Market Update

The S&P gained 0.8% last week to finish at 4137.64. The Nasdaq gained 0.3%. Volume was below average for the week once again. Earnings season kicked off Friday. A handful of earnings reports were released, including three from big banks. Earnings estimates continue to fall. The consensus for 2023 is now $219.83 down from $220.45 last week. Earnings are forecast to grow 0.8% in 2023. Analysts are backloading earnings with 9.7% growth expected in Q4. Analysts are guessing that 2024 earnings will jump 12.3%. Even without a recession, that kind of growth seems unlikely.

Meanwhile, the futures market has the odds of a rate hike in May at 78%. The fed-funds rate would rise to 5.0% - 5.25% with a quarter-point hike. The futures market is estimating a 15.1% chance that the funds rate will be at or above 5.0% by November. It’s estimated that there is a mere 4.3% chance the funds rate will be at 5.0% or higher by year-end. The futures market is showing a whopping 76.7% chance that the funds rate will be cut two to four times by year-end.

The 3M T-Bill is at 5.03%. The two-year Treasury is at 4.18% and the 10-year is at 3.52%. The 3M/10Yr is inverted by 1.51%. It is the steepest inversion in 40 years. The Federal Reserve uses the 3M/10Yr in its recession forecasting models. The Federal Reserve is forecasting a recession in 2023. It is expecting “A mild recession starting later this year with a recovery over the subsequent two years.” The Fed is expecting rising unemployment as well. “Historical recessions related to financial market problems tend to be more severe and persistent than average recessions,” Fed staff noted in the meeting minutes. The Fed went on to estimate that the economy would recover by 2025.

Earnings estimates are too high in 2023 and 2024 if the Fed’s forecast for recession is correct. The futures market might be right about two to four rate cuts later this year, but only if the Fed is right about a recession. No recession means no rate cuts. The Personal Consumption Expenditure Index (PCE) one-month annualized trimmed mean rate is 4.0%. It was 4.1% in September 2022. The Fed’s wage growth tracker three-month moving average has turned up. It bottomed out at 6.1% in Dec/Jan/Feb before climbing to 6.4% in March. Rising wages will keep inflation higher longer and cause margins to compress. It seems likely that the rate of decline in inflation will slow. It is even possible it reverses. Rate cuts in 2023 without a recession would increase the likelihood of a reversal in the inflation trend.

Earnings season is here. Guidance will be more important than the actual earnings numbers. The stock market could challenge 4,325 with a better-than-expected earnings season. The S&P is trading above its rising 200-day moving average. Despite questionable fundamentals, it appears that the stock market wants to move higher. A bad earnings season might change that. The 200-day moving average is around 3,940 and is first resistance.

Economic Indicators

U.S. Small-Business Confidence dropped in March. The survey blamed uncertainty surrounding the banking turmoil. It fell to 90.1 from 90.9. The reading is well below the long-term average of 98. The drop erased the year’s gains. The NFIB survey is focused on small businesses. Small businesses account for almost half the jobs in the private sector. NFIB chief economist Bill Dunkelberg told MarketWatch that “…almost all (small business owners) now see deteriorating business conditions and poor prospects for sales.”

There were other signs of weakness last week. Initial jobless claims rose to 239,000 from 228,000. Jobless claims have been drifting higher for several weeks now. As well, U.S. retail sales fell 1.0% in March after falling 0.2% the prior month. But industrial production was stronger than expected, rising 0.4% in March, up from 0.2% the prior month. It is the consumer that drives the U.S. economy though.

Inflation continues to subside… slowly. Core CPI rose 0.4% down from a 0.5% increase in February. Core CPI year-over-year rose 5.6% in March up from 5.5%. The tick-up should reverse in coming months. Producer prices fell 0.5% in March after falling 0.0% in February. Core PPI rose 0.1% after rising 0.2% in February. Core PPI year-over-year rose 3.6% down from 4.5% in February. The numbers have much improved since this time last year. Inflation may be back to 2.0% by sometime in 2025, but probably not without a recession. Nominal revenue will feel the headwind of falling inflation until then.

Norwood Economics finds itself in agreement with the Federal Reserve. We’re looking for a mild recession starting in the second half of 2023. Earnings estimates are too high if we’re right.

Wealth Management, Investing and Dalbar

Good wealth managers deliver value to clients in many ways. Financial planning is critical to a successful retirement. It's hard to get where you want to go without a plan. Estate planning is critical to ensuring your assets go to whom you want when you want. Insurance planning guards against wealth destroying events. Tax planning helps ensure you don’t pay more taxes than necessary. And then there is investing.

Investment portfolios should be constructed to help investors achieve their financial planning goals. Portfolios should also be designed with both estate planning and taxes in mind. It’s all interconnected. Understanding your investment goals is critical to the wealth management process.

Earning a real rate of return that allows funding of all spending goals is a basic requirement. Beating an index is not. The former means a successful retirement. The latter does not.

Yet measuring portfolio efficiency is important. An advisor who isn’t adding excess risk-adjusted return (alpha) shouldn’t be paid an active management fee. But that doesn’t mean you don’t continue to use them. It just means you don’t pay them for a service they aren’t providing. You do pay them for the services they are providing. Everyone needs help with wealth management. Most people need help with investing. The do-it-yourself investing model doesn’t work for most people. Dalbar has been documenting that fact for almost 30 years now.

Dalbar is a well-respected market research firm located in Boston Ma. They have tracked individual mutual fund investor performance and found it wanting. Average equity fund investor returns lag far behind market returns. Large-cap equity fund investors lagged the S&P 500 by 4.32% in the 20-year period ending in 2011 for instance. That’s a tremendous loss of wealth over a 20-year period. More recently, Dalbar’s quantitative studies show average large-cap equity fund investor returns lagging the S&P 500 by 3.52% per year over 30 years. Investors trailed the S&P 500 by 10.32% in 2021. What’s going on?

Harmful behavioral biases that’s what. Investors allow fear and greed to hurt their returns. Recency bias, status quo bias, anchoring, and a whole slew of other behavioral biases negatively impact investor returns. Chasing performance, chasing crypto, chasing lottery tickets (through ETFs like ARK). Piling into the market in late 2021. Bailing out in October of 2022, early 2009, and the summer of 2002.

Wealth managers can more than earn their keep in the investment arena by helping clients avoid their worst behavioral biases.

Avoiding big losses is more important than squeezing every penny out of the next bull market. A good wealth manager can help you keep your eye on the ball, allowing you to achieve a successful retirement.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist