After a tumultuous period surrounding the outbreak of the COVID-19 pandemic, the first half of 2023 has seen markets steady, inflation subside and fears of a recession lessen. What does the rest of the year hold, and how should it impact investment decisions? Join us for a rest-of-the-year outlook on those issues, and more, with Cetera Chief Investment Officer Gene Goldman.
Speaker 1 (00:09):
Good afternoon for those of you on the East Coast for the rest of us and to Gene here, good morning. Welcome to Leaders. It's a forum brought to you by Arizent, the parent company of Financial Planning and I'm Financial Planning's editor and Chief Brian Walheimer. Today I'm with Gene Goldman, chief investment Officer at Cetera and he's going to talk with us about the economic outlook for the rest of 2023. Welcome Gene.
Speaker 2 (00:33):
Thank you. Thank you Brian. Thank you for the opportunity to chat with you and your audience. Thank you.
Speaker 1 (00:37):
Absolutely. Before we get started, I know you heard in the instructions at the beginning that you can send questions live for Gene through our chat feature. We'll get to as many as we can. You don't have to wait until the end. Go ahead and put them in and if there's an appropriate time to pull them up I will do so. If you're watching this later on demand, keep an eye out for future live events so that you can register and take part in the discussions live. But we're just going to jump right in today. Gene, I know we talked a lot about the Fed, interest rates. Things have, interest, rates have been climbing, fending off inflation, starting to get inflation in check, not quite where the Fed wants it to be yet. What are you expecting for the rest of the year with the Fed?
Speaker 2 (01:18):
Sure and thank you Brian for the great question. For a long time we've been very critical of the Fed. The Fed made a lot of verbal gaffes, a lot of mistakes, A lot of say 2021 classic one is inflation is transitory. So the Fed has made a lot of mistakes. I think we're pivoting now to see the Fed is actually doing a great job. We're seeing inflation roll over pretty fast as you alluded to. So I think the rest of the year in early next year, what we're seeing with the Fed is, we'll call it the Fed is going to be pausing but maintain a higher for longer perspective. So let me parse in the two components. So why pausing? Well think about the Fed. The Fed has been extremely aggressive in terms of raising rates. If you look at the last rate hike cycle from 2016 to 2019, the Fed went from zero to 2.5 percent in the Fed funds rate.
(02:08)
So it about three years to go from zero to two and half percent. This current cycle we're in now to go from zero to two and half percent, it took them six months. So you see how aggressive the Fed has been in terms of addressing the inflation issue. Also, as we mentioned, inflation is rolling over pretty quickly. You look at CPI trailing three months, trailing six months, trailing 12 months, it is rolling over pretty quickly and the good news is that housing inflation is not yet reflected in CPI. If you look for example at asking rent in apartments.com website we track very closely asking rent is down about 1.7% year over year. This is not yet truly reflected in CPI. So CPI is rolling over pretty fast. Also, the last component to think about is the component of the ISM. So the ISM PMI surveys come out once a month and they're the first look at the last month's economy and prices paid component.
(03:03)
What manufacturerers, what service companies are paying for, for prices for input prices tends to lead CPI about three to six months in advance. And we're seeing prices peak component, especially on the manufacturing side fall pretty quickly. So the second part of the question is why hire for longer and hire for longer? We have three reasons. Number one, although inflation is flowing pretty quickly, if you break out goods versus services, inflation services inflation is still pretty uncomfortably high. And if you think about labor, labor is the primary component of services inflation. The Fed really needs to slow the labor market. This is why the Fed will be maintaining rates higher for longer. Second reason, inflation is still above the fed's 2% target. I know there's rumors out there that the Fed is talking maybe maybe about raising the target from 2% to 3%. We think that's nonsense because if the Fed does it, they lose credibility.
(03:57)
And the third issue, why not issue the third perspective of why we expect this higher for longer in the Fed funds rate is that Jay Powell is a student of Fed history and he always references mistakes the Fed has made in the past. His classic reference, he talks about Paul Voelker in the seventies in the early eighties where Voelker, the head of the Fed back then made lots of mistakes. Remember Voelker raised rates, cut rates dramatically and then raised them again and think about the markets, the financial markets were all over the place. He wants to avoid that. So by avoiding that, he does this by keeping rates higher for longer. And then I think the second part of your question is how does it affect investment decisions? And clearly the Fed, the Fed policy affects investment decisions all over the place, but in our opinion there's two ways it affects it.
(04:42)
Market volatility and bonds. So you think about volatility, we do think volatility will be increasing. We've had a great year where the is trudged around 13 to maybe 17, 18, 19 very low volatility in an environment where the Fed is raising rates. But we do expect volatility to increase a lot more. The Fed is a very poor track record of guiding us into a so-called soft landing. Think about this, the last 15 rate hike cycles, the Fed has pushed us into a policy or a recession in 11 of the last 15 times. And history shows that only a recession can slow both price and wage inflation. By depressing consumer spending, the markets are going to be worried about this. Another reason for increased volatility is that markets are not getting a hundred percent sold on a higher for longer. If you look at the implied funds rate at the end of next year, this is at 4.3%.
(05:34)
So this is about a hundred basis points less than today's level. So markets are not yet anticipating this higher for longer. The second investment decision opportunity. Bonds, bonds, bonds. We are big fans of bonds, especially on the high quality side. They're very attractive. You think about the key points on the yield curve, the two year and the 10 year, the two year is a great proxy for the fed funds rate. It's basically what the market is saying The Fed funds rate will be one year from now. So as the Fed starts to slow down, maybe cut rates next year, you'll see a two year come down pretty quickly. The 10 year is important tied to borrowing rates. We do think with inflation flowing with the economy, slowing down with really yields pressure in the economy, you expect longer term yields to come down. So on our portfolios we've been very, very optimistic towards bond prices. We've been adding duration quarter by quarter and I think bond investors overall are doing the same thing. We posted a tweet yesterday or the day before, we talked about that this year every week except for four weeks, we've seen positive bond mutual fund inflows. So again, bonds and volatility are going to be big stories when the Fed starts to pause and maintain a higher for longer perspective.
Speaker 1 (06:46):
So you're not a hundred percent sold on the market rebound that we're all excited. We watched the market last year, have an absolutely terrible year and we've enjoyed those of us with our 401(k)s, have enjoyed seeing some bounce back, but you're not a hundred percent sold on that for the rest of this year and next year yet.
Speaker 2 (07:06):
Yeah, I think if you pivot towards what you think about the market, and I think for the stock market, we look at it at a tale of two cities, I think near term we're cautious and basically we're cautious because the Fed has raised rates, but the market still needs to grapple for this higher, for longer perspective. And you're already seeing the economic impact. For example, consumers, consumers are under pressure. You have student loan repayment and you've got tax bills, you've got savings dwindling, you've got credit card delinquencies. Think about this, credit card debt is now exceeding 1 trillion dollars the first time ever. And think about this, we have 70 million more credit cards issued than pre pandemic levels. Also remember, no one's refinancing mortgages anymore. So you can't use your mortgage as a bank machine because rates are higher. So you've got the fed raising rates, you've got consumer under pressure, your valuations are price in absolute perfection today, the s&p 500, the forward PE ratio is about 19, say 19 and a half, much higher than average.
(08:05)
And you can have a higher pe, but you can't when rates are high, when yields are high, when inflation's high. Also you've got more treasury supply coming, pushing yields likely higher. So that's sort of our near term caution. But again, the tail of two cities - next year we are pretty optimistic. We do think if there's a recession it's probably going to be mild. Second of all the fed cuts rates next year, third of all profit margins are stabilizing pretty fast. Corporate earnings look great next year, especially compared year over year. We do think Q2 is the earnings decline low. So again, near term cautious and plus September is a very terrible month. The stock market historically speaking and the rest of this and late and next year we do expect a better opportunity.
Speaker 1 (08:46):
I know when we talked last week, Gene, you talked about the Fedometer that you've developed at Cetera. What is that? What can tell me about it? What's it say right now?
Speaker 2 (08:59):
Fedometer. So it's one of the resources that we produced in terms of the Fed. So we all know how important the Fed is. There's the old added bull markets don't die of old age, but rather they're killed off by the Fed. But understanding the Fed is very difficult, especially you look at last year and earlier this year we started term the Fed being very hawkward. That means that fed's very hawkish, but they're very awkward in their communications. They're raising rates last year and this year. But their communication was really awkward, especially at press conferences, some of the communications. So with this in mind, we wanted to build a tool for our advisors to use for their clients like a monthly fed monitoring tool that provides contact on current fed policy and on potential future fed policy. So what we do in this Fedometer is we measure key data points the Fed uses to determine policy around labor, around inflation, jobless claims, core CPI.
(09:50)
And then you merge this together with important market indicators to indicate what the market is saying about interest rate policy, the two-10 spread, for example, copper prices. We take all this information and we show where the Fed is today relative to where we think the Fed should be more aggressive or less aggressive. And I think the beauty of this piece is this is a very easy way to discuss the Fed with your clients. As a side note, it's on cetera.com, it's on Twitter, it's on LinkedIn. What is it saying today? It's saying that the Fed is well too aggressive, the Fed needs to either stay pausing or cut soon. And I'm not trying to pat ourselves in the back, but I do think the Fed's Susan Collins and Chris Waller came out and read the yesterday and today, both of them made comments that were pretty specific to our Fedometer in terms of some of the things they're seeing that we're seeing. I know it might just be a coincidence but we'll think they're using us as one of their inputs.
Speaker 1 (10:44):
We'll, we'll take it. Right. You touched on recession earlier, you said maybe not a full-blown heavy recession here. What are you expecting and what are the ramifications of this? I mean I think you said sort of a sector by sector or was a rolling recession, isn't that what you said?
Speaker 2 (11:03):
Yes. Yeah, exactly. So I think let's take a step back. So let's use interact about recessions. Let's use history as a guide for the all context. So if you look at since World War ii, we've had 12 expansions that averaged about 64 months and we've had 12 recessions average about 10 months. So expansions have average about 64 months, recession is about 10 months. Recessions are a normal part of our economy right now we're about 40 months into an expansion. So from a numeric standpoint, we'll probably due for a recession in the next couple years, but one to two years. But the question is, is the recession around the horizon? And from my perspective, I'm not too worried if we have a recession or not because at the end of the day it doesn't matter if the economy is above zero or below zero, even if we have a recession, it's likely going to be mild and we can point to many points.
(11:52)
Number one, labor market. The labor market is a strong foundation. Yes, the labor market is starting to weaken. So we've seen the third month in a row that payrolls have come in below 200,000. Unemployment rate has moved up from 3.5 to 3.8%, but jobs are still plentiful. We looked at this data point on the jolt survey and it said that back in March about 55% of responders of survey people said that jobs are plentiful. Today it's about 40%. So there still are plenty of jobs. It's come down, this is what the Fed wants. The Fed want the labor market to slow down, but beauty of the labor market is coming off of a very strong base. Another reason why we would expect if we have a recession, a mild recession, kind of close to zero, is the housing market. The housing market is not like how it was back in the seventies and eighties.
(12:44)
We have high owners' equity within homes. That is good in the sense that owners are not being forced to sell homes. So the third reason why we expect if there is a recession, it's mild. Again, we're not worried about above zero, below zero, we just think it's going to be very mild if the economy slows down is what we call a sector recession, that we expect a recession, if we have one, to be a sector by sector, not a sharp 2008 recession where everything falls right at once, we expect a recession that mildly rolls through the economy sector by sector, not all at once. And why do we think this? So you look at what's in recession today easily. Housing is autos, manufacturing, what's not - consumer spending. Consumers are spending like crazy. We got the ISM services index that came out today, came out well above expectations.
(13:33)
Consumers are still spending money. So we're seeing clear signs of areas in recession today are starting to stabilize, are starting to improve. Let me give you some examples. So new home sales have risen, especially on new home sales, on new home sales construction, new home sales. You look at the home builder, sentiment surveys have been very strong. Auto sales. Auto sales have picked up. Auto sales are not yet at 2019 levels that sort of pre pandemic levels, but they're bouncing back pretty quickly. Manufacturing is in the recession right now, but it's starting to stabilize. We saw the PMI manufacturing survey come out I think Friday, last couple few days ago. And the indices are stabilizing pretty well. And then if you look at construction spending on manufacturing facilities, this is surging. Yes. Part of it is due to the CHIPS act, the IRA, all that stuff together, you're seeing surging on manufacturing, construction spending.
(14:28)
And then even yesterday factory orders came out, you exclude transportation. factory orders came in much higher than expected. So the point here is that the areas that are in recession that sector by sector sector are starting to stabilize ever so slightly. The areas not in recession. Consumer spending, for example, leisure spending, they're starting to slow down, they're starting to face headwinds. I know I talked about this before, but consumer has some headwinds coming down the pipeline. Student loan repayment, tax, savings dwindling the fed said savings are going to be drying up relative to 2019 levels. Sometimes they're in this quarter. You're seeing credit card delinquencies rise. You're seeing again, more people using credit cards. So again, the consumer is likely under pressure. And then going back to the recession, corporate America is less expecting a recession. We're looking at some data from FactSet. FactSet said in second quarter the word recession and S&P 500 earnings calls fell to 62 and Q1 was 13th.
(15:29)
This is the fourth straight month of decline of the word recession in the earnings releases. So what's all this mean from an investment standpoint? What's therefore what's the actual investment advice? We would definitely look to increase value exposure. Growth has had a huge run in the market this year. We would definitely look to increase value and we're overweight value today. Small caps are pretty attractive. Yes, small caps are likely going to take it on the chin a bit if the fed pivots and starts to raise rates again. But small cap valuations are extremely cheap. Small caps have already taken a hit already and then maybe non-US. We're really watching relative inflation rates between the US and other countries. Interest rate policy, other central banks versus the Fed. And clearly I think the Fed's closer to being done than other countries, especially the ECB. We're watching this carefully as this will lead to ideally a weaker dollar and by increasing non-US exposure, great, great opportunity to take advantage, especially in a weaker dollar environment. I know lately the dollar has been rattling for the last couple of weeks. We're watching this carefully, but again, value. small caps and non-US are some opportunities we're looking at potentially.
Speaker 1 (16:38):
Sure. What about specific sectors? I know you talked a little bit last week about what healthcare, agriculture, where are some opportunities you think sector wise?
Speaker 2 (16:51):
Yeah, definitely, definitely. So our three favorite sectors that are number one, industrials. Industrials are extremely attractive to us. First of all, valuations are not too frothy. Second of all, within industrials you have agriculture spending. You have the demand for food, the climate change, changing directions of where food is being grown. Huge, huge spending on agriculture, on just agriculture spending. Also with industrials, defense spending, defense spending is surging. You look at the unfortunate events in Ukraine, you realize that the governments, the economies have not had prepared for a different type of war. Instead, you're seeing a war with less aircraft. And this is really changing how governments are looking at spending money for future defense buildup. Case in point, you look at Canada and ECB, last year they spent about 2% of GDP on defense spending, now they're about 8% GDP , clearly spending more money. And also a lot of companies in the defense spending industrial area have indicated some very high historic order of backlog.
(18:00)
So again, defense spending and agriculture spending will drive industrials in our opinion, plus the dollar weakens as we do expect. Great, great for non-US sales. Second of all, this is kind of controversial, but our second favorite sector is financials. We do think if there's a recession, again, we don't necessarily say a recession now, but if there is a recession coming, we expect it to be very mild. And you look at the amount of money set aside by banks, maybe a little bit too much in terms of protection from future losses. Second of all, valuations are extremely cheap within financials, especially larger banks. Third of all, you've seen a lot of ratings downgrades. We think this is creating an opportunity from a valuation standpoint. Also, capital markets are opening in the last say, couple weeks. Even today we've seen IPOs, IPO announcements. We saw today this morning an IPO company and I can't really talk about individual stocks, but a company that sells tennis rackets and ski boots, for example.
(18:57)
Some of their items announced a big IPO this morning. We saw big IPO late last week. So IPOs are coming back, great for capital market, great for the financial services industry because they'll have easier comps. And the third area, kind of a boring area, but it's one of the cheapest areas out there. Healthcare. Healthcare is very cheap. Also, it's very much of a defensive sector and then a lot of drugs are coming off patent. We do expect to see a lot of M&A activity. So again, our three favorite sectors, industrials, financials, healthcare. We like technology, but we think valuations are too pricey right now. But industrials, financials, healthcare are our big opportunities right now.
Speaker 1 (19:37):
I'm glad you mentioned technology because that's one thing I wanted to ask specifically about. We're constantly seeing money being put into artificial intelligence, AI, a lot going in there. Is there a bubble there? There's so much that can be said about what AI can and will do and how it's going to change life for everyone in so many ways. But this feels weirdly nineties dot com-y to me sometimes when you see some of the things. How do you evaluate AI as an investment right now?
Speaker 2 (20:12):
Yeah, great, great question. So everyone has AI fever. I mean, and I think AI is going to be very important to our economy, to technology, to our jobs, to everything on the go forward basis. I tell people on my team, we talk about this, I think AI is like the best thing since electricity in the sense that back in the 1890s when electricity came out, we all knew it was going to be big. We had no idea how big it would be. AI is the same thing. We know AI is going to be big, we just don't kow how big they'll be. You think about this, the future on a lot of different jobs, like even doctors, scientists, financial advisors for example. They'll be able to tap into AI to help assist their business, expand their scope, expand their work, expand achievement. So we think AI is going to be huge and just think about what it does from a productivity standpoint.
(20:58)
There's some estimates that can add about 1% to overall global productivity growth for the long run. And then the spend on AI is huge. So back in 2022, it was estimated about 450 billion dollars was spent on AI. If you look at 2026, the estimates are about 900 billion, a doubling in AI. And really the primary error is through software basically as a way to mitigate surges that we saw in wage inflation as a great catalyst to reduce service, to improve productivity. And I think the timing of AI was very interesting, the surge in the valuations, because AI becoming part of our economy also coincided with the semiconductor cycle and the semi cycle. A lot of companies had to replace semiconductors. Why not use one that helps through ai? So all this together has created a huge valuation bubble. So our key point is that fundamentals are strong in ai.
(21:52)
We like ai. Long term valuations today are extremely pricey. PE ratio of the Russell 1000 growth NASDAQ composite, it's pretty high. And from us, as you said, it reminds of the tech bubble back in 99, early 2000s, lots of excitement, lots of companies tapping into technology back then tapping into AI today. But not every company will survive. And I think the key point in AI investing is use active management. I think active money managers are going to do a great job in terms of figuring out who the winners are, who the losers are. Think about back in 2000 when we saw a tech bubble come down, active money managers in thousand 2000, 2001, 2002 did extremely well because they were focusing on the right leaders looking at underlying revenue growth. Looking at back then the late nineties was all about price to clicks. Today they'll be looking at who are going to be the survivors. So AI is important just like y2k, not y2k, just like Tech Bubble, but there'll be key drivers in AI and use active money management, those guys, those people, those analysts digging in on companies.
Speaker 1 (23:00):
Sure, I haven't seen any questions come in yet. I do want to remind our audience, you can type a question into the chat box right now, but we're about winding down. So Gene, we'll give it a minute and see if anybody throws anything in there. But before we go, is there anything else that you wanted to touch on, anything we missed? I know you said that there's some new data that came in today. You probably touched on some of that already, but just give you an opportunity for anything else you want to toss out there.
Speaker 2 (23:26):
Yeah, I think the big three takeaways, what we're telling our advisors to tell their clients, we have a very volatile market. We have a very uncertain market right now in the sense of the market is doing pretty well, but you have some key end points coming. What do you do? What are the basics? And I go back to basic blocking and tackling and there's three things you do. Number one, make sure your clients are diversified. I know that clients today, they're looking at the surge in the Magnificent seven and they're like, why am I buying value, international or bonds doesn't make sense. It does make sense. So make sure your clients are diversified, please, please. Second of all, to make sure that diversification is in line with their long-term objectives. It's a great time to sit down in front of your clients and say, okay, I know you should be a 60/ 40 client, 60% stocks, 40% bonds, but because of the surge in growth, maybe you're out of whack a little bit.
(24:18)
Let's reevaluate where we are. Let's go back to the basics. The third thing is market volatility. I alluded this earlier. We're going to have a ton of market volatility coming up, but market volatility is a normal part of investing. You got to remind clients about this. If you look at, I saw a study, I think 37 of the last 43 years, the S&P 500 has been positive, but in those positive years, the average intra year loss is down about 13.3, 13.4%. So what this means is that markets have an upward bias, and we know this, this is why we're in financial services, but more importantly, volatility is a normal part of the game. You got to hold hands, hold your client's hands. You've got to communicate. One thing, I started in this industry back in 92, 93, and we've seen everything from the Mexican peso crisis to long-term capital to the tech bubble. All these uncertainties and what do you do when times are tough, when there's volatility? Number one, explain to your client volatility is normal part of the game. Number two, communicate with them. Reach out to them, let them know. For example, my company, my team and I, when there's a big dislocation, we're over-communicating - conference calls, commentaries, writeups, Twitter, all this stuff because clients are going to be calling you saying, Hey, why is Dow down 500 points? Or why is NASDAQ done? You need that ammunition. So again, overcommunicate to your clients is very, very important. Sure.
Speaker 1 (25:42):
One question that popped in asks if you can expand on your favorite areas of fixed income right now.
Speaker 2 (25:47):
Oh, great. Great question from Lauren Corona. Hey Lauren. So we love high quality fixed income. So we like treasuries, we like investment grade. The area that really scares us the most right now is high yield. You think high yield is a little bit overbought and two reasons. Number one, you look at for the last year or so, you've seen very low, very much of a lack of new issuance in high yield bonds. Because of this, high yield spreads are narrow because basically high yield investors are going in and buying seasoned investments or buying issues in the secondary market. This is squeezing down the spread between high yield and treasury. As we all know, when there's more risk in the market, high yield spreads in the wild need to be compensated more. What we're seeing is that spreads are actually coming down because investors are saying, I'm not buying new issues as much, so I'm going to buy secondary issues.
(26:42)
We think high yield spreads are artificial narrow. Secondarily with high yield, what worries us is that if you look historically, something we tweeted maybe a couple weeks ago, commercial real estate is a concern overhanging the market. So now you've got commercial mortgage backed securities spread, which is sort of a proxy for commercial real estate and high yield. These two tend to track very closely. They're very highly correlated. But what we're seeing now is that commercial mortgage backed spreads are like that, but high yield spreads are staying very narrow. That worries them. So we do worry. So this is why we think high yield is a little bit overvalued and there's some concerns coming down the road. So we love investment grade. That's so great. We're cautious about high yield rate. Great question. Thank you.
Speaker 1 (27:24):
Yeah, I think we're probably about out of time at this point. And so I do want to thank you, Gene for sharing your time, your insights with us. It was really great to have you on our Leaders forum today.
Speaker 2 (27:34):
Thank you. Thank you for the opportunity. It's great to talk to you again. Thank you so much.
Speaker 1 (27:38):
Absolutely. So for Financial Planning and Arizent, I'm Brian Wallheimer, a big thank you to our audience today for coming out and for some questions and. we'll see you agai soon.
