A Quarterly Reflection

In place of our Weekly Reflection, we are sharing the Quarterly Reflection that we publish at the end of each quarter. It is a little longer read (7 minutes!) with a spotlight shown on the economics, markets and financial planning topics of the current time. Please share your feedback, thoughts and questions by clicking here.

On the Economy

Year-ends always bring reflection and assessment of which predictions came true. This season most pundits would rather move on as quickly as possible from any discussion because the truth is, most were terribly wrong in reading the tea leaves. Almost no one believed that Russia’s troops amassed along Ukraine’s borders meant Vladimir Putin would actually attempt the high risk of a low return war; it did not fit what Westerners thought of his ambitions. Almost no one believed that the Federal Reserve would follow through with historically steep interest rate hikes, even in the face of obstinate inflation; it did not fit what Americans had seen during this century’s central bank’s accommodative policies. And yet these two events touched nearly every soul on the planet.

Due in large part to these events, the world’s developed nations are quickly moving into the contraction phase of the economic business cycle. The duration and the difficulty of this period is still uncertain; most experts are not predicting complete financial meltdown, even if it will be uncomfortable and challenging for some time to come. Overlapping the downturn are two massive shifts that will be more lasting – deglobalization and the rise of the worker.

The tremendous economic boost that the East has received over decades of business development by and in conjunction with the West is reaching a new phase. Using the economic and political power they have amassed, Asian countries and primarily China, seem keen to dismantle parts of the increasingly complicated and fragile trade alliances with the West. Both the U.S. and China see the outcomes as a net benefit to their own bottom lines. Simmering concerns about the relationship that began under the Trump Administration’s policy of tariffs and provocation exploded into full-on chaos with the COVID-19 pandemic and its bandmate, supply chain issues. If corporations had not already been considering the viability of doing business so far away from the end -consumer, they are certainly reconsidering it now. Over the last several years, developed countries have begun on-shoring, or at least “near-shoring”, the production of goods and services. It is likely that thistrend, call it de-globalization or re-globalization, will pick-up momentum in a recession.

The other development is the world’s changing workforce, a dynamic that has been discussed but perhaps not widely appreciated. What the pandemic wrought, continued global unrest and aging populations have exacerbated.

Certain segments of the population that self-selected out of the workforce during the pandemic have, surprisingly, been unwilling to return. Older workers permanently retired sooner than statistics would have indicated while millions of others switched industries, upending business plans and forcing employers to sharply raise wages in the U.S. to keep operations going.

Per a new report from McKinsey, Europe is in trouble. In a region where laws strongly favor workers and historically turnover is low, attrition is still picking up. “Companies can’t get the people they need, and they are losing the workers they already have, while falling behind in areas such as technology and innovation that affect the region’s long-term competitiveness.”

Developed nations with aging populations have and will suffer most in this Great Attrition period. Japan, a critical U.S. ally in Asia, has demographics that point to declining economic, political and economic prowess. Even China, with roughly 19% of the worlds’ working-age population, will see declines even if fertility rates start rising again with relaxed family policies. Researchers at Bloomberg have studied the effects of aging populations and say that the upward pressure on wages will come with a host of other issues. For countries like Mexico and India, where the median age continues to be low, a ready supply of workers is a key differential in economic growth and standard of living increases. Emerging economies are going to see the biggest gains from growing youth populations.

The Federal Reserve certainly knows the coming impacts of deglobalization and labor shortages. Yet its focus on reeling in the excesses of the past will deliberately inject further fragility, aka a recession, into our economy in the near-term. The only prediction that can be ably made is that 2023 will be messy. And to paraphrase the book, We’re Going on A Bear Hunt, we can’t go over the mess, we can’t go under the mess, we have to go through it.

On the Markets

2022 saw the demise of the “risk on" investment. Risk on means exactly what it sounds like – shunning the safe in favor of the exciting, much less certain, option. High risk investments in cryptocurrencies plummeted from $3 trillion in total assets in 2021 to just $840 billion last month. Of the 39 companies that began publicly trading on U.S. exchanges in 2022, the median return since trading opened is negative 68%. Growth stocks, like the ones denoted by the acronym FAANG, dominated the markets on the way up the last 10 years and on the way down in 2022. Facebook, Amazon, Apple, Netflix and Google have become as stale as their acronym and led the Nasdaq Index to its 33% loss last year. Unicorns, as startups valued over $1 billion are nicknamed, may have lost even more. An investigation by Bloomberg says that private investors in these companies have written down their valuations by 40% and there may be more costs to come.

As the market washed out these excesses, the usual safe, or risk off, securities did not provide the usual protection.

Gold prices ended roughly in line with where they started the year, odd because gold is generally seen as the best hedge against inflation; gold is real and therefore does not lose value. Bonds also failed to provide a ballast last year.

No one would consider a typical bond security as part of the risk on category, but they did carry significant risk given the increases in interest rates. Bonds returned losses for a second year in a row, failing to provide a safe haven just when investors needed it most. When the Fed starting raising rates at the steep clip last March, moving from 0% to 4.5%, the investors holding bonds paying low coupons sold them in favor of buying new bonds paying higher coupons commiserate with the new higher market rates. The silver lining going forward here is the outlook for better yields ahead.

Strong returns came from Energy sector stocks, given the shock of Russia’s invasion into Ukraine and resulting supply issues. Had it not been for that scenario, “liquid gold” may have traded along the lines of other securities, bumpy and emotional. Utilities returned 1.57%, the only other sector to post a positive return. Healthcare and Consumer Staples, the types of services and goods we use generally in any type of economic storm, managed only slim losses. Among the big losers were Technology, Consumer Discretionary, Real Estate and Communication Services (i.e., media and entertainment stocks).

Globally, other parts of the world performed better than the U.S., even when faced with tougher financial conditions. Indicators are pointing to a recession in Canada, Germany, Sweden and the U.K. Yet, markets have held up. Comparing the performance of the MSCI EAFE Index, focused on Europe and Asian companies, it outperformed the S&P 500 Index by 4.0%. Stocks in developed international countries tend to pay higher dividends and have

lower prices with better fundamentals, like strong positive cash flows, which have helped them avoid massive markdowns even in these (pre)recessionary times.

What is next is probably more of the same, a market that rhymes with but does not exactly repeat 2022. Hoping for a quick turnaround might be foolhardy as most analysts do not think that stocks fully reflect the true costs to their bottom lines of inflation, interest rates and expensive employees.Even the beaten down growth stocks are not yet buys. As Dan Loeb, CEO of hedge fund firm Third Point, tweeted "I don't think camping out in the last

decade's darlings, with rosaries in hand, hoping for a comeback, will be the winning strategy."

Instead, high quality, or put another way, boring, investing looks to be the best path forward this year. Not that it will be easy but it will be the basics for investing. Companies trading at decent valuations with positive earnings, positive free cash flow, low debt and paying dividends will provide the best opportunity for returns. These are typically the big behemoths of their industries, the firms with solid product and loyal, consistent customers.

On Personal Finance

There is no sugar-coating it, 2022 was hard. If it was a movie, it be hard to categorize because it had it all. There was political intrigue, war, bizarre business dealings, financial upheaval and lots and lots of drama. In fact, you probably would not even watch it. You would let someone else watch it and give you the highlights.

But it was no movie and now we all need to move forward amidst this dynamic landscape. Americans are good procrastinators but this is not the place or moment to put off your personal financial (re)engineering. An economic storm is underway; make sure you are prepared and have safe cover.

Put pencil to paper

Depending on how much you enjoy planning, or how you feel about how things are going for you personally, a review might make you anxious or have the opposite effect of being calming. But right as we embark on the annual, unavoidable ritual of filing taxes, this is a perfect time to kick the tires on your wealth plan.

Once charted, stay involved

Even though it might be tempting to throw in the towel, keep investing. One way to stay on the path is to make sure you have the right allocation in different assets for you and your time frame. As we talk to clients about risk, we consider capacity, tolerance and composure. All three of these also play a role in determining the right investment strategy and allocation.

Your capacity is the amount of money you can “afford” to lose without sacrificing your ambitions, be it an early retirement, a second home, and so on. Tolerance is your attitude and ability to rationalize trade-offs in different risk-reward scenarios. Your composure is your ability to stay level in both depressed and elevated markets.

Remember, neither the downturns or the sunny days last forever. Even though it is easiest and is much more fun to plan and dream while markets and economies are brimming with good tidings, any time is a good time to get finances in order.

“In delay there lies no plenty.”

~ William Shakespeare, in his play “Twelfth Night”