September 30, 2023

By Andrea Young on September 30, 2023

Where’s Our Head

Market Commentary

What Changed?

September 28, 2023

The S&P 500 is down 5.4% since September 14. That’s a big move in a short period of time. The selloff began a few days prior to the Fed’s decision on interest rates, which was revealed on September 20. However, the selling gained steam following Chairman Powell’s press conference and has yet to relent. Clearly, there was something in the Chairman’s rhetoric that spooked stock investors. Up until that press conference, stocks had defied the sharp upward move in interest rates. In fact, the S&P 500 had risen nearly 10% from April 6, which was the date the 10-year Treasury yield bottomed out this year at about 3.30%, through September 14 (the beginning of the 5% correction). The yield on the 10-year is now 4.55%, nearly a 16-year high and a whopping 125 basis points above that April low. 

Maybe the question should be how stocks rose so much in the face of rising interest rates rather than why that trend broke in just the past couple of weeks. After all, low interest rates were a primary justification for high stock valuations for a very long time while the Fed kept interest rates artificially suppressed. One valuation technique that takes into consideration the level of interest rates is the equity risk premium, or the ERP. The ERP is a measure of the added return over the risk-free rate (yield on Treasury bonds) that investors require as compensation for investing in stocks. To arrive at the market ERP, we can simply subtract the yield on the 10-year Treasury note from the S&P 500’s earnings yield, which is simply the inverse of the price-to-earnings (P/E) multiple. The chart below shows the estimates of ERP in green, with the blue line representing the earnings yield on the S&P 500 and the orange line representing the risk-free rate (yield on the 10-year Treasury). You will see that the current ERP of 1.0% is the lowest it’s been in the past 20 years and well below the average of 3.6% over that period. This means that at the S&P 500’s current level, investors are only demanding a very small return premium to the current risk-free rate of 4.55%. 

As with any valuation model, there are inherent problems with the ERP. The most obvious is probably that almost nobody expects the risk-free rate to remain at the current level for the next 10 years. In fact, we could easily see that rate at a much lower level in 12-18 months as it becomes clear that the interest rate hikes to date are having a big negative impact on economic growth. If the 10-year yield were to settle at 3.0%, the ERP would increase to about 2.6% – much closer to historical averages. Still, the ERP is more informative than the P/E multiple because it incorporates the level of interest rates into stock valuations. 

Our calls for caution are suddenly looking more justified. This period of adjustment as the Fed keeps interest rates elevated in an effort to crush inflation could last a little while. This does not mean it’s time to give up on stocks. Missing just a few of the best trading days over long periods of time can dramatically impair long-term equity returns. Don’t be that person. Stay invested, but invested in quality companies that can endure what may come. 

Peace, 

Michael 

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Weekly Wisdom

A Government Shutdown Looms

September 28, 2023

Why a Shutdown and What Are the Impacts?

The United States government is on the brink of a potential shutdown, which could result in a multitude of ripple effects on the U.S. economy. Speaker of the House, Kevin McCarthy, has faced continuous roadblocks in his effort to pass new spending legislation. The opposition is focused on reining in longer-term spending, Ukraine funding and immigration spending specific to Eagle Pass.¹ Recall that McCarthy faced troubles when becoming Speaker of the House in January of 2023 and has since been forced to walk a tightrope amid threats to remove his speakership. Given the divisions within the U.S. Senate, there is a sense that a shutdown is becoming increasingly likely.

There have been 14 government shutdowns since 1980, many of which only lasted a few days.² The most recent shutdown lasted a lengthy 34 days, spanning from December 2018 and into January 2019, and cost the U.S. $3 billion – or 0.02% of GDP.³ During this period 800,000 out of the 2.2 million government employees were furloughed. If the government is unable to allocate funding to its 438 federal agencies by October 1, a shutdown will occur. It is estimated that this shutdown would be more costly than the last shutdown, reducing U.S. GDP by around 0.15% every day the shutdown persists.⁴

There are key differences between a government shutdown and the debt ceiling issue that the country faced earlier this year. The debt ceiling is a cap on how much the U.S. can borrow, and it needs to be periodically raised. If not raised, the U.S. would have to default on its debt, resulting in severe consequences like a recession and questions regarding the legitimacy of the U.S. dollar as the global reserve currency. This possible shutdown, driven by a lack of all federal agencies being funded, would not result in consequences as severe as a debt default, but would still have material financial impacts.

Where’s Our Heart

Advisor Spotlight

What’s your role at LWM?

Wealth Advisor.

Do you have a specialty we should know about?

At one point in my career, I worked as a convertible bond analyst. It was primarily credit analysis, but I like to believe that the same tools of critical discernment can carry over into portfolio and plan analysis.  

How important is overall financial planning with your clients?

Crucial. The plan is the framework for everything. The success of that dictates how one spends the latter part of their life and with how much emotional and financial well-being. Constructing a well-diversified portfolio is a means to achieving goals, but we first must determine what those goals are.  

What is your daily mantra – personally and professionally?

The Zen proverb, Chop Wood/Carry Water. On a metaphorical level, it speaks to the power of simple actions and the mindfulness, consistency, determination, and perseverance utilized in whatever the pursuit or goal. To maintain a still mind when physically busy enhances the ability to be more present, aware, and perceptive. Life is measured in blinks. The only moment in time that truly captures the experiential and involves the freedom of agency is the present. It is so hard to be there, but I try! 

If you were to listen in on your clients’ conversations with their friends and family, what would they say about you?

I think they might say that I listen. Truly listening to someone is what undergirds the power of empathy. There are situations where there are no words that can provide any real solution or solace. However, just being present and allowing someone to feel heard creates a profound and visceral connection that sustains us even through the hardest of trials.

How do you incorporate the head and heart with your clients? 

The early phases of advisor/client engagement are about building a relationship. The initial analysis is more qualitative than quantitative in nature. You will have clients who have lost jobs, marriages, relatives, financial security etc… If the very first thing you do under those circumstances is grab the calculator, then you don’t get it.

What is the biggest lesson you have learned in your career?

This field is relationship-driven. It is as simple as that. Many RIAs try to put their own twist on investment strategies & planning philosophies; but the real differentiator is the interpersonal piece. There is vulnerability involved in sharing deeply personal information. To instill trust, you must be emotionally invested, and if you are not, clients can easily sense that.

What is the most fun you have in your career?

There are a lot of moments where bad news needs to be delivered. However, there is nothing more rewarding and fun than delivering positive news and seeing the emotional reaction.  There are people who do all the right things regarding disciplined saving but still have real fears about financial security and the ability to retire. When you provide a client with a visual illustration of a plan model that exhibits a high probability of success, it can be powerful. I have seen tears of relief and surprise.    

Do you have any hobbies and/or special interests?

Trail running with my four-legged wingman, spending time in the mountains, watching the Boston Bruins or the English Premiere League team, Everton, and collecting tacky fridge magnets.

To learn more about Peter, click HERE.

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Well-thy Conversations

Prioritizing Mental Health in the Digital Age with Susan Reynolds (EP. 19)

As the world becomes increasingly digital, the allure of technology has become all-encompassing. When growing up with mobile phones, smart watches, access to the internet, and many more digital devices that can pull us away from reality, it is easy to get sucked in and caught up, leaving us slightly addicted to this form of entertainment. 

In this episode, Barbara Archer is joined by digital well-being expert Susan Reynolds to discuss the pros and cons of social media and digital technologies.

To listen to the podcast episode, click HERE.

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Well & Well-being

It makes sense that as your income and assets increase, you grow more financially comfortable. That’s a good thing. The more wealth you build, the more freedom you can attain from the day-to-day stress of meeting your expenses and worrying about your financial future.

However, greater financial success also comes with greater risk. You have bigger bills to pay. More loved ones rely on you for financial support. The value of your property ― and therefore the cost to repair it ― increases. You become a more attractive target for lawsuits. The list goes on.

Yet, many people underestimate or overlook these risks as they focus on the more pressing, easily quantifiable parts of their financial lives. That is, until the unexpected happens ― illness, disaster, an accident or even death ― and the financial consequences become clear and possibly unmanageable.

A proactive review of your insurance coverage surfaces these risks and can make the difference between manageable and insurmountable loss when something goes wrong. To help, here is a summary of insurance categories and considerations to review regularly with your financial advisor.

To read the full blog post, click HERE.

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Our Latest Empower Women Podcast

Check out our September Empower Women Series Podcast interview, Navigating Senior Living: What are my Options?,  with Camille Ciarametaro.  Camille talked about different retirement community options and their features. She also discussed the costs associated with each and what resources are available.

You can also read our event takeaways by clicking HERE!

Click HERE to listen to the podcast episode.

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