that is because a pronounced mix shift toward lower-wage workers masked more rapid wage inflation within categories.4 The tight labor market may have manifest itself in the 3.6% increase in restaurant prices recorded in April, as labor is the largest expense item at most restaurants, and, unlike other reopening beneficiaries, this category did not see price compression in the year ago period.1,5

Several unusual factors are coming together to suppress labor supply. Fortunately, these may be addressed in the coming months. Some able workers have left the labor force due to fear of contracting or spreading infection. But additional vaccine distribution, the steady reduction in new Covid cases since mid-April, and the May 13 relaxation of guidelines by the Centers for Disease Control and Prevention may give these workers the confidence to return to employment.6 Others have left to care for children, as about half of U.S. school districts remain in hybrid instruction mode.7 This could improve in the coming weeks as schools close for summer vacation and households with children transition to fully in-person options like day care or summer camp where necessary. Generous unemployment insurance may provide an incentive for some workers to remain unemployed.8 While the $300 weekly Federal Pandemic Unemployment Compensation benefit expires September 6, many states are reacting to the possible disincentive to work by ending it earlier, removing another potential obstacle to labor supply growth.9 

Recent comments by Federal Reserve committee members suggest the central bank leadership continues to view the recent pickup in inflation as a transitory development.10 We believe these comments have helped to calm the capital markets in recent days, as they indicate the Federal Reserve is unlikely to respond to the recent inflationary data releases by tightening monetary policy. This is consistent with the long-term policy framework revision the Federal Reserve adopted in August, in which it targets an average inflationary level of 2% over time.11 Under its revised framework, the Federal Reserve may aim to respond to persistent disinflation as occurred over the last ten years by engineering an overshoot, or price gains moderately above the average 2% target for some time.

Our point of view in the great debate is aligned with the Federal Reserve: We believe the recent pickup in inflation is likely to be transitory. That said, there are of several types of disconfirming evidence whose emergence might give us pause to reconsider. If CPI and other inflation measures continue to exceed expectations, and the sources of inflation broaden to include larger and stickier components of household spend, such as shelter and health care, it would suggest that inflation may persist. In the labor market, if job openings remain at record levels, nonfarm payroll additions stagnate, and wages accelerate, we would fear a pernicious wage-price spiral taking hold. In the capital markets, the forward inflation curve implied by Treasury Inflation Protected Securities remains inverted.12 If a selloff in long-term TIPS flattened the curve, removing the inversion, that would suggest fixed income investors are anticipating a prolonged inflationary period.

If investors fear inflation will persist, we believe they will favor value stocks, and interest rate sensitive stocks, such as banks. This was apparent in the three-day selloff, as value outperformed growth, and banks outperformed the broader market.2,12 Over the last year, we have been gradually repositioning our equity portfolios to benefit from the reopening trade. This included a shift toward value and interest rate sensitive stocks. Therefore, we are already somewhat prepared for a more sustainable inflationary environment. However, we also added to cyclical exposure as part of our reopening thesis. These stocks could be vulnerable should investors worry that tighter than expected monetary and fiscal policy could slow economic growth or even spark recession. From May 10 to May 12, the Russell 1000 Value declined 3.3%, the Russell 1000 Growth declined 4.8%, the BKX bank index declined 2.9%, and the S&P 500 declined 4.0%.

In our fixed income portfolios, we have been positioned for rising interest rates for some time. This includes holding a shorter duration than our benchmark, which reduces the portfolio’s sensitivity to rising rates. We have also invested in fixed-to-floating rate securities, which may hold their value or even appreciate as interest rates rise. In addition, higher interest rates enable us to invest the funds from maturing securities into higher yielding replacements, generating more income over time than would otherwise be possible, without taking on additional risk.

1Source: U.S. Bureau of Labor Statistics. Consumer Price Index Summary. May 12, 2021.

2Source: Bloomberg and Roosevelt Investments.

3Source: U.S. Bureau of Labor Statistics. Job Openings and Labor Turnover Summary. May 11, 2021.

4Source: Bureau of Labor Statistics. Employment Situation Summary. May 7, 2021.

5Source: Wall Street Journal. Some, But Not All, of the Price Jump is Transitory. May 12, 2021.

6Source: U.S. Centers for Disease Control and Prevention. Interim Public Health Guidelines for Fully Vaccinated People. May 13, 2021.

7Source: Davidson College. Return to Learn Tracker. May 14, 2021.

8Source: Wall Street Journal. More States to Reject Extra $300 Payment for Unemployed. May 11, 2021.

9Source: Wall Street Journal. Fed’s Clarida Surprised by Inflation Report, But Stresses Need to See More Data. May 11, 2021. Fed’s Waller Says Inflation Jump Likely Temporary, Urges Patience. May 13, 2021.

10Source: Federal Reserve. Federal Open Market Committee Announces Approval of Updates to its Statement on Longer-Run Goals and Monetary Policy Strategy. August 27, 2020.

11Source: Federal Reserve Bank of St. Louis and Roosevelt Investments. On May 14, 2021, the TIPS implied five-year breakeven inflation rate was 2.68%, which was greater than the five-year, five-year forward inflation expectation rate of 2.34%.

12From May 10 to May 12, the Russell 1000 Value declined 3.3%, the Russell 1000 Growth declined 4.8%, the BKX bank index declined 2.9%, and the S&P 500 declined 4.0%.

April 2021 | Equity Commentary

Published on May 10th, 2021

April 2021 | Equity Commentary

Market Overview

The good news continued in April, with the S&P 500 index crossing 4,000 for the first time. The U.S. economy posted real GDP growth of 6.4% in Q1, nearly surpassing the pre-pandemic level of GDP. Earnings season in the U.S. is also off to a strong start, with better-than-expected results arriving as pandemic risks fade into the background. In our view, growing optimism is being reflected in sustained investor appetite for risk assets.

Earnings season is in full swing, and early signs indicate American corporations are in robust financial health. As of April 30, 87% of reporting S&P 500 companies delivered better-than-expected results, which is far higher than the historical average of 65%. Should the trend largely hold, corporate America could deliver the highest share of quarterly earnings beats since 1994.

Importantly, corporations are not just barely beating estimates—they are surprising significantly to the upside. According to data firm Refinitiv, corporations have historically beaten estimates by an average of 3.6%, but so far in Q1 2021, profits have been averaging 22.8% above expectations. All told, the recent string of strong results has S&P 500 companies on track to post their fastest rate of earnings growth since at least 2010. The caveat is that corporations have the benefit of coming off historically weak comparisons in 2020, but at the same time, earnings have rarely looked this good.

Retail sales and capital goods orders have surged beyond prior cycle peaks, which suggests more upside to S&P 500 revenue forecasts in the coming months. After the 2008 Financial Crisis, it took retail sales and capital goods orders 41 and 46 months, respectively, to pass prior peaks. In aggregate, these economic readings suggest the US economy is experiencing one of the strongest recoveries in decades.

The labor market is also showing signs of marked improvement, with the number of job openings very close to its pre-pandemic peak. Weekly unemployment claims and monthly layoff announcements have fallen to post-pandemic lows. In the Fed’s recently published Beige Book, a common theme emerged: employers were reporting shortages of workers, and many said they were having difficulty hiring. Among the areas reporting the most shortages: drivers, entry-level workers, childcare, nurses, and information technology. In other words, a fairly diverse range of jobs.

The labor force is estimated to be 5 million lower than it was before the pandemic, as many people dropped out of the labor force for a variety of reasons – boomers retiring, women staying home for childcare, people fearful of catching and spreading the virus, and/or folks who are content living on expanded unemployment benefits. But the large number of job openings—and employer frustration in filling them—may be best explained by the Economic Policy Institute’s Heidi Shierholz: “One reason is that in a system as large and complex as the U.S. labor market, there will always be pockets of bona fide labor shortages at any given time. But a more common reason is employers simply don’t want to raise wages high enough to attract workers. Employers post their too-low wages, can’t find workers to fill jobs at that pay level, and claim they’re facing a labor shortage.” April’s weaker-than-expected jobs report – with U.S. employers adding 266,000 jobs versus the expected 1 million – may be anecdotal evidence of Ms. Shierholz’s theory playing out.

Only a few weeks after the passage of the $1.9 trillion American Rescue Plan, President Biden is now pushing another $1.8 trillion package called the “American Families Plan” (this in addition to the $2.3 trillion infrastructure plan). This plan aims to expand educational opportunities and childcare, funded partly by the largest proposed tax increase on wealthy Americans in decades. The initial proposal for tax increases includes pushing the top marginal rate for individuals to 39.6%, increasing corporate taxes to 28% from 21%, and raising capital gains taxes to 43.4% for individuals who earn over $1 million annually, inclusive of the 3.8% net investment income surtax. Treasury Secretary Janet Yellen is also negotiating with foreign allies to institute a global minimum corporate tax.

It’s quite a bit to digest. Government spending feeds directly into GDP growth, but higher taxes can create distortions in the markets, particularly if the capital gains rate is doubled for a slice of the population. Efficient allocation of capital is another story altogether. At the end of the day, we know from history to watch what politicians do, not what they say. With a narrowly divided Congress, many of these proposals will likely be watered down if they make it to the finish line at all. The biggest risk to the markets in the interim, in our view, could be the legislative uncertainty to follow.

The U.S. has arguably turned a decisive corner in the battle against Covid-19. Hospitalizations in Michigan – the worst hot spot in the U.S. – are falling again, and some states are reporting zero new coronavirus deaths for the first time in a year. More than half of American adults, or close to 150 million people, have received at least one vaccine dose. In the EU, officials have finally accelerated the pace of vaccinations to the point where they are above the rate in the U.S., helping to spur a material downturn in new infections there. Brighter days look to be ahead.

As of April 30, 2021

April 15, 2021: Update on Financial Markets – 2021: The Year of Reopening

Published on Apr. 16, 2021

April 15, 2021: Update on Financial Markets – 2021: The Year of Reopening

Jason Benowitz, CFA, CMT®, Senior Portfolio Manager and Richard Konrad, CFA, CFP®, Director of Value Strategy, sit down to discuss:

  • Covid-19: the light at the end of the tunnel grows brighter
  • Fiscal Policy: short-term support and long-term debate
  • Interest Rates: you can have too much of a good thing

First Quarter 2021 | Fixed Income Commentary

Published on April 16th, 2021

First Quarter 2021 | Fixed Income Commentary

Market Overview

The Current Income Portfolio (CIP) declined by -1.04% during the first quarter, with corporate bonds declining by -1.77% and preferred securities by -1.03. On a relative basis, CIP’s corporate bonds outperformed the intermediate corporate bond index return of -2.19% and CIP’s preferred securities outperformed the Wells Fargo Preferred Stock ETF (PSK) return of -1.38%.

U.S. Treasury yields increased throughout the first quarter, with the market-implied first interest rate hike by the Fed moved up to December 2022, rates climbing by over 60-80bp in each of the 5, 7 and 10-year U.S. Treasury note maturities, and the 2Y – 10Y segment of the curve growing steeper by almost 80 bps.

The sharp rise in yields drove longer duration securities to underperform to a greater degree, in both corporate bond and preferred securities markets, as their higher sensitivity to changes in interest rates effectively translated into greater losses from the move higher in rates. As a result, CIP’s corporate bonds outperformed the intermediate corporate bond market due to CIP’s slightly shorter duration. CIP’s preferred securities also slightly outperformed PSK due to CIP’s shorter duration as well as to its greater allocation to institutional fixed to floating rate preferred securities. CIP’s institutional $1,000-par preferred securities gained by about 0.94% in the first three months of the year, whereas CIP’s retail $25-par preferred securities declined by -1.55%. Institutional preferred securities, which all have fixed to floating rate coupons, held up better than retail fixed rate preferred securities due to the nature of their coupon structure, in that the floating rate component can sometimes benefit from expectations of higher interest rates. Credit spreads remained steady throughout the month, with CIP’s corporate bond credit spreads ending the quarter unchanged, relative to the prior quarter, and CIP’s preferred securities credit spreads widening slightly.

Looking forward, we expect that the impact of fiscal stimulus and vaccination progress should continue to boost economic growth and remain supportive of credit risk assets. Moreover, the Federal Reserve remains committed to highly accommodative monetary policy over the near term, with the ability to adjust the rate paid on excess reserves as well as the average maturity date of monthly asset purchases, should the need arise to make further adjustments. In addition, retail flows and demand for new issues in U.S. credit markets continue to be strong, despite the slightly negative total returns year-to-date, and yields in the U.S. also remain attractive to foreign investors on a hedge-adjusted basis.

While these factors are supportive of current valuations, CIP is positioned defensively with respect to the possibility of rising rates. Client accounts are currently funded with a shorter duration than the intermediate corporate bond market, and the duration of existing accounts edges even lower as time passes. In addition, by including fixed to floating rate coupons and limiting the fixed rate preferred securities coupon purchases to those with coupons at or above 5%, we believe CIP’s preferred securities allocation is positioned to perform opportunistically, in relative terms, than other fixed rate instruments if interest rates rise. In fact, with about one-third of the portfolio maturing in the next 1-3 years, we look forward to the opportunity to reinvest the proceeds into higher yielding securities in the future. We continue to seek to provide investors with high quality, risk adjusted, high current income without taking on excess credit or interest rate risk to do so.

As of March 31, 2021

Jason Benowitz Featured in Reuters “US STOCKS-Wall St ticks lower in choppy trading ahead of Fed minutes”

Published on Apr. 8, 2021

Jason Benowitz Featured in Retuers “US STOCKS-Wall St ticks lower in choppy trading ahead of Fed minutes”

“The Fed leadership has generally not been concerned with the recent rise in interest rates, suggesting it reflects a pickup in growth rather than inflation. Any signs of inflation is … generally expected to be transitory,” said Jason Benowitz, senior portfolio manager at the Roosevelt Investment Group in New York.

Read the Full Article Here

March 2021 | Equity Commentary

Published on Apr 7, 2021

March 2021 | Equity Commentary

Market Overview

To say investors embraced “risk-on” sentiment in the first quarter may be an understatement. Most risk assets and equity categories moved higher, with value stocks and small-caps posting the biggest gains. Growth stocks moved higher, but continued to face growing headwinds from rising interest rates. We have noted in previous commentaries that extraordinary stimulus measures could result in excess liquidity sloshing around the financial markets. More liquidity supports higher prices, but it can also push investors too far out onto the risk curve (cryptocurrencies, GameStop, etc.). We believe it is important to focus on quality and to avoid “chasing” in this type of environment. For March, the S&P 500 was up about +4.4%, and this index returned +6.2% in the first quarter.

President Biden signed the $1.9 trillion ‘American Rescue Plan’ into law on March 11. The bill includes direct payments to most American households, a significant expansion to the child tax credit, an extra $300/week in unemployment benefits through September 6, and billions of dollars across state and local education, Covid-related public health measures, and additional business loans.

There is plenty more in the bill. To appreciate the scope of direct payments, consider a young, middle income family with three kids. By qualifying for the stimulus checks and the child tax credits, the family could receive perhaps $15,000 from the federal government. In short, the bill is massive, and a majority of dollars are making their way into the real economy.

The labor market continues to show signs of stabilizing. In the last week of March, just over 714,000 people filed for state unemployment benefits, which was up slightly from the week before, but still marks drastic improvement since the pandemic began. Overall hiring accelerated for the month, with U.S. employers adding a seasonally adjusted 916,000 jobs—the strongest gains since August 2020. There are more job seekers entering the labor market and more job postings available, a good sign the recovery is gaining momentum. The unemployment rate fell to 6.0%.

The tanker blocking the Suez Canal made major headlines last month, putting additional stress on already strained global supply chains. The Suez Canal is responsible for facilitating about 13% of global maritime trade and 10% of seaborne oil shipments, making any delays meaningful. The Suez bottleneck was not the only problem in March—in the ports of Los Angeles and Long Beach, dozens of container ships were continuously waiting to offload medical equipment, consumer electronics, fuel, and other goods. These two California ports handle over 30% of U.S. container imports, which helps explain delivery delays and issues with inventory restocks in the U.S.

Perhaps the most acute shortages are being seen in the supply of semiconductors, initially caused by manufacturers being caught off guard by surging demand, as the U.S. economy began its sharp recovery last spring. Demand typically declines in recessionary periods.

Supply issues were later exacerbated by even stronger demand as global economies recovered, and were dealt a further blow by a serious fire at a Japanese semiconductor manufacturer—which will likely curtail supply for at least a month. Semiconductors are used in cars, and several automakers have been forced to halt production of various makes and models due to lack of essential components. The end result is that factories are reporting the sharpest rise in prices for inputs they’ve seen in nearly 10 years, which could add to inflationary pressures this year.

The 10-year U.S. Treasury bond started the year yielding 0.9%, and as of April 1 yields 1.7%. A growing economy and expectations for higher inflation—two conditions present in the current environment—could continue pushing rates higher. We have long expected interest rate ‘normalization’ as the economy shifted back into growth mode, so rising rates do not necessarily send off any alarm bells. Rates are still very low in a historical context.

Looking ahead, inflation may be of more concern. Inflation can be pernicious if it ‘runs away’ or is left unchecked—it can suppress growth in the real economy and diminish medium- to long-term return expectations in the capital markets. In the U.S., however, the issue of the last decade has been not enough inflation, so in the short-term, higher inflation would arguably be welcomed. In a testimony to Congress this month, Chairman Powell seemed to err on the side of not worrying: “[The Fed] might see some upward pressure on prices. Our best view is that the effect on inflation will be neither particularly large nor persistent.” He also added that the Fed, for now, remains strongly committed to accommodative policy given the economic recovery still has plenty of runway.

Should inflation become an issue down the road, it is important to remember the Federal Reserve has a range of tools to combat rising prices. Raising the interest rate it pays banks on excess reserves, reducing or ending bond purchases, raising the federal funds rate—these are just a few examples of policy decisions the Fed could implement to fight inflation.

There are also deflationary forces still at work in the U.S. economy. Technological innovation has lowered the prices of many goods and services over the last few decades, and aging baby boomers are entering a period in their lives when people typically consume less, which could be a drag on demand. The pandemic appears to be accelerating retirement for many boomers, which could be another neutralizing force on price pressures.

Apart from the recent surge in Michigan and slightly higher case numbers nationally, pandemic news was largely good throughout the month. Hospitalizations and deaths continued on a downtrend, and better weather has created more spending opportunities for consumers. Air travel is also returning to levels not seen since the early days of the pandemic, underscoring the eagerness of Americans to return to normal life. Stocks have been wavering between the ‘reopening’ trade and the ‘shutdown’ trade, as investors grapple with whether companies that benefited last year during the shutdown will be able to grow as strongly now that economy is reopening.

Our largest concern about the pandemic over the past few months had been the potential for another wave of infections to sweep the country, necessitating additional shutdowns. However, with the dramatic decline in cases from the peak as well as accelerated vaccinations, we now believe it is unlikely we will see another significant wave. This, in addition to the improvement in economic data we have seen over the past month, gives us more optimism looking ahead.

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What the Inflationistas May Be Missing

Published on Mar 18, 2021

What the Inflationistas May Be Missing

Commentary

Investors are concerned that rising interest rates could choke off a nascent recovery. Many economists agree that long-term Treasury yields are rising because investors expect more growth and inflation. While these might be good things, you can have too much of a good thing. In particular, the pace of change matters: the roughly 75 basis point increase in the 10-year Treasury yield in the first ten weeks of this year is a rapid adjustment that creates the potential for disruption.

While we continue to monitor the situation, at this point our concerns have not reached the level where we find it necessary to safeguard our equity or fixed income portfolios from this risk beyond the natural diversification steps that we ordinarily take.

Presently, the potential for inflation is a source of angst in the investment community. But these inflationary fears come against a backdrop of decades of disappointingly low inflation, or disinflation. The drivers of disinflation have not gone away; indeed, some have intensified. Demographic pressures weigh on aggregate demand, as the proportion of U.S. residents past retirement age marches higher. Digital disruption pressures prices across the economy, with the pandemic accelerating this trend. On the other hand, globalization has stalled in recent years. While changes to trade policy may restore some global linkages, the post-pandemic priority of supply chain resilience over cost could reduce the disinflationary influence of this factor going forward.

Those who argue that we are on the cusp of outsize inflation typically focus on the nexus of fiscal stimulus, household savings, and pent-up consumer demand. However, this ignores the supply side of the economy, which will also grow with reopening. Supply growth may address shortages, relieving some pricing pressures. The nearly ten million unemployed U.S. workers is a lot of slack capacity in the labor market, which makes it difficult for pernicious inflation to sustain itself via a wage-price spiral.

Inflationistas further argue that price increases in commodities like crude oil, agricultural crops, copper, and lumber will be transmitted through the economy. But commodity prices similarly ran hot at the outset of the last economic recovery, while inflation did not follow. The U.S. economy is complex with many links in the chain that converts raw materials to finished goods. Higher corn prices on the farm are not sure to translate into higher cereal prices at the supermarket. Moreover, U.S. economic output under normal conditions is about 90% services and 10% goods. Goods inflation alone is therefore unlikely to have much of an impact on the overall economy.

There is also the unprecedented pace of asset purchases by the Federal Reserve, which has increased the money supply by about 25% from pre-pandemic levels. But the central bank purchased significant assets in the prior recovery without stoking inflation. One reason for not stirring up inflation was the payment of interest on excess reserves, a practice the Federal Reserve initiated in 2008, which creates an incentive for banks to deposit funds at the central bank, rather than lend them out. If the Federal Reserve were concerned about inflation today, it could raise the interest rate on excess reserves, which would slow the leakage of money supply growth into the real economy. This is a tool with little cost other than the political optics of paying out more to the banks. The Federal Reserve could go further if necessary, by tapering its asset purchases or raising its benchmark interest rate, but those steps would weigh on real economic activity.

Endorsing this view, Treasury Secretary Janet Yellen said last week that the Federal Reserve has learned how to manage inflation. Because of depressed comparisons in the year-ago period, inflation measures could accelerate in the coming months, generating headlines, but we expect those impacts to be transitory. Inflation expectations remain well anchored, as measured by Treasury Inflation Protected Securities, or TIPS, whose prices imply a slowdown in medium-term inflation after a near-term pickup, an inversion that is rare for this market.

Interest rates could move higher without inflation if investors anticipate a faster pace of real economic growth. If this shift were to happen slowly, with a modest accompanying rise in inflation expectations, it would be the Goldilocks scenario that the Federal Reserve wants to engineer. But if the adjustment came too rapidly, it would be self-defeating, weighing on the economy and capital markets.

Fortunately, the Federal Reserve also has tools to manage this scenario. The easiest is to shift the weighted average maturity of its asset purchases out farther along the yield curve, a maneuver that was known as Operation Twist when it was last employed in 2011. The Federal Reserve could go further if necessary, by initiating a yield curve control mechanism, as currently practiced by the Bank of Japan, by changing its forward guidance to forecast zero interest rate policy further into the future, or by increasing the overall pace of asset purchases, though these more extreme steps carry additional risks.

In analogous periods historically, rising interest rates early in economic recoveries left choppy equity markets in their wake without provoking bear market drawdowns. Bear markets typically follow the last interest rate increase by the Federal Reserve, rather than the first. In our view, there could be less equity market disruption from higher interest rates in this cycle, because the Federal Reserve is more transparent, offering substantial forward guidance, and holding press conferences after each committee meeting.

Recent easing actions by the Bank of Japan and the European Central Bank could reduce the near-term risk of dislocation because sovereign rates in these nations act as an anchor on U.S. Treasury yields. Moreover, after the rapid advance in Treasury yields over the last ten weeks, it seems reasonable there could be a pause for digestion. Lastly, in April, the Federal Reserve added a temporary exception to its supplementary leverage ratio rule for large banks, allowing the banks to own Treasury securities without holding capital against them. The exception is due to expire March 31, and large banks may be reducing their Treasury holdings in advance of this deadline, pushing yields higher. Though it has become politically fraught, we expect the Federal reserve to continue the exception for at least some Treasury holdings for some length of time, which may reduce this source of pressure on yields in the near term.

February 2021 | Equity Commentary

Published on Mar 8, 2021

February 2021 | Equity Commentary

Market Overview

Stocks rallied in the first half of February, with both the S&P 500 and the tech-heavy Nasdaq posting fresh all-time highs. Stocks were ushered higher by a strong Q4 earnings season and progressively better news regarding the availability and administration of vaccines. However, equities felt pressure later in the month from rising Treasury bond yields, which generally tends to drive volatility in high growth/high valuations stocks. The Nasdaq’s performance in February reflected the dynamic between bond yields and stocks—the index gained more on the upside during the month, but also lost more on the downside. We expect this type of volatility to persist until the market has fully adjusted to the new level of rates. In spite of the choppiness, the S&P 500 still finished February with a gain of 2.8%, while the Nasdaq finished up 1%.

By the beginning of March, nearly all companies in the S&P 500 had reported quarterly earnings, and the results were good. 77% of companies reported positive earnings and revenue surprises, with an average earnings surprise of +16%. If 77% holds, it would mark the third-highest percentage of positive earnings surprises in 12 years.

S&P 500 companies also generally raised guidance for current and future quarters, a sign that boardroom sentiment is improving. Bloomberg estimates that S&P 500 companies ended 2020 with around $2.6 trillion in cash reserves, the highest level since 2013. If the pandemic risk continues to fade and the economy pushes along the path of recovery, there’s good reason to believe some of this corporate cash buildup will be returned to shareholders in the form of dividends, buybacks, or both. We may also reasonably expect higher levels of private fixed investment, a trend which is likely to boost economic activity in the coming years.

More fiscal stimulus is on the way. The House of Representatives has already passed a version of the Biden administration’s $1.9 trillion American Rescue Plan, which includes another $1,400 in direct stimulus payments, an additional $1,000 child tax credit, and an extension of unemployment benefits to August 29. The Senate passed its own version of the bill, which the House can consider, but the price tag is not likely to change. While we still believe $1.9 trillion may be overkill relative to the current economic situation, it is difficult to make the case that additional stimulus will hurt stocks or the economic recovery in the near- to medium term. There’s the old saying that investors should not “fight the Fed.” We think that investors should not fight the federal government, either.

It is quite possible that all of the extraordinary monetary and fiscal policies, taken together, could drive inflation higher. All three Covid-19 stimulus packages featured transfer payments made by the government directly to American households and businesses, in the form of stimulus checks, expanded unemployment benefits, PPP loans, and other small business loans which effectively became grants. The M2 money supply is rising at an unprecedented 25% year-over-year rate.

Inflationary pressures are already starting to show up in the commodities markets and in US Treasury bond yields. The price per barrel of crude oil has rallied +30% year-to-date, copper prices are +50% over the past year, and the cost of shipping freight is up over +200% over the same period. Lumber prices have also doubled over the past year on the heels of a housing boom, adding materially to the cost of a new home. It seems the debate is no longer whether we are stuck in a deflationary pattern, but rather how much inflation could surprise to the upside.

While higher inflation in 2021 and beyond is certainly a rising possibility, it is not a foregone conclusion. Other conditions that tend to spur higher inflation—such as tight job markets and a lack of spare capacity in the economy—are currently missing. We believe the real risk with inflation is that it also raises the risk of monetary tightening, which could inject volatility and weigh on valuations across the capital markets. The upshot is that the Federal Reserve is more transparent than ever, with very clear and frequent forward guidance being offered to the markets. We think it is premature to expect this Federal Reserve to change course any time soon, as recent minutes indicate no appetite for monetary tightening in the near-term.

Pandemic data continues to improve. The average number of vaccine doses eclipsed 2 million per day for the first time beginning on March 3, underscoring improvement in the campaign’s organization and execution. At the beginning of February, the daily average was about 1.3 million. We expect the figures should only get better from here, as the Johnson & Johnson vaccine was cleared by the FDA, and as Pfizer and Moderna both increased production. The federal government also scored a victory by brokering a production deal between Johnson & Johnson and Merck, two companies that are otherwise rivals.

We continue to be concerned about variants of the virus, as there is little data to date about the vaccine’s efficacy against new strains. Of particular concern is the P.1 variant discovered in Brazil, which early data suggests is more contagious and may have the ability to infect even those who have already had Covid-19. All signs point to the vaccines being strong enough to mitigate the onset of an entirely new pandemic, but more data is needed to understand the scope of the risk.

February 2021 Memorial Business Journal: “Financial Market Update: What Will 2021 Bring?” by John Roscoe

Published on Feb. 14, 2021

February 2021: John Roscoe Featured in Memorial Business Journal “Financial Market Update: What Will 2021 Bring?”

To paraphrase a famous line by author Charles Dickens: “2020 was the best of times, and it was the worst of times.” In fact, 2020 might end up being recorded as one of the wildest in history for investors.

Read the Full Article Here

Jason Benowitz Featured in TD Ameritrade Network “On the State of the Economic Recovery”

Published on Feb 12, 2021

Jason Benowitz Featured in TD Ameritrade Network “On the State of the Economic Recovery”

Jason Benowitz says that the path of the economy and capital markets will be determined by the path of the virus as the Fed and its global brethren continue to backstop the capital markets.


Watch the full video here
The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.

January 2021 | Equity Commentary

Published on Feb 8, 2021

January 2021 | Equity Commentary

Market Overview

Stocks began the year with modest declines, as the S&P 500 fell by just over 1% during January. Investors continue to wrestle with the crosscurrents of the ongoing Covid crisis and its economic implications on the one hand, and copious amounts of fiscal and monetary stimulus on the other. While risks remain elevated, we are optimistic that the ongoing vaccination efforts can go a long way toward restoring a semblance of economic normalcy over the next several months.

Economic data has been mixed in recent weeks. Industries which tend to be more exposed to the pandemic, such as travel, leisure, and entertainment, have struggled, while more insulated areas of the economy have fared better. The December jobs report was illustrative of this dichotomy, as in the aggregate the economy shed 140,000 jobs, but strip away the 372,000 losses in restaurants and bars, and the rest of the picture appears brighter. The majority of industries added jobs during the month, and the unemployment rate held steady at 6.7%. Retail sales have weakened of late, as December marked the 3rd consecutive month of sequential declines. It is likely no coincidence that this weakness has transpired during a period in which Covid cases were rising precipitously. While the pandemic has impacted many businesses negatively, the housing market has been a notable exception, as it has benefitted from both deurbanization and nesting trends, as well as the historically low mortgage rates available in the aftermath of the Federal Reserve’s interest rate reductions and asset purchases. Single-family starts and permits were quite strong in December, just the latest in a long line of healthy housing market indicators over the past several months.

The Federal Reserve held its latest FOMC meeting last month, and our takeaway is that the committee remains quite dovish. The Federal Reserve downplayed near-term inflationary concerns and reiterated that it remains premature to begin tapering asset purchases. Its base case for the economy is that strong growth is likely to resume as vaccines become more widely available, though it noted the downside risks associated with a slow initial vaccination rollout and new Covid variants. In our view, the Federal Reserves’ risk assessment is more heavily weighted towards the near term, while its longer-term outlook is more bullish. We therefore think it is all the more important that Congress was able to pass the most recent $900 billion fiscal stimulus bill at the end of December, and we believe that more aid will be forthcoming with Democrats now in charge of the executive and legislative branches. Historically, the central bank has been prone to tighten policy in response to financial market instability, and in this regard, there was some concern that froth in certain pockets of the market might force the hand of the Federal Reserve. Federal Reserve Chairman Powell, however, allayed these concerns by making it clear that he is far more concerned with achieving his goal of maximum employment, the implication being that monetary policy is likely to remain highly accommodative for the foreseeable future.

President Biden recently proposed a $1.9 trillion fiscal stimulus plan, which is largely comprised of increased unemployment benefits, additional stimulus checks, support for state and local governments, and funding for coronavirus vaccinations and testing. Republicans have most recently countered with a $600 billion proposal of their own. While Democrats could use the budget reconciliation process to enact much of $1.9 trillion in support that they are seeking, President Biden has suggested that his preference would be to work with the GOP to reach a mutual agreement. Ultimately it appears highly likely that some degree of incremental stimulus will be passed. With today’s economy being significantly stronger than it was last year when the CARES act was enacted, we do not think that the full $1.9 trillion is necessary. In our view, any amount in between the range of the two proposals would be sufficient to support the economy and satisfy capital markets. We are cautious, however, that inflation could create challenges over the long term. Over time, as the economy fully reopens, the release of pent-up demand alongside of the lagged effects of historic amounts of fiscal and monetary stimulus could unleash a powerful growth phase. This could drive inflation higher and take bond market yields with it, creating a less favorable environment for stocks, in our view.

Covid remains a key risk factor for the economy and capital markets. The path of the pandemic will likely dictate the future course of the economy, and in this regard, we are concerned with the latest variants of the virus which may be more highly transmissible, and perhaps less vulnerable to the current generation of vaccines. It is therefore not out of the realm of possibility that we see yet another wave of infections, perhaps during the spring. That being said, it does appear that vaccines remain effective in reducing worst-case outcomes from the new coronavirus strains. That could make a potential next wave less problematic for the economy, as we assume that policy makers would be less likely to impose additional lockdowns if there was a lower probability that the health care system would be overburdened without them. While risks remain elevated, we are optimistic that between the vaccinations currently being administered, and those in various phases of development, that the resources are available to foster a return to normalcy over the near to intermediate term.

Reddit Mania Overshadows Outstanding Earnings Season for Tech

Published on Feb. 6, 2021

Febuary 2021 Jason Benowitz’s commentary featured in Bloomberg: “Reddit Mania Overshadows Outstanding Earnings Season for Tech”

Anyone distracted by the Reddit-fueled circus in stocks this month may have missed an important fundamental story: A stellar earnings season for technology companies that helped the group’s shares outperform the market once again.

Read the Full Article Here
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