2023 Stock Market Update

Yanni Niebuhr [00:00:01]:

You welcome, everyone. We appreciate you taking the time to join us here for this webinar. Today we’re going to be talking about why it’s important to stay the course and what we’re expecting when we’re looking ahead. For everyone in attendance, please note that there is a question box you can access at any time during this webinar. And we’ll do our best to get to as many of those questions as we can by the end of the presentation. Now, allow me to introduce Kara Murphy. Kara is the chief invest officer of Kestra Investment Management. Kara, welcome.

Kara Murphy [00:00:29]:

Thank you.

Yanni Niebuhr [00:00:29]:

Prior to joining Kestra Kara was the Chief Investment officer at Goldman Sachs personal financial management and before that the Chief Investment officer at United Capital and AIG Funds. Kara is a member of the CFA Society of both New York and Dallas Fort Worth. And on more personal side, she serves on the board of directors for welcome Home, a nonprofit she founded to provide support for newly resettled refugees. Kara, thanks for being here.

Kara Murphy [00:00:51]:

Thanks for coming. It’s always fun to chat with you. Yanni and I want to second your mention of questions and whatnot. So folks should keep in mind that I love to take questions and we’ll leave time towards the end to kind of take those. So I’m going to first talk about a presentation that we put together that talks about the principles of long term investing, because when we work with advisors and their clients, there are some sort of common mistakes that can lead to negative outcomes in terms of growing your wealth over time. So we wanted to be able to kind of bring that home into some easily understandable lessons. But then I’m happy to talk about kind of what we’re seeing in the market today and what we’re expecting.

Yanni Niebuhr [00:01:37]:

Yeah, sure. There’s a lot going on. I’m sure there are plenty of people on this that are going to be asking questions of what’s next.

Kara Murphy [00:01:43]:

Yes, there’s always some interesting things going on, for sure. All right, shall we dive in?

Yanni Niebuhr [00:01:51]:

Dive right in. Feel free.

Kara Murphy [00:01:53]:

Great. So Yanni mentioned that I have three children, so one of my favorite times of the day is story time with them. And I’m a big reader, so every night I usually have a different book than I’m reading with each of my kids. And while they’re a little older now, so they’ve grown out of ASOP, that experience really drove home for me how some of these stories are so important and really timeless. And out of curiosity, I started doing a little bit of research on ASAP himself. And little did I know that ASAP was actually born over 2000 years ago, right? Yeah, he was born in ancient Greece, and we don’t have any firsthand writings of his or anything like that. So what we have are echoes of what has been written about him since then. But what we think is that he was born a slave. And by some accounts, he was born Ute. And according to a couple of stories, he helped a priestess at a local temple at one point. And then ISIS, the goddess that that priestess served, wanted to thank him. And so she gave him the gift of storytelling. So with that gift, he was then able to talk his way out of slavery and eventually to become a counselor to kings and other really brilliant men, such that the likes of Aristophanes, Sophocles, Aristotle, have all written about him. And so think about how compelling this is, and then think about the stories that are attributed to ASOP that, number one, have endured for over 2000 years. They’re fairly simple. They use animals to convey simple lessons. But my goodness, if we’re still trying to teach our kids these lessons 2000 years later, they must be hard to learn. As simple as they seem, there’s a reason why these stories will resonate. And as simple as these stories are, they were powerful enough to sort of get ASOP from slavery, from being mute into a timeless character who we still talk about 2000 years later. So all of that is kind of the backdrop for these types of lessons. In terms of long term investing, some of these are going to seem fairly straightforward and simple. But hopefully, with the data that we show you, it’ll also be evident that they’re very hard to follow. Sometimes simple rules are not so simple to follow. So with that, let’s dive into what is probably Asop’s most well known tale, which is that of the rabbit and the hair. I’m sorry, the hare and the tortoise. And I always like to say that, give me the tortoise any day. I’m very much a tortoise investor. But there is on any given day, given the headlines, given what’s happening in the market, there is a temptation to be the hare. I always like to share. I spent much of my life in New York City taking cabs. Today. It’s Ubers. And that used to be an indicator for me on the market. When I got in the back of the cab and somebody asked what I did and I told them I was an investor. If the cabby was bugging me for stock tips, that was a sign that there was a little bit of excess interest in the stock market. And whenever I would answer something like, well, just buy the S and P 500, it was very unsatisfying. They would never like that answer. But here’s why I often give that advice. So on the right, we have this study that’s done by a firm called Dalbar. They’ve been doing this for decades. And what they do is rather than look at, say, the returns of the S and P 500, they look at actual client accounts and what’s been happening in those client accounts and how much money do they earn. And as I said, they’ve been doing this for decades. They look at equity accounts, they look at bond accounts, they look at mixed accounts. This year is just looking at equity accounts. So the average equity fund investor from 1992 to 2021 earned an average of 7.1%. That’s not bad. But if you look at the SP, the S and P returned almost 11%. So why that huge disparity?

Yanni Niebuhr [00:06:05]:

That’s really surprising.

Kara Murphy [00:06:06]:

I wouldn’t have expected it’s massive and consistent every year that they do this, this is what they find. The reason is not fees. So fees are an important part of your overall return, and they certainly do reduce your return a little bit relative to what the SP offers. But the big reason for this lower return is because people buy at the wrong time and they sell at the wrong time. So this is the investor behavior. We are not taking full advantage of what the market offers. So think about this. You have the S and P 500. That’s your tortoise, right? That’s the slow and steady. Just stick there every day. And then you have the average fund investor who’s like, I’m going to be the hare. I know when to get in, I know when to get out. And the fact is, on average, over time, people can’t do it. All right, so why is this so easy to run afoul of? So in the next chart, we’ll see what happens if you miss just a couple of days in the market. So, again, we’re looking at very similar time period from 1990 to 2022 if an investor misses only ten of the best trading days, right? So think about that. There are 250 trading days in a year. Multiply that times 30. If we pick out only the ten best, what’s the impact on an investor return? It goes down by more than half.

Yanni Niebuhr [00:07:28]:

Wow.

Kara Murphy [00:07:28]:

So this is just to drive home. You don’t have to miss that many good days in order to really hurt your returns. And then, of course, the more bad days that you miss, the lower your return over time. And that goes down very, very quickly. And a lot of people are like, yeah, but I’m not going to miss the best days. I’m going to know when to get back in. But if you look, historically, the ten best days tend to be followed by the worst days. So you have to sit through those really crappy days when you want to hold your stomach or hold your nose because the market feels so bad, because it’s after those bad days that the market tends to rebound.

Yanni Niebuhr [00:08:06]:

And most people wind up second guessing themselves on when they should get back in.

Kara Murphy [00:08:09]:

Absolutely. And often, to your point, people might sell at a good time, right? You sell and then you see the market go down. You’re like, I did a great job. But how many people make that second decision to buy back in in order to be there for the rebound. The fact is the numbers are telling us that people don’t.

Yanni Niebuhr [00:08:28]:

All right?

Kara Murphy [00:08:29]:

So if you think about that hare and the tortoise, they’re locked in this race. The hare is laughing at the tortoise, saying there’s no way that you’re going to beat me. The hare is so confident, he takes a nap. Sure enough, he sleeps right through the tortoise, running across the finish line. And that’s because the tortoise had time on his side. He was very consistent. Every available minute that he had, he was marching towards that finish line. And so if we look at on the right, the probability of a positive return. So if you’re in the market for one day, your chances of earning money are only 53%. That’s only a little bit better than blackjack. I hate gambling. I hate gambling for this reason, because I want better than that. I want better ODS than just 53%. So if you put your money in the market for a month, your chances of making money go up to 63%. If your holding period is ten years, your probability of earning money is 97%. That’s as close to a guaranteed return as my compliance department will allow me to offer.

Yanni Niebuhr [00:09:35]:

I was going to say I’m shocked to use the word guarantee there at.

Kara Murphy [00:09:37]:

All, but that’s right. I know.

Yanni Niebuhr [00:09:41]:

That’S impressive. I mean most people don’t realize that.

Kara Murphy [00:09:44]:

I know. And what’s interesting is that there have really only been two periods when even in a ten year time period we’ve had negative returns, one of which was 2008. And from 2008 today the market has multiplied by multiple times. So if you were able to hang on just eleven years, you had extraordinary returns during that time period. So this idea of consistency and persistency and if an investor has to learn one single rule, ASOP would be proud, consistency and persistency of being in the market. All right, but we’re going to get to some more challenging lessons here. The tortoise and the hare taught us one thing. Now, the three little pigs, what have they taught us? Now, I mentioned I have three children, so I know what it’s like to have three very different personalities in the house. If you remember this story, you have three little pigs who are setting off on their own and their parents are waving goodbye. They have their sticks with a little bag over their shoulder. They’re ready to start off on their own. The parents say, don’t forget about the big bad wolf. Be careful. They’re like, I got it, dad, Mom, I’m good. So the first little pig so excited. This is just like my little one. She wants to be at the center of the party. She doesn’t want to wait for anything. So imagine her setting up this house using any materials that she can. She just wants it done really quickly. And I mentioned this is a lot like the hair, right? These are the folks who want they just want it to happen super quickly. They don’t want to take their time. But there’s a danger to that, right? There’s a danger to rushing into this story that sounds really compelling without really sort of taking the time to build a framework that you need. And so this reminds me a lot about crypto, and it’s interesting how the conversation around crypto has changed so much over the last couple of years. But if you look at, again, investor behavior in crypto, like, what are people actually doing and what are they actually earning, it tells a very interesting story. Now, crypto, unfortunately, it’s a little harder to look into people’s accounts than it is for traditional stocks and bonds. So the best thing that we can do is look at the number of individuals who are downloading apps to be able to trade crypto. And so go back to 2021. We use bitcoin here. Bitcoin was up 66%. That was a really tremendous return, right? And people were getting really excited about it, if you remember. I don’t know, Yanni, if you were getting, like, clients asking you about it, but I was certainly getting a lot of folks asking me about it. During that year, the number of crypto app users doubled. So it’s safe to say that the individuals who are investing in crypto probably doubled over that time period. You can probably guess what happened in 2022.

Yanni Niebuhr [00:12:28]:

I felt like that year, every single client we had a conversation with, they were asking about it, wondering what was going on, how it was used, where it’s going to go, because everybody felt like they were missing the boat, right?

Kara Murphy [00:12:39]:

But then think towards the end of 2022, how that psychology had changed, right? So crypto then was down 65%. So we’re now even below where we started, 2021. And guess what happened? The number of app users halved. So that means people bought in after crypto had risen, and then after it started to decline, then they sold out of it. That’s not a great experience.

Yanni Niebuhr [00:13:05]:

No, it’s not. And it’s telling. They’re looking at the annual returns. You say, all right, well, 66, and then negative 65. I made a 1% return. Right. And then you look at the ending and beginning numbers.

Kara Murphy [00:13:13]:

You’re like, no, not the same thing. No. And then if we look at 2023, lo and behold, bitcoin is up again. And so think about the tremendous volatility that we’ve had from one year to the next. And then to your point, Yanni, look at that starting price and the ending prices. We’ve had all that ajita and all those opportunities to make really bad decisions. And bitcoin has been flat over a two and a half year period. This highlights to me the danger of looking for the quick fix. It also highlights how if you get into this kind of, like, nichey type of asset class, you’re really beholden to this potential roller coaster ride and turn up. We know what happens with the little pigs. The big bad wolf eventually comes, as it did for bitcoin in 2022, and blew the whole house down without a whole lot of effort. So in the story we have, the little pig then runs to the siblings house and that sibling. I’m going to take a few liberties here, but this is more like my son, who’s the super conservative one. He sees what’s happened to his little sister and he’s like, that’s not going to be me. I’m going to build this with the strongest twigs I can find. I’m going to wrap them together. So nothing’s ever going to happen. I’m going to take whatever cash I have, I’m going to stick it in my mattress, and I’m going to be good. So sister comes knocking. She’s now in his house as well. But this is the other danger that I think often gets overlooked. There’s a danger of taking too much risk and just blowing it all in bitcoin. But there’s also a danger in being too conservative and sticking in cash. And I think the last couple of years have been particularly a great example of those dangers. So we did a little exercise here and we pretended like we had a kim shop where we had a basket full of eggs and beef and milk, the kinds of things that most Americans buy on a regular basis. Sure. In 1990, at the beginning of this time period that we’re looking at, that basket would have cost about $6.91. And Yanni, I don’t know if you remember this, but back then you might have been counting out your pennies, right? There might have been that little tray that said, take a penny, give a penny. It’s okay to say no, but you.

Yanni Niebuhr [00:15:28]:

Fast forward unbelievably cheap when you look at it. You can barely buy the eggs now for 691, right?

Kara Murphy [00:15:35]:

And these are not your free range organic eggs or your grass fed beef. Like, this is just straight up run of the mill stuff, right? So just with the passage of time, you’re looking at almost a three fold increase in those costs. And so for somebody like my son, who has all his cash stuffed under his mattress, he’s losing value every single day. And even if you can pay with bitcoin, it doesn’t really help.

Yanni Niebuhr [00:16:02]:

No, especially when bitcoin stayed the same over that three year period, right?

Kara Murphy [00:16:08]:

In this case, you have the big bat wolf who shows up and he looks at this house with the cash sticking out from the mattress and he says, I’m not going to huff and puff. I don’t have to. I’m just going to sit and wait because time is going to do my job for me.

Yanni Niebuhr [00:16:22]:

All right?

Kara Murphy [00:16:22]:

So in this story, then, you have the two kids, they sit it out, they realize that their money is dwindling away with time. And so they rush out to my middle daughter. She’s the one who she does all the preparation, she does the research. She convinced us to adopt a puppy recently, and she literally had a PowerPoint presentation for us with citations and what.

Yanni Niebuhr [00:16:41]:

PowerPoint presentation?

Kara Murphy [00:16:43]:

Yes, she did. She did.

Yanni Niebuhr [00:16:46]:

Yeah.

Kara Murphy [00:16:46]:

It was remarkable. So she’s the one whose house you want to go to when the Big Bad Wolf arrives. She’s got her materials. She’s got the mortar and the brick and the shingles and all this taking.

Yanni Niebuhr [00:16:58]:

Care of the puppy.

Kara Murphy [00:17:00]:

She is actually taking care of the puppy. I mean, I’m doing a fair amount too, but no, she’s waking up at 530 in the morning to take her out. Like, Power to her, she’s been good. In this case, this takes a lot longer to craft. Right? You have to make sure that you have the right materials. You have to sort of test it out. You have to make sure it can withstand different environments.

Yanni Niebuhr [00:17:24]:

Right?

Kara Murphy [00:17:24]:

But sure enough, her brother and sister arrived. The three of them are now camped out in this more stably built house. And the Big bad wolf arrives. And they’re like, I’m good. Pass the oreos. We don’t have any problems. And so if you look at the right, we call this the quilt chart, and you’ve probably seen different versions of this, but the idea is we take a number of different asset classes and rank the returns on a calendar year basis. And what you’ll see is that it’s kind of all over the place. So it’s very hard to predict which of these asset classes is going to outperform on any given year. But if you follow that middle one with the blue and the red outline, that’s a diversified portfolio. So that’s one that uses a little bit of stocks, little bit of bonds, some international, some domestic. So what you’ll notice is that that really sort of treads along the middle there. And if you then compare returns over that whole period, it’s among the highest returning asset classes and it’s among the lowest levels of risk. So with that, by mixing these different asset classes together, you can get a smoother ride that over time, gives you a much better return and risk profile than what you would get with any single one. But it’s important to remember, we do this because the Big Bad Wolf is always out there somewhere, right? And that’s a normal part of the market, right? I said before, if you’re invested for ten years, your chances of success are extraordinarily high. But during that time period, there are plenty of times when the market turns down. So if we could go to the next slide, then what we’ve done is taken different levels of market downturns. So on any given year, the market will decline by 3% as many seven times. Like, on average, actually, seven times. And then if we look at a 20% bear market, you’re talking about every two to three years to experience a bear market. Really?

Yanni Niebuhr [00:19:25]:

It’s that often, right?

Kara Murphy [00:19:26]:

It doesn’t feel that way because we had a long period of time post financial crisis where we didn’t experience a bear market at all. But then 2020 we had one, and then 2022 we had one. So that’s actually not unusual when we look back at like 100 years worth of history. So it’s good to remember this is a normal part of the cycle. You can’t panic. You have to be ready for it ahead of time. All right, so that brings us to our third story, which is Goldilocks and the Three Bears, which was actually not written by it’s not attributed to ASOP, but I like threes and I like goldilocks and I like curly haired young children who wander around alone in the woods. So if you think about the Tortoise and the Hare is all about persistency and consistency. The Three Little Pigs is all about building that diversified portfolio and being ready for negative market events. The Goldilocks is really a story about finding what’s right for you because your right portfolio may not be the right portfolio for somebody else. And that’s okay, right? And this is the work that Yanni, you guys do so well in thinking about an individual’s starting point, what are their hopes and dreams, what are their goals, and then marrying that to the right mix of assets to make sure that they line up properly. So what we did here is we often talk about stock bond mix in a portfolio. So a 2080 portfolio has 20% stocks, 80% bonds, and then we have different level mixes kind of as we go across that. So what you’ll see is returns over that 30 ish year time period. Returns generally go up the more stocks that you have in a portfolio.

Yanni Niebuhr [00:21:09]:

So more risk and reward makes sense, right.

Kara Murphy [00:21:12]:

And generally if people look at those returns, everybody’s going to pick the 80 20 portfolio because I want the higher number. Right? But then we add in the max drawdown. So at some point during those 30 years, what was the maximum amount that that portfolio dropped in a given period of time? And that’s where the rubber really hits the road, right? That’s the big bad wolf at your door. And that 80 20 portfolio went down by almost half in 2008. So you have to think about that if you’re getting close to retirement and you’re kind of a bit of a nervous Nelly and you have to imagine yourself watching your portfolio go down by half if that gives you ajita and that makes you want to hit the patent button, that’s not the right portfolio for you.

Yanni Niebuhr [00:21:56]:

Exactly.

Kara Murphy [00:21:57]:

Thinking about what that experience is like and dialing into the right one is so important. All right, so with that, I want to highlight to another part of this. Once you identify the right portfolio, you want to make sure that you stay there and we stay there by rebalancing. So if you imagine a portfolio that’s 60% stocks, 40% bonds, generally speaking, the stocks are going to go up higher than the bonds. So periodically you got to bring them back into the right balance. Again. If you don’t do that, your portfolio starts to look like a much higher risk portfolio and then you become at risk of that downdraft. So you want to make sure once you get the right lane, you do what you need to in order to stay there. All right, so let me just summarize kind of what ASOP is out there trying to tell us in terms of crafting portfolios with the tortoise and the hare. You want to be consistent, focus on the long term. You want to be prepared for the big bad wolf. You want to have a risk aware portfolio that can withstand any type of market drawdown. And then of course, you have to make sure that the portfolio that you’ve chosen is the one that’s right for you. Your goals, your risk tolerance, all that good stuff. And so what’s interesting is that ASAP, as I mentioned, we’re still talking about him 2000 years later, and he was able to make his mark by providing these very simple kind of tales and got recorded in this timeless way by some of the greatest minds in Western civilization. So don’t forget that just because these things might seem simplistic, they’re incredibly important. And in fact, as we look at the value that financial advisors like Yanni and Team offer, the great amount of value that they offer is in this kind of behavioral coaching, making sure that clients understand how their portfolio is set, making sure that they can get through these market events and make good long term decisions. And over time those have shown to provide great value to end clients. So that’s the great work that you guys do.

Yanni Niebuhr [00:24:05]:

I appreciate it. It’s reminding that it’s a marathon, not a sprint, not trying to chase turns and figuring out what’s most important to someone.

Kara Murphy [00:24:12]:

Absolutely, yeah. That’s not an easy process and those things can change over time and that’s okay. But you need so Yanni, I do have some material talking about the current market and kind of what we’re expecting.

Yanni Niebuhr [00:24:28]:

I’m sure there’s quite a few people on here that would be really itching to understand where are we going, what’s happened so far and where are we headed.

Kara Murphy [00:24:36]:

Okay, well, it’s been a very eventful year. This year is just an overview of what the market has done so far this year. And what’s interesting is that these numbers here are not that unusual in that US. And non US stocks have been the best performer so far this year. Bonds look okay, kind of low single digit return, which is pretty decent. But what’s surprising is that it’s the complete opposite of what we saw last year.

Yanni Niebuhr [00:25:10]:

Right.

Kara Murphy [00:25:10]:

For the calendar 2022 we had stocks down 20%, we had bonds down 15%, and commodities were the standout. And of course, this year they’re actually in negative territory. So it’s just been very interesting how the first half of 2022 is essentially a mirror image of what we saw last year. And it’s a good reminder of sort of like the vagaries of the market and how things can really change on a dime and not be really expected. So, again, another case for having a diversified portfolio so that you’re not caught flat footed when these changes happen.

Yanni Niebuhr [00:25:45]:

It reiterates exactly that blanket chart that you showed, even though last year commodities saved the day, this year if you’ve owned all commodities, you’d be in trouble.

Kara Murphy [00:25:54]:

Absolutely. Yeah. And then there were a lot of people who were giving up on fixed income late last year. And look, we’re like back to positive returns again. So you can’t call that timing in looking out, like across 2023, we’ve had this theme of landing in turbulence. Oh, sorry. Let’s talk about this economic dashboard. So we came up with this to try and highlight where we feel like we are in the business cycle. And I grew up in this business with this idea of don’t fight the Fed. So if the Federal Reserve is tightening monetary policy, they’re raising interest rates, things are going to slow down. Now, we’ve had this gauge actually farther in the red than it’s showing here. We’ve lightened up a little bit because they’re close to the end of their Fed rate tightening, but it is still in restrictive territory.

Yanni Niebuhr [00:26:45]:

Sure. Now, when you say don’t fight the Fed, because that was a lot of the news for a while that everybody was saying, all right, the Fed’s raising rates and then they think they’re going to lower rates and now they’re possibly going to start again raising them, but the market keeps chugging on. From that standpoint, it’s kind of interesting that everybody was saying don’t fight it, and yet here we are saying the Fed is going to raise rates and the market keeps going up.

Kara Murphy [00:27:07]:

Yeah, I mean, it’s such a good point because that theme worked very well in 2022. Right. Fed was being restrictive and risk assets came down significantly. The market has been telling us this year that we don’t care about the Fed anymore. We’re good. Thanks, Fed and Powell and all you guys. What we’ve been looking at very closely is the forward expectations. So a couple of weeks ago, the markets were still expecting the Fed to start cutting rates by the second half of the year.

Yanni Niebuhr [00:27:36]:

Right.

Kara Murphy [00:27:37]:

Those expectations are starting to inch back up again, so that the market’s gotten a little less excited about Fed rate cutting. And so I think that’s the story that’s going to be important in terms of where the market goes from here. How long does it take for the Fed to start cutting rates and how long do rates. Stay at this high level. And that’s where we’re a little bit more cautious, I think, than a lot of other market participants. Okay, now manufacturing, you’ll see, is the second section there. This is the area that really got impacted the first by this tighter monetary policy and slower economic growth. We have a lot of manufacturing indicators trying to look I don’t think we have a chart here, but a lot of indicators have been suggesting for a number of months that manufacturing is going to go into negative territory, and we’ve seen activity come down a lot, and so we’d expect some additional deceleration there.

Yanni Niebuhr [00:28:31]:

Now, what does that typically mean in Signal when that happens? What’s that? I said, what does that typically mean in Signal when you start to see those things happen in those indicators?

Kara Murphy [00:28:38]:

So the one that we look at is, ism manufacturing, and that’s a monthly survey. Do we have that? Oh, thanks, Ryan. Oh, here we go. Okay, great. So this is a monthly survey where the survey producers go out to manufacturing country companies around the country and say, hey, are things better or worse than they were last month? So a series of very simple questions. If they’re better, then that number is above 50. If they’re worse, then that number is below 50. And then they have all these different questions and they aggregate them together. So as that aggregate number goes below 50, that suggests that manufacturing activity is contracting. Typically, this is a good indicator of where overall economic growth in the US. Is going. And so if you look there, we crossed 50 in October of last year, so we’ve been below 50 for seven months. Now, this is generally a pretty good precursor to recession, anywhere between three and six months. We’re already at seven months. Okay, so it’s unusual, actually, that we’ve been below 50 for this long and not hit recession. But this is definitely kind of the source of a lot of the weakness in the economy. The strength is in the consumer side because what we’ve seen is that the labor market is still the strongest that we’ve seen in 60 ish years. People feel pretty good even though consumer confidence is down, they’re continuing to spend money and wages are increasing. So consumers have really been the source of strength in this market so far, and that’s even held up housing. So housing, we just had some data come out today where housing data was surprisingly strong. So we’ve definitely seen a lot of weakening, but not in the big negative territory that we might have expected a year ago, given how much interest rates have increased.

Yanni Niebuhr [00:30:34]:

Housing is something we’ve gotten a lot of questions on, say, well, the price is going to come down. And then you look historically and the amount of houses built and population growth, and a lot of people now are sitting on two and 3% interest rates in their mortgage. So why would they ever sell their house? So everybody’s wondering, when can I get a good deal again?

Kara Murphy [00:30:50]:

Right? It’s gotten to this really interesting dynamic. And I was just looking at these numbers this morning that the number of homes for sale is about the lowest it’s ever been today. So think about this. You have interest rates that are way high and should be driving prices lower, which should pull in additional buyers. But to your point, because people have two 3% interest rates, they’re like, I’m not going anywhere, I’m just going to sit. And right now you can borrow. If you have a mortgage at two 3%. If you have cash and you put it in a money market at five, why would you give that up? Right? So a lot of people are kind of going through that that can only last for so long, because at some point there are people who have to move for a job or retiring, and they need to downsize. So at some point that’s going to start to work off. But right now it’s actually led to an even tighter housing market, which is really all right, let’s take a quick peek. I won’t go through all of this, but this is basically our outlook and where we are, what we’ve seen so far is the growth in stock prices has happened at a time when earnings expectations are declining. Usually it doesn’t happen that way. And so what that means is that the market has become even more expensive than it was. And then on top of that, the growth in the S and P 500 has been on the back of just a handful of stocks.

Yanni Niebuhr [00:32:23]:

Right. So seven or ten stocks that have done basically everything.

Kara Murphy [00:32:26]:

Absolutely. I was looking at even just a measure, S and P 500, which is market cap weighted. Right. So it’s overly dominated by the largest stocks, which are the ones that have been doing really well. And then I compared it to the equal weighted SP 500. There’s a difference of ten percentage points so far this year between those two measures. So it’s just a way of highlighting really how much those largest stocks have been driving stock market growth. So it feels like the market has gotten ahead of itself here, especially with the economy continuing to decelerate. So we’re cautious here, and we think that there will be a recession second half of this year, but because we don’t think it’ll be a deep recession, and because it’s very hard to call these timings, we don’t want to be overly cautious in terms of where the market is. We want to pull in our horns a little bit, be a little bit more conservative, find some opportunities in fixed income, find some opportunities outside the US. But we still want to be there for when the market starts to normalize again. We have other charts, but let me just pause there. And Yanni, we can kind of take the conversation where you want to go.

Yanni Niebuhr [00:33:34]:

Sure. It is interesting. So you mentioned fixed income, which people, for a very long time were getting frustrated with returns, and you mentioned international markets, which, I mean, if you owned anything outside of large cap US. Growth for the last decade, you really didn’t do anything. So you’re beginning to see opportunities outside of the US.

Kara Murphy [00:33:51]:

Yeah, absolutely. It’s interesting because as you point out, for the last like, ten years or so, it’s been hard to justify owning anything outside the US. But of course, we like to look at very long periods of time, and there have been long periods of time when the US. Has actually lagged other parts of the world. And going forward, we see the valuation differential between the US. And non us. Has gotten to extremes, to levels that we’ve never seen before, meaning that the US. Is so much more expensive than non US. And then on top of that, valuations are much, much lower outside the US. And earnings expectations seem more reasonable. And then the last thing that I’ll throw on there is a big benefit to the SP over the last ten years has been a stronger dollar. And there are a number of reasons to believe that at the very least, the dollar won’t continue to increase relative to other currencies like it has. So that’s a tailwind for US. Stocks that may not be there in the future as it has in the past.

Yanni Niebuhr [00:34:51]:

Okay. And then you mentioned recession you expected this year. What kind of a recession do you expect? Is it a very deep one? Is it a rather shallow? Is it long for years? Is it short? Based on your research, what are you thinking?

Kara Murphy [00:35:03]:

Yeah, and I always say this carefully because we’re expecting a relatively shallow recession, but I don’t say that without a lot of caution, and I always like to share. I was a financials analyst working at AIG during the financial crisis, so I know how bad things can get. But the key difference between that experience, which was a very dramatic, very gut wrenching downturn, is the amount of leverage that was in the system then versus today. So when we look at the amount of debt that consumers had on their balance sheet in 2008, it was extraordinarily high relative to history. Companies, it was less. So, though companies did have a fair amount of debt on their balance sheets. And then what had happened was that that high level debt on consumer balance sheets then got engineered in such a way that it found its way to places that people didn’t even know. Right. And the risk ended up being so much bigger than what people realized. So it’s this financial engineering that allowed this risk to find its way to unexpected places. Today, when we look at debt, consumer debt levels are actually much, much lower than they were in 2008, period. The housing industry in particular has been much more conservative in the types of mortgages that have been given out. Companies have a little bit higher level of leverage, but if you look at the amount of money that they’re spending on their debt, it’s still relatively low than private compared to prior periods, which is kind of remarkable given how much increase in rates that we’ve seen. Now, there are some areas of the economy where people have raised the alarm bells, rightly? So things like commercial real estate, specifically office. So that’s definitely an area where we would be concerned. But overall, if you look throughout the system, the level of leverage is much lower than it was in 2008, which generally translates to a much softer downturn than what we would experience.

Yanni Niebuhr [00:37:08]:

Okay, well that’s all things being considered, that’s a positive outlook on things from that standpoint. And then you mentioned here talking about interest rates and where you think the Fed is headed. People were expecting come the end of the summer and possibly even then, lowering rates are starting to and now that’s looking a little bit further off. Do you think that’s still in 23? Do you think that’s pushed off in the 24 at this point?

Kara Murphy [00:37:27]:

So our bet would be that it happens later rather than sooner. So we’ve already seen as recently as a couple of weeks ago, markets were calling for Fed rate cuts starting in September. So that’s really soon. I feel like I’m already buying backpacks for my kids to return to school and whatnot now those have really been pushed off to the end of 2023. Beginning of 2024.

Yanni Niebuhr [00:37:52]:

Okay.

Kara Murphy [00:37:52]:

And our view has been that typically the Fed doesn’t start to cut interest rates until there’s a recession or some sort of crisis. So if we were to clearly go into recession in the near term, then yes, we could see Fed rate cut sooner. But given kind of where things are trending right now, it’s not going to be for a little bit.

Yanni Niebuhr [00:38:11]:

Okay, and then you mentioned there the opportunities in fixed income. Where are you seeing those opportunities?

Kara Murphy [00:38:18]:

So in particular, we’ve started to go out the duration curve a little bit. So buying a little bit longer dated fixed income, particularly in Treasuries, corporates high grade munis. So we wouldn’t go super far out on the credit risk curve, things like high yield and junk bonds. But if you’re in the middle part of the curve, so think like five to seven year duration and you’re in pretty good high credit quality, then we think as rates start to normalize, that will be so the Fed starts to come to the end of its Fed rate hiking. You can benefit if Fed rates start to come down again and you’re insulated from a credit perspective. So we think that there are some interesting opportunities there.

Yanni Niebuhr [00:39:02]:

So moving up that yield curve a little bit, still remaining a little cautious, but staying with stuff that’s high grade.

Kara Murphy [00:39:08]:

Yeah, exactly.

Yanni Niebuhr [00:39:09]:

Okay, well, that was very helpful. I don’t know if you have anything else on your end, but if not, we’ll open it up for the questions.

Kara Murphy [00:39:17]:

Maybe as people type in their questions. Ryan, if we could go to just the last slide. Stocks for the Long Run I just want to highlight this because I love this chart. I don’t know if you were able to join us, Yanni, for the call that we did with Professor Siegel, but he has been in this business for 50 years and really made his name and being able to collect all of this data, looking at different asset class returns for the last couple of hundred years. And mind you, he did this at a time when there was no such thing as Excel. He was doing it on graph paper. But the remarkable thing about this so I’ll just highlight a couple of things and then this looks at real returns. So it seeks out the impact of inflation. So if you look at gold, there kind of bouncing around the bottom. I get a lot of questions about gold, a lot. And my answer is always there are periods of time when gold can do well and is helpful as an inflation hedge or hedge against some sort of crisis. But if you think about it with what we would call a strategic asset class, something that you want to own for a really long period of time, gold has not been a great sort of creator of wealth over time. And then if you look at stocks, look at that red line, that’s the kind of average return over time. And you’ll see there are periods where stocks maybe return a little bit more than that average predicted. And there are periods when they return a little bit less, but they keep coming back to that 6.7% real return. And that longer term return has been remarkably consistent. And so I have this quote from Professor Siegel. Stocks are the most volatile asset class in the short run, but the most stable in the long run. Right. So it gets back to this idea of persistency and consistency. It can be hard to sit through in a year like 2022 when stocks are off an awful lot, but they are far and away the best builder of wealth over time for individuals.

Yanni Niebuhr [00:41:12]:

This data just flat out reinforces the fables you just talked about showing it’s like, yes, that there will be volatility. Yes, there are ways to make the quick buck, but you can also turn around and see the big divergence down. But staying in the long term here, it proves its own trajectory.

Kara Murphy [00:41:28]:

Absolutely. And this is 200 years. I mean, that’s an impressive going back.

Yanni Niebuhr [00:41:33]:

That far, that had to be difficult. That’s impressive. But I’m actually rather shocked to see that the dollar has fallen so far.

Kara Murphy [00:41:38]:

And that’s not even inflation. I know. And that’s the impact of inflation.

Yanni Niebuhr [00:41:42]:

Yeah, it’s incredible.

Kara Murphy [00:41:44]:

Yeah, that was the last thing I wanted to share off to you.

Yanni Niebuhr [00:41:49]:

Perfect. Well, I appreciate it. Well, now we’ll take the questions here. Sarah or Ryan, I don’t know which one of you is going to be sending those off for us here, but we’ll get started on those questions.

Sara Lohse [00:41:58]:

Awesome, I’m happy to help with that. So we have one going back to the beginning of your presentation, kara, you talked about the Dalbar study. Someone wanted to know, are those institutional investors or real retail investors or both?

Kara Murphy [00:42:15]:

Those are individual retail investors. It’s a really good question because it’s not easy to get those returns. You have to look into millions of different accounts. Yeah, but those are individuals.

Sara Lohse [00:42:26]:

Thanks for clarifying that. We have a question. When and how should alternative investments be considered in a diversified portfolio?

Kara Murphy [00:42:36]:

Yeah, that’s a great question. So as you can see here, stocks do a really great job of building wealth over time. In general, I have this bias towards simplicity. So stocks and bonds are very liquid. They’re a great builder of wealth over time. That said, alternatives, given the right conditions, can help a risk return profile over time. Now they add complexity, they often remove liquidity. But for clients who are able to withstand that, who are able to take the time to understand the additional complexity and understand the impact on the overall portfolio, they can be a really great addition. But you don’t have to have that in order to grow wealth over time.

Sara Lohse [00:43:21]:

Okay, for a retiree with no debt, how much cash would you keep in the bank?

Kara Murphy [00:43:28]:

Well, congratulations. First of all, that’s pretty remarkable. This is probably a better question for Yannis. I don’t know if you want to.

Yanni Niebuhr [00:43:35]:

Take a first for that one. It’s just everybody is unique. Your wants, your goals, your desires, or everybody is different. So we have plenty of clients where I’ll tell them their emergency fund goal is 25 grand and they tell me that if it’s anything less than $100,000, they’re not going to sleep at night. So everybody’s unique. There’s a psychological number and there’s the mathematical. So what I tell you there from that standpoint is just having the conversation with your advisor.

Kara Murphy [00:44:03]:

And I think to your point, Yanni, like being realistic about what is going to keep you up at night and what are your must have spend if you need to be able to draw on emergency fund.

Sara Lohse [00:44:16]:

Why would one put money in a five to seven year bond at 3% when you can get it in one year at 5%? And why would you go further out in the credit term?

Kara Murphy [00:44:26]:

Yeah, that is also a great question and one that comes up now with what we call an inverted yield curve, right? Where long term yields are usually higher than short term yields, but instead they’re the opposite right now. So the reason why you would do that is because looking farther out, we were talking earlier about the Fed decreasing interest rates, and over time we expect those money market rates to come down and to have a right sizing of the yield curve. So today it’s lovely to earn four or 5% in basically a risk free asset, but we don’t anticipate that that’s going to last forever.

Yanni Niebuhr [00:45:02]:

Right at that point in time, you’ve missed the boat on it switching, and you’re not going to see that appreciation.

Kara Murphy [00:45:07]:

Exactly.

Sara Lohse [00:45:11]:

How concerned should we be about the banking crisis?

Kara Murphy [00:45:15]:

Yeah, another great question. It’s something that we’ve been following very closely. And I mentioned earlier, I was a banking analyst for many years, so I was having a little PTSD in March as those banks failed. So what we think is that regulators did a very good job trying to ring fence this issue. SVB signature gosh, I’m blanking on that silver gate and the fourth one, first Republic, First Public. Those four banks had fairly unique business models in the banking world. And again, not to excuse them, and not to say that there aren’t risks elsewhere in the banking system, but those business models were fairly unique, and regulators stepped in with size, force and speed to kind of ring fence the issue and try and prevent it from spreading elsewhere. So they said, we’re going to extend FDIC deposit insurance to larger depositors. And another key thing that sometimes gets missed is there was a regulation that was put in place during the financial crisis to help banks sort of work through bad loans. So particularly commercial real estate loans, banks are able to, if a loan starts to go sour for a lot of consumer loans and short duration loans, banks are forced to kind of take a charge against a loan that has started to go sour within a very short period of time. For commercial real estate loans, the Fed essentially gave banks a several year window to try and work out those loans, which means that if they have a loan that’s starting to go sour, they have more time to be able to work through it. They don’t have to take the capital hit right away. So that helps to protect the banking system in general from having this big downdraft. And as I mentioned, we’re looking closely at offices in particular because commercial banks have such a large exposure to this area. But what that means is as you start to have commercial real estate loans that go bad or don’t get paid on time, it doesn’t create a hole in the bank’s balance sheet. But what it does is take up space so that banks become more conservative, they can’t give out new loans. And so we’re already starting to see banks, small banks in particular, kind of pull in the reins and offer less credit, particularly to small businesses. And so small businesses tend to be a huge economic engine of economic growth in the US. And so that kind of feeds into our recession thesis over the latter part of the year. So we think it’ll contribute to a slowing in the economy, but not necessarily precipitate in an additional crisis.

Yanni Niebuhr [00:47:55]:

So you think it’s completely different than Eight, where we had a completely different financial issue there? You think this one’s more muted and we’re better prepared and regulated compared to that period of time?

Kara Murphy [00:48:05]:

I do. It doesn’t mean that there aren’t any problems. Right. I’m sure we’ll see some more regulation coming down. Powell is just testifying on this yesterday. But the starting point of leverage is just so different today. And if you look at capital levels in banks today versus pre financial crisis, in many cases, they have ten times the amount of capital that they did back then. Yeah, it’s remarkable what’s going on with.

Sara Lohse [00:48:34]:

The debt ceiling slowdown and how might that affect us?

Kara Murphy [00:48:39]:

So it’s actually remarkable to me how quickly we’ve been able to kind of move past this debt ceiling issue. The fact that we were able to raise the debt ceiling without I know it felt hairy heading into that agreement, but most kind of policy watchers that I spoke to expected it to get a lot hairier than it actually did. So we were able to come to an agreement in raising the debt ceiling. And from folks that I talked to in DC. That the next thing on the docket is the budget for next year, which also sounds like there are a lot fewer kind of really hairy issues to be able to contend with. And so folks are saying that this sort of budget showdown is not going to be as bad as what we’ve seen in other years. Now, the comeback is that this is a more contentious political environment that we’ve had in years past. And all that’s totally fair, but I would say that the government has functioned remarkably well given the political rancor that we see on TV every night.

Yanni Niebuhr [00:49:41]:

Right. I think it became to the surprise to everybody that it got resolved so quickly. The question everybody keeps asking is that the curtail in government spending going forward going to impact the economy at all? Do you think there’s going to be impact from that or do you think it’ll be pretty status quo?

Kara Murphy [00:49:55]:

Yeah, this has been an issue that’s just so easy to kick the can down the road. And if you look at the amount of the US. Budget that is nondiscretionary, it’s the vast majority of every dollar that’s spent by the US. We don’t have discretion over. I think especially with Republicans now in control, we’re going to see some more belt tightening and some more reapportioning. But if we listen to what politicians are telling us, Social Security is not on the table, and that’s a massive chunk of the federal outlay budget over time, we’re going to have to contend with these things if we don’t want the US debt to continue to swell. But it’s become a hot rod issue that nobody wants to touch.

Yanni Niebuhr [00:50:38]:

Sure.

Kara Murphy [00:50:39]:

So my guess is that nobody will until they absolutely have to.

Yanni Niebuhr [00:50:44]:

Everybody’s trying to let someone else do it.

Kara Murphy [00:50:46]:

Absolutely. And I don’t blame them. It’s not fun, it’s not going to be an easy one to do.

Yanni Niebuhr [00:50:51]:

You’re not going to make everybody happy. I wouldn’t want to be the person in charge of that.

Kara Murphy [00:50:54]:

Yes.

Sara Lohse [00:50:56]:

Staying on the topic of the government and debt, do you have concerns about the growing US debt and the debt to GDP ratio?

Kara Murphy [00:51:06]:

Yeah, we used to have a chart on this because it’s so interesting. Pre COVID, the US debt to GDP had been increasing at a pretty decent rate, and then COVID, it just went to the stratosphere. We’ve seen it hook down a little bit, but not that much. It’ll continue to come down a little bit, but it’s going to be hard to really bring it back down to an area that I think a lot of people are comfortable with. But a couple of things to keep in mind. One is when you compare the US debt to GDP ratio to other developed non US countries, in many cases we’re a lot lower. So, like Germany, Japan, we’re well lower than ratios that they had. So it just goes to show that you can continue going up and it doesn’t necessarily impact what market participants view as your credit worthiness. Thank you, Ryan. So this is a great example going back to the 1960s, and we can see that huge spike during COVID on the right and then how it’s come down a little bit, but we still have a long way to go to get to pre COVID. But the other piece that’s interesting is if you look at the debt service ratio to GDP, so how much is the US Government spending on a monthly basis to pay the interest on these loans? It’s really, really low. Before COVID it was actually the lowest it had been since 1960. So it’s really counterintuitive. You can have this huge ballooning in debt, but the cost of servicing that debt is actually low. But think about it like a mortgage, right? You’re able to take out a much bigger mortgage and that 2%. Like your mortgage payment is just not that big on a month to month basis. Now that starts to change with higher interest rates.

Yanni Niebuhr [00:52:55]:

Well, that’s why I was going to ask next, so when does some of that come due? That it’s going to be an issue later on?

Kara Murphy [00:53:01]:

Yeah, and it’s in the next couple of years, it starts as that older debt matures and they take out new debt. Thanks, Ryan. This is household debt service. This is a good example, though, about why we think this recession will be more shallow. Right. Because even with higher interest rates, you can see that household debt service payments, like how much an individual household is paying on a monthly basis for debt, rising pre COVID levels. So it’s pretty remarkable. But from a government perspective, the longer that we stay at this high interest rate level, the bigger the national debt becomes. Which is also why the Fed needs to be super aggressive in killing inflation now so that they can bring down rates, and then we don’t have this kind of ballooning problem, so it can continue for a while. And I know that’s hard for people to stomach sometimes.

Yanni Niebuhr [00:53:58]:

The government’s got their playful.

Kara Murphy [00:54:00]:

Yes, for sure. Which is why I’m in this seat and not in DC.

Yanni Niebuhr [00:54:05]:

I was going to say exactly. I’m not doing that.

Sara Lohse [00:54:10]:

Is there anything you have as far as what you think is going to happen with unemployment? I know right now it’s sitting at about 3.5%, but that’s not common when you’re going into recession.

Kara Murphy [00:54:22]:

Absolutely. I get this question a lot, and I get another version of this question, which is, I don’t understand how we can have recession when unemployment is only at three and a half percent. And the answer there three and a half percent. You’ll see that? I mean, look at this. You have to go back to the 1950s to see a level of unemployment that is this low. There’s some argument to be made that this unemployment rate actually understates the tightness of the labor market. So extraordinarily tight market jobs, very, very plentiful. And then, of course, wages we’ve seen increasing significantly. That is scaring the pants off the Fed because it’s higher wages that get built into the system, and that’s inflationary pressure that’s much harder to pull back out of the system. So what we’ve started to see, our initial claims have begun to tick up, still at a very low level, but the number of people who are newly jobless and applying for assistance has started to increase again, still very low, but an indication that things are beginning to loosen up. Wage increases are also starting to peter out a little bit. Again, not to a point where the Fed feels comfortable, but off the highs that we had seen, like late last year. So what we would anticipate to happen is that this loosening of the labor market continues. That’s healthy. It’s painful if you’re one of those who’s worried about your job. But from an macroeconomic perspective, that’s a healthy part of the cycle unfolding. And typically this happens later in an economic cycle. We talk about leading economic indicators. This is a lagging economic indicator. So it’s not until the economy has really slowed that we start to see pronounced weakness in the labor market.

Yanni Niebuhr [00:56:04]:

Okay, so, Sarah, in the essence of time, I don’t have any more questions yet, but let’s find one last one and then we’ll end there.

Kara Murphy [00:56:14]:

All right?

Sara Lohse [00:56:15]:

No pressure. I just have to pick a great one.

Kara Murphy [00:56:17]:

Yeah. Okay.

Sara Lohse [00:56:25]:

What’s causing inflation to stay sticky?

Kara Murphy [00:56:31]:

Yeah. So Ryan, see if we have the CPI goods and services chart that would be helpful. We often break down consumer prices into two buckets. There’s goods, prices and services. So think a couch, a hammer, a house, those things are all in the goods bucket. And then services are things that you pay for getting your nails done, getting your taxes done. It’s something where you need like another person at the end to do something for you. So that light blue line there are goods prices and you can see that the Fed targets 2% goods. Price inflation is already below 2%. Yay. The Fed did a great job there. The challenge is services. And that gets back to that wage piece that I mentioned earlier, services. Because there’s a person attached to that. You need a person to deliver that service. When wages go up, the cost of that service goes up. And once you raise somebody’s wage, if you hire somebody at $20 an hour, you can’t go back to them six months later and say, oh, well, inflation is down. We’re going to cut your pay to $18 an hour.

Yanni Niebuhr [00:57:39]:

Yeah, it doesn’t work that way.

Kara Murphy [00:57:40]:

Yeah, so that’s where it gets into the system. It gets very sticky, so it takes a little while. And that’s also why you need to see labor market weakness to start really bringing those services prices down.

Yanni Niebuhr [00:57:51]:

All right, so one of our coworkers here was telling me how her high school son just got a summer job making like $23 an hour. $23 an hour. I was making a quarter of that if I was lucky.

Kara Murphy [00:58:04]:

Oh yeah, for sure. I think I work for $3 at the public library.

Yanni Niebuhr [00:58:11]:

Well, Kara, thank you so much. Time for your time. The data, the insights, it’s incredibly helpful and we very much appreciate it. For everyone that was watching, this session was recorded and it’s going to be made available on BHG’s website shortly. So thank you all for listening.

Kara Murphy [00:58:25]:

Thank you. Take care.

Yanni Niebuhr [00:58:27]:

Take care.