David Nelson:
Welcome everyone. My name’s David Nelson from NelsonCorp Wealth Management being joined today by Jake Woodcock. Jake is portfolio manager, he’s been with us a number of years, does a really nice job and important job as far as in times like we’re in right now. Today is Monday, June 13th, I want to emphasize that, and it’s the morning. We’ve had some tremendous volatility that’s taken place last several days. There was a report that came out. The Consumer Price Index Report came out this past Friday, the number came in a lot higher than what people had anticipated and subsequently we’ve seen as far as the stock market and the bond market sell off pretty significantly the last several days.
David Nelson:
Before I move any further I want to wish everyone a happy Father’s Day, those of us that are lucky enough to be fathers out there and grandfathers, enjoy the day, it’s your special day and it’s an important job that we all play.
David Nelson:
I’m going to go to slide two here and just leave it up here for a second as far as talking about the disclosure, which kind of outlines a few of the things, the important things, as far as what we’re going to be chatting about today.
David Nelson:
So moving on to the important stuff, what we think is quite important in particular and very timely as far as what we’re going through right now. The big headlines are the inflation concerns and then the ripple effect that may have as far as in various areas. Again, unless you’ve been under a rock you realize that over the last several months things have been volatile, but more importantly the last few days as some of the new reports have come out it’s been even more volatile.
David Nelson:
So the slide that we have here Jake is quite important, it’s addressing the issue of risk assets, primarily we’re focusing on this particular one on the Dow and looking at it over a period of time and the impact that inflation is having and how this tool is helping us to make better decisions as far as one of the pieces of the puzzle, but an important one to say the least.
Jacob Woodcock:
True. So we’ve talked about for a while now the inflation and interest rates are kind of dominating the narrative in this market cycle. We talk a lot about the weight of the evidence and how we look at a lot of different things, but each cycle kind of has different metrics have different importance and different cycles, and this one is definitely the driver that we’ve been seeing.
Jacob Woodcock:
So David mentioned the CPI report that came out on Friday, market was expecting some moderation there, we didn’t get it, we saw things actually move a little bit higher. And what was also notable was it was really broad based, wasn’t just energy, that catches the biggest headlines are food, pretty much everything was consistently moving higher.
Jacob Woodcock:
So what we try and analyze here, we’ve heard a lot about peak inflation and we kind of want to look at what is the importance of that peak inflation. So in order to assess that we take the previous six months average of inflation and compare it to the current values. So if the current value is above the recent average we kind of determine that we have not reached peak inflation, it’s still moving higher. In order to say that we’ve reached peak inflation we need to see that roll over and actually we need to see the current print below that six month average. And what we see in this analysis is that while inflation is continuing to rise prior to peak inflation stocks and risk assets in general just really struggle if we measure the returns during those periods. They’re not necessarily negative at all times but definitely below average and flat in a lot of cases, and so really struggling to move anywhere until we see that inflation reverse.
Jacob Woodcock:
And then somewhat optimistically once we see that reversal, if we look at those big peaks in the late ’70s and the early ’80s, once we do see that reversal inflation does come down pretty fast as far as the year over year change. Some of that’s a statistical effect from you’re coming off a high base so it’s harder to keep upward pressure. But once we see the rollover it does come down pretty quickly. And again, in the analysis stock market returns in that environment tend to be pretty positive and really that’s regardless of what interest rates are doing or whether we’re in a recession or not in a recession. If we see peak inflation and are coming down that does tend to be a good environment for stocks.
David Nelson:
Good point, an important point. I think when we talk about inflation and people look at markets they’re saying when’s this thing going to end? Obviously we don’t know, but as you emphasize there as that thing starts to roll over more often not we see some pretty nicer turns in a relatively short period of time. So again, no assurance that’s going to happen as far as this go around, it’s anyone’s guess as far as when things are going to start turning over as far as inflation and heading down in a significant way. So again, we’re prepared and we’re making these decisions day to day, and I will continue to update as far as through these type of mediums. So use the term weight of the evidence, I like that term. We use it a lot as far as around here. The next slide is basically talking about again, we’re still on the topic of inflation. We’re looking at two year type offerings as far as government type bonds, 10 years, et cetera, et cetera on here. What is this chart basically telling people?
Jacob Woodcock:
This is really looking at what the market’s expectations are. So what’s priced in in terms of inflation, and it breaks it down as you mentioned David, we were looking at two years out, five years out, 10 years out, where does a market think inflation is going to be? And basically the market prices that by comparing nominal treasury bonds, which are the standard bonds everyone thinks of, or the most of the yield is quoted on, CNBC or in the paper are just standard treasuries. And then there’s TIPS, treasury inflation protected securities. Those are bonds that have a component attached to the CPI so there’s some inflation protection there for investors. Comparing those two can tell us what the market expects inflation to be out in the future. They’re not always right but I think it’s beneficial knowing kind of what the market is currently projecting.
Jacob Woodcock:
And right now compared to the previous decade or so near term inflation is projected to be higher, so that’s the green line we see on the right hand chart side of the chart is the highest. Currently two year inflation is expected to come in at a little over 4% per year. And then the gold line below that is the five year, so five year inflation is projected at just over 3%. And then the orange line is the lowest that’s 10 year inflation is projected to come in at 2.7, 2.8% per year for the next 10 years, which really that long term inflation is roughly speaking just barely above where we’ve been pricing it for the past decade. So long term inflation expectations haven’t changed so much, near term inflation the market still expects that to be quite high. And we’re seeing some of those dynamics.
Jacob Woodcock:
You might see a lot of discussion as far as the yield curve and an inversion where short term rates are higher than long term rates. This is kind of the driving force behind that. And in one near term we expect things to be rough, that’s why that yield curve is kind of determined to be a recession indicator and why you hear so much about that. But it’s really just dynamic is just near term market expects things to be tougher than the long term.
David Nelson:
So inflation matters at very important variable as far as in looking forward and trying to figure out as far as what asset to invest in, as far as to make money. We’ve basically been in a period of give or take, I call it 30, 40 years where we’ve had interest rates dropping and that 30, 40 years as rates have dropped it’s been a pretty favorable environment as far as for stocks, it’s been pretty favorable as far as bonds. And subsequently the returns as far have been either at the norm or they’ve been above as far as the norm.
David Nelson:
And we have been talking about for quite some time that we’re going to be going into a different period of time, a different era where interest rates are probably going to be trending up for the foreseeable future. And if they are then what we just looked at as far as that previous slide is going to be quite important as far as trying to make decisions going forward. What impact Jake does… I know the headlines are screaming now as far as that if all this transpires that we’re going to start seeing a lot of pressure on earnings, stock earnings, and stock earnings obviously are going to translate into stock prices and the importance of that, but maybe if you can spend just a little bit of time as far as talking about this particular slide and what it’s illustrating here pertaining to earnings.
Jacob Woodcock:
Sure. So what we’re looking at that green line is year over year earnings growth expectations from analysts, so basically it’s the expected earnings per share that the trailing 12 months, and we can see that the current projection on the right hand side of the chart we’re still ticking up. So we’ve heard a lot of these stories as far as concerns about recession or just economic slowdown and a lot of that’s attributed the Fed is going to cause demand destruction, and people are going to stop spending because interest rates are higher.
Jacob Woodcock:
So the thing that this slide is illustrating is analysts, their take is that earnings are still growing. So even with the slowdown we saw Q1 earnings actually come in weaker than expected. Q2 is not looking great. So kind of the interesting thing I think here is that all the earnings growth for 2022 is really now being placed on the back half of the year. So the hope is we go through a week patch here and going into Q2 we start to see a pickup and that’s really the hope here is analysts still expect earnings to grow for what I’ll refer to the slow down and inflation eroding earnings, analysts are still saying they go higher.
David Nelson:
Analysts obviously aren’t right all the time, analysts in my opinion have a tendency to ramp things up a little bit greater, but again, earnings still today, not projections but reality, still look pretty good. Now having said that why is it that the market is rolling over as much as it has? It’s again, people are looking forward markets are looking forward trying to make those important decisions as far as about tomorrow, nevermind yesterday, what’s going to happen tomorrow.
David Nelson:
Now, if we look at the final slide that we have today it’s looking at essentially earnings as well, and it’s taken a little bit different approach, and it’s going to I think of the four that we brought today I think this one is probably the most telling, and maybe you can point out as far as on the right hand side there what that is basically telling folks out there.
Jacob Woodcock:
Here we are looking at… So I said I think an important distinction here is the analyst estimates that we’re just looking at. That’s what we call a micro analysis, that they’re getting in the weeds of looking at individual specific companies and estimating what that company’s earnings are going to be based on business dynamics primarily. So am I still… Can I track customers? Can I charge a fair price? What are my cash flows going to be? So that’s what we call the micro level.
Jacob Woodcock:
There’s also what we call the macro level, which this this chart would be a macro chart where we take those individual earnings estimates, we add them all up. We slice and dice something to give us kind of that 30,000 foot view. It’s the big picture here. And so when we take a macro approach in particular for earnings here, what we like to look at is earnings acceleration more so than earnings level or year over year growth. This is actually a rate of a change or a rate of a change so it talks about how quickly things are speeding up or slowing down.
Jacob Woodcock:
And we’ve seen that orange line in the bottom clip that’s circled there jumped sharply. We saw 2021 was just a huge, huge rebound for stock earnings after the 2020 slowdown, things came roaring back. So high earnings acceleration, it tends to be very good for stock returns. And that’s what we’ve seen to date.
Jacob Woodcock:
However, looking at where we think this thing’s going based on with the rate of change and where we’re coming from matters and so now we’re coming off a very high level, and then where we’re seeing quarter two earnings come in we expect this probably to fall all the way into negative territory by the end of the month.
Jacob Woodcock:
So really from a kind of a big picture view analysts may still be positive on their individual companies but when we aggregate those to the overall market that’s definitely where we’re seeing the slowdown. And so it’s kind of important to keep in that mind when you’re listening to people or reading people what their view is micro versus macr because it makes a huge difference in what you’re trying to accomplish. So I said analyst view is that they’re hopeful that earnings continue, but in aggregate we’re definitely seeing slow down.
David Nelson:
So Jake, we’re almost out of time here, I just wanted to ask if you were to summarize all the above here as far as that we went through what is your take? You’re an investor out there, you are probably close to retirement or in retirement, what’s my read as far as from what you just brought up today?
Jacob Woodcock:
So hopefully people are looking to us for that as far as what they’re thinking is. My takeaway is this is a really tough macro environment as we just talked about. The big picture looks really rocky with inflation, interest rates and growth. I’ll note kind of my key takeaway is that if you do the math, we’ve talked a little bit about this, we talked about it on the last segment we did here, I think a lot of the decline that we’ve seen, 20% on the S&P, 30% on the NASDAQ, I’d say a lot of that can simply be attributed to just re-pricing valuations based on interest rates. I really don’t think that there’s a ton of growth slow down priced into stocks, and you can see that in those analyst estimates, which like I said micro versus macro, but they get a lot of attention. People put a lot of value on those analyst estimates.
Jacob Woodcock:
And I think if you do the math, I really think what we’ve seen so far is simply interest rates coming up, discount rate rising and reprising valuations. If we go into a period where we do see significant slow down I think we could see a lot further decline in stocks just because I don’t think a lot of that is priced in.
David Nelson:
Very important information, we’ll continue to keep you current as far as we’re planning on doing this monthly, as we mentioned last month. All this information again isn’t to try to overwhelm it’s to try to keep you current as far as in our thought process, what we’re thinking here, what we’re doing here as far as to try to help individuals as far as in troubled times like now.
David Nelson:
Clearly this inflation issue has come about fairly quickly, it’s been around as far as at the lower levels for quite some time, but seeing this type of increase is pretty dramatic. Coming out of COVID has really, really rocked the boat in a lot of areas. We’ve seen it again at the pump, we see it as far as going to the grocery store, we see it everywhere. So we will keep monitoring things. We will help make decisions as far as on what makes sense at various points in time. But clearly if you have questions, comments, we just want to emphasize again, this is just one of the additional tools that we’ve tried to add to keep people current, but if you have any specific questions do not hesitate to give your financial advisor a call and we’ll do everything we can to try to answer your questions. So with that, appreciate your time today Jake, thank you very much. Thank you folks. Happy Father’s Day to those out there that are fathers. Have a great week.