Aaron Tuttle, CFA®, CFP®, CLU®, ChFC

GWS Chief Investment Officer

Are we on the verge of a recession? That seems to be the number one question on all investors’ minds. In this quarterly market summary, we’ll take a deep dive into this and other key market themes from Q1 2022. As always, we’re here to give you actionable advice so you can make informed decisions with your money.

Theme #1: Recession Signals Historically, one of the most accurate predictors of a coming recession has been an inverted yield curve — exactly what we’re experiencing in the market today. Typically, the yield curve is upward sloping. When it inverts, it signifies that short-term debt vehicles have higher yields than similar long-term instruments. As we always take care to mention, no one has a crystal ball to know what the market will do. Still, having kept an eye on the yield curve and other economic factors, our investment committee anticipates we are approximately six months out from a recession.

Theme #2: Markets Moving Past Headlines Given the Ukraine-Russia war, it’s easy to blame Russia for inflation. In reality, monetary policy, lockdowns, and other government policies laid the groundwork for inflation long before the war. Inflation will continue on as supply chains become less global and more regional. The markets are already moving past their initial reaction to the Ukraine-Russia War (even if the headlines have not). Instead, markets seem to be reacting more acutely to changes in Federal policy.

Theme #3: Low Unemployment

We’ve seen strong unemployment numbers in the last few weeks. Even if we have a recession, we could see unemployment staying low. Real wages are likely to drop through this, and companies will be more hesitant than before when it comes to letting people go. Instead of seeing more employees laid off, we anticipate a rise in the cost of energy, food, and other consumable goods.

So, What Does This Mean for My Portfolio?

Many clients have asked, “If we’re heading into a recession, should I pull out of the market now and go to cash?”

Our answer is: Not necessarily. There is still value to be had in equities, and completely pulling out causes you to miss the chance for those potential gains. Plus, with high inflation, you also risk losing your principal if it’s not growing at all.

The market typically peaks 13 months after an inverted yield curve happens. So, we need to be more diligent and ready to move on things. It makes more sense to look at more defensive equities than to complete sidestep into cash.

Conclusion

From an inverted yield curve to the Ukraine-Russia war and unemployment metrics, there’s plenty to keep an eye on as we head into Q2. We don’t anticipate that the recession will hit this quarter; however, it’s prudent to be prepared and review your portfolio strategy with your advisor if you have any questions.

Our Commitment

As always, the GWS Investment Committee is committed to the following investment management goals for our clients in 2022:

1. To pursue long-term returns that first and foremost strive to help clients work toward all goals in their financial plans.

2. To seek excess return above each portfolio’s benchmark over a three-year trailing time period and a full market cycle, in order to hopefully cover client fees and add surplus to their portfolios.

3. To implement investment strategies that align with each client’s personal volatility and benchmark sensitivity to help them remain confidently invested and long- term focused. We’ll continue to provide updates on these and other market happenings, so be sure to subscribe to our YouTube channel so you never miss a Weekly Market Insight webinar (Wednesdays at 3:30 p.m. CT). We’ll see you there! —

Disclosures

The opinions expressed are those of Aaron Tuttle and Gatewood Wealth Solutions as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material is for general information only. This material does not constitute investment advice and is not intended to endorse any specific investment or security.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested directly. Returns represent past performance, are not a guarantee of future performance, and do not indicate any specific investment. Diversification and strategic asset allocation to not assure a profit or protect against loss.

When interest rates rise with fixed income securities and bonds, bond prices usually fall, because an investor may earn higher yield with another bond. Moreover, the longer the maturity of a bond, the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. The bond’s issuer is obligated to return the investor’s principal (original investment). As a result, high-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase, and reverse repurchase transaction risk.

Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA & SIPC.

Executive Summary

As the market continues to bounce back post-pandemic, we’ve seen some interesting themes emerge. This quarter, we’ve reported weekly on many of these topics, such as rising inflation, signs of economic recovery, the strength of the dollar, and the seasonality of market behavior — all while keeping a sharp eye out for signs of an impending correction.

Let’s dive into the key themes that emerged in Q3 and talk about whether or not there should be a concern for a correction.

Theme 1: Cautionary Components in our Dashboards

First, we’ll start with the yield curve. As a refresher, the yield curve graph shows yields, or interest rates, of bonds with equal credit quality but different maturity dates. So, for example, a normal curve reflects higher interest rates for 30-year bonds compared to 10-year bonds, which you might expect (a higher return for holding the bond longer).

Think about it this way: banks can create money by loaning out their depositors’ cash, using a short-term payment and a long-term receipt. If the outcome is positive, it doesn’t matter where the interest rate is; banks can profit from lending long and borrowing short, which allows them to create credit (or money) in the system, bullishly affecting asset prices.

If the yield curve flips, banks begin to stop borrowing. Instead, they may call loans to pay depositors, which in turn shrinks the money supply.

This quarter, the yield curve showed a significant amount of movement. We ended the quarter close to where we started, but there was quite a bit of change over the last few weeks as rates came off their lower bound and moved back up 20 basis points (remember, a basis point is a hundredth of a percent). At the moment, we do not see a pullback. Demand for cash is greater than the demand for loans, so we likely don’t have to worry about a correction — yet.

Where is our concern coming from? We see from the following spider graphs that the money supply has dipped. Our spider graphs give a high-level look at how well the market is doing. Remember, the market is a forward-looking economic indicator, so it’s the first to dip.

In June’s graph, you can see an essentially robust economy, save for transportation and consumer sentiment. Those dips are primarily due to the chip shortage’s impact on vehicle purchases and resulting consumer sentiment.

Then, in July, we started seeing a deterioration in that bullish percent index. With the money supply dipping like this, we’re keeping a close eye on our dashboards for other signs of an impending correction. Now, moving into August, the money supply has slowed, and the bullish percent index is further down, which is concerning. But remember, it is customary to see a pullback in money supply as we get closer to September and October.

Theme 2: The Dollar as the “Fastest Turtle”

When it comes to the money supply, we see countries worldwide trying to solve the same problem: printing. Some are printing more money; others, less.

Compared to other major world currencies (e.g., the yen, euro, Canadian dollar, pound, krona, and franc), the dollar is quite strong. The continued strength is mainly because the U.S. dollar is a global currency, holding its demand. This gives the U.S. Federal Reserve an advantage over many other countries, as the global market makes the dollar more attractive.

Next, let’s look at credit spreads on BBB (“triple B”) bonds, the lowest quality while still being investment grade.

The spread, or extra yield someone gets for taking credit risk, has remained constant throughout the quarter. Bondholders did get paid to hold a little extra credit, which is what the Morningstar graph shows at the bottom: higher-yield bonds performed well.

The data tells us so far; markets are not pricing in credit risk. Interest rates are moving up, but they’re doing so across the board. If we were to be moving into a recession, the bond market hasn’t predicted it yet.

Theme 3: Global Energy Problems Emerging

Basic materials and industrials were among the lowest-performing sectors in the U.S., reflecting a broader global energy issue. We haven’t seen oil prices as high as they are now in the U.S. since 2014. Furthermore, China is suffering an energy crisis due to a general global coal shortage and an unfavorable trade policy with Australia (which has since been revised).

Still, those aren’t even the biggest energy headlines this quarter. Instead, the main story here is Europe’s sky-high natural gas prices. In April, the price was under $20, but it’s already spiked to $117. These spikes ignite shock waves through the system, impacting fertilizer prices, ammonia plants, and greenhouses. In many ways, Europe’s food sector is simply not economically viable at these prices. We guess there will be a sharp market correction as gas prices get resolved, but we don’t know what that looks like yet.

Fortunately for the U.S., natural gas issues are somewhat regional, so we see a domestic impact, but it is not proportional.

Other Q3 Observations

While not standalone themes, there were other observations worth mentioning this quarter. The observations are:

• The third wave of coronavirus did happen, but new medical options lessened its severity.

• We see exports — not imports — grow as cargo ships struggle even to make it into port in the U.S., let alone get unloaded.

• The U.S. grew more quickly than the global economy. Global GDP was only 5%, primarily due to issues with emerging markets (such as the Chinese real estate debacle).

• Municipal bonds performed well, while taxable bonds stayed reasonably flat.

• Secretary Yellen has called for a debt ceiling, saying we will default on bonds if we pass one by Oct. 18. We don’t think this will happen, as not enough people are pushing for it. If it does go through, we don’t believe the “Build Back Better Bill” will go through at its total proposed $5 trillion thresholds.

• The Federal Reserve met in September to discuss their balance sheet. While their strategy isn’t finalized, they signal they will likely reduce those assets at the end of the year and continue mid-2022. About $600-700 billion in asset purchases will be added, growing the balance sheet to a bit of shy of $9 trillion. That’s still a lot of accommodative policy, but it’s a bit of a tightening relative to where we were.

Please contact your lead advisor about how these themes impacted the market and portfolio performance this quarter.

Conclusion

While we see early signs of an impending correction in our dashboards, we don’t believe there is cause for concern just yet. Still, if the yield curve starts dropping, you’ll find us becoming more conservative. We continue to keep a finger on the pulse of the market and will be sure to update you with important updates to our dashboards.

To learn more about correction concerns in Q3 2021, be sure to listen to our recap video below.

To ensure you don’t miss an update, join our live Weekly Market Insight webinars on our YouTube, LinkedIn, and Facebook accounts. We’re here to help make sure you’re doing the right things to preserve your wealth — a crucial part of our mission to help you become and remain financially self-reliant.

As always, feel free to reach out to your lead advisor with any questions or discussion points!

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Disclosures

Securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.

The opinions expressed are those of John Gatewood as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended to endorse any specific investment or security.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested directly. Returns represent past performance, are not a guarantee of future performance, and do not indicate any specific investment. Diversification and strategic asset allocation do not assure a profit or protect against loss. When interest rates rise with fixed income securities and bonds, bond prices usually fall because an investor may earn a higher yield with another bond.

Moreover, the longer the maturity of a bond, the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. The bond’s issuer is obligated to return the investor’s principal (original investment). As a result, high-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase, and reverse repurchase transaction risk.

When it comes to choosing funds to invest your money, there are virtually infinite possibilities in the market. At GWS, our Investment Committee has meticulously whittled down our approach to just a handful of strategies that we find most effective for our clients.

Think of our investment strategies like a menu. As the client, you can order whatever you like. But, as a good server, we’re going to recommend specific strategies to you based on your preferences, lifestyle, goals, and financial plan. So, even though the pasta special is award-winning, a chicken and vegetable dish might be more aligned with your health goals and palate!

Ultimately, the decision is yours, but the onus is on us to educate you on what strategy likely aligns better with your goals and financial plan.

High Risk, High Reward? The Role of Beta in the Market

Have you ever heard the phrase, “High risk, high reward?” That quip references beta or risk. Beta measures a portfolio’s volatility relative to its benchmark. A beta greater than one suggests the portfolio has historically been more volatile than its benchmark. Conversely, a beta less than one indicates the portfolio has historically been less volatile than its benchmark.

So, let’s say you have a beta of 2 or double the market. If the market goes up 10%, you go up 20%. 1 But if the market goes down 10%, you’ll also go down 20%. That’s where the idea of “high risk, high reward” comes from.

In general, the amount of risk you take should be correlated to the length of your time horizon or when you’ll need the money. For example, if you’re 30 years old and investing in your retirement, you have a long-time horizon and can take on more risk. On the other hand, if you’re 30 and investing money you’d like to use to purchase a home in the next five years, you have a short time horizon. Therefore, you would want to invest in a strategy that posed less risk.

Unpacking Investment Strategies

Read on for a description of our investment strategies and how to determine which is best for you. We are entirely agnostic to these strategies, meaning we don’t favor one over the other. For a deeper dive into each, feel free to reach out to me or any member of our investment committee.

Not yet a client of ours? Then, select “Request a Meeting” in the upper right-hand corner of the page, and we’d be happy to connect with you.

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Strategy #1: Builder Works Well For Early Investors; Wealth Accumulators

This strategy is all about the long game. It is most appropriate for people with a long-time horizon who can get compensated for bearing volatility. The Builder strategy is meant to leave benchmarks in the dust!

This is one of our flagship strategies, and even though it’s geared toward younger investors, some of our clients keep them forever and contribute to the account over time. So, if you’re an aggressive investor and want to hold forever, this could be an option for you at any age.

Strategy #2: Tax-Wise

Works Well For High Earners Who Need to Keep Their Taxes Down; People Who Generally Hate Paying Taxes

This strategy is all about keeping as much of your wealth for you (and out of taxes) as possible. To aim towards this, we are cautious with capital gains. This is because your earnings net of taxes matter. So, for example, in retirement accounts [e.g., 401(k), IRA, SEP IRA], you can trade as much as you want and never pay a capital gains tax.

But in taxable accounts, you must pay very close attention to how often you trade. For example, if you trade within 12 months, you’ll have short-term capital gains losses. However, once you hit 12 months and one day, you’ll instead be counted as a “long-term” hold from a tax perspective, which is more favorable.

Historically, we used mutual funds for this strategy, but we’ve transitioned to using nearly all ETFs. Why? A benefit of ETFs is that they reduce — or in some cases, avoid entirely — capital gains distributions. That means they’re more tax-efficient compared to similarly structured mutual funds.

ETFs can also be traded during the day, so we’re not held to a single end-of-day value. Thus, if we have to trade quickly, ETFs are much more favorable. In most cases, they also come at a lower cost (although we don’t shy away from using more expensive funds if we think we can make the client more money from a net standpoint).

We, of course, try to beat benchmarks, but that’s not the goal with this strategy – lowering taxes is. So, the performance may zig-zag much more closely to the benchmark in this approach than Builder, for example. (We call that difference a tracking error; this strategy would be considered low to medium.)

Strategy #3: Moat

Works Well For Investors that Love Individual Stocks

Maybe your parents told you fairy tales when you were little or asked them about your kids. Either way, chances are, when we say “moat,” you know exactly what we mean. Just like a moat was a small border of water around a castle intended to keep intruders out, this moat keeps competitors of high-performing stocks at bay.

The story goes that this is the analogy Benjamin Graham taught Warren Buffet when he mentored him on stock picking. “If you’re Coca-Cola, what’s your competitive advantage that keeps your competitors at bay?” That competitive advantage is the moat.

At GWS, our Investment Committee does extensive research to determine what companies have an “X-Factor” advantage to outperform their competitors continually. Our relationship with Morningstar allows us to dig deeply into stocks for these qualities, and then we add a quantitative layer of analysis over the top. Typically, this strategy aligns with our tax-wise strategy’s quantitative buy/hold timings, but not always. So instead, it’s more about specific companies who are outperforming (and suggest that they will continue to exceed).

We typically see a lot of “DIY” investors in this strategy. They like following individual stocks and tracking performance, and they tend to shy away from ETFs and Mutual Funds out of personal preference.

Strategy #4: Signal

Works Well For: Clients Who Have Rollovers, Are Approaching Retirement, or Are Retired

Some would consider this our flagship strategy. We use a time-tested approach to following quantitative indicators – a firm’s trade secret rooted in following a technical signal.

How does it work? The signal we have developed broadly pinpoints where dollars flow globally to see where we’re getting exposure. For example, last year, this strategy picked up on high-performing categories like technology and stay-at-home stocks. At the same time, it avoided types like cruises and airlines, and as a result, we had significant exposure to those categories that did well. This is a disciplined, daily trading strategy that closely follows a rules-based process and algorithm.

The driving factor behind the algorithm is momentum. We won’t catch performance perfectly at the bottom of the peak (no one can), but if we can catch it in between over and over with your holdings, you may outperform the markets. Many advisors in our firm hold their money – particularly for retirement – in this type of account. It’s a significant reason for the firm’s success.

Ultimately, an essential part of your investment strategy has the right amount in the market for the right amount of time in the market. Our Planning Committee does a great job helping you figure out exactly how much you should keep as a cash buffer, so the rest can be in the market growing and working for you. Watch this video from Chief Planning Officer Christina Shockley for more on that topic.

We discuss these strategies and themes – especially beta – each week in our Weekly Market Insights broadcast. Be sure to subscribe to our GWS YouTube channel, so you never miss an episode, and download a calendar hold here.

Note: We also have a tactical bond and qualified bond strategy; ask your advisor for more details.

1 This is a simplification and does not extract the risk-free rate. It is immaterial on return and overly complicated to include.

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Disclosures:

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance references are historical and are no guarantee of future results.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF’s net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.

Chinese real estate developer Evergrande had global markets on edge this week. As loyal listeners to our Weekly Market Insights might recognize, we called out the potential of China’s rapid expansion of their money supply to disrupt the market about two weeks ago (watch the replay here). Let’s dive into what caused China’s housing bubble, as well as what this could mean for the future of the global economy.

Chinese Housing: Bubble Decades in the Making​

China’s real estate market leverage has been excessive for over a decade. As a result, there have been reports of substantial concrete structures being built. China has over-leveraged with more concrete units than households. Now, because China has been in a bubble for some time, they created a “three red line” policy.

With this policy, China will slow down its bubble and hope for a soft landing. Here are the metrics of the guidelines:

1. 70% ceiling on the debt to asset ratios after excluding advanced receipts

2. 100% cap on the net debt ratio

3. 100% cap on short-term debt cash rate

According to a sales manager of Evergrande Wealth, “more than 80,000 people – including employees, their families, and friends as well as owners of Evergrande properties – bought WMPs that raised more than 100 billion yuan in the past five years.” They call themselves a conservative company; however, they promoted 11-13% rates of return for real estate and leveraged unconditional marketing tactics — such as giving away Gucci bags — to attract customers.

Overleverage

When we look at Evergrande as a whole, they have about $300 billion in total liability, and $7.4 billion of that is due over the next year. Then diving a little deeper, $850 million in interest payments is anticipated over the next year, and $150 million of that is due in the next two weeks.

Rising Risk

Many are calling this the Lehman Moment, which is referencing a contagion. We do not think China will make the same mistake; however, this does not prevent them from making new mistakes. In short, we do not believe it is a Lehman Moment, but there is a contagion. It will be felt throughout the economy. All economic activity is interconnected. For example, the risk of default and a distressed lender is moving high yield debt rates up in general. Other marginal borrows or distressed borrows are seeing their lending costs increase. It is being felt across the entire debt market. Or it is contagious. Is it enough to create a domino effect; unlikely since the PBOC will step in before this occurs.

A typical retort to the Lehman Comparison is Evergrande debt has tangible assets, not financial assets. First, real estate is both a tangible and financial asset. But the problem is not the physical aspect, but what people are willing to pay for something. Second, if real estate prices drop precipitously, it will not matter how tangible they are if they are pennies on the dollar. (As an example: here is a viral video of 15 tangible buildings being destroyed which were never completed:

The Debt Limit

Another headline is the spending and debt limit bill that passed in the House on September 21st. It is currently sitting in the Senate. The bill has a suspension of the debt attached, but since it is a spending bill, the Republicans can filibuster it. They likely will play this game of chicken. The House Speaker is scheduled to deal with the infrastructure bill on the 27th. In short, there is little time, and the U.S. government could default in October if the debt limit is not extended. We expect accusations to fly, but ultimately the debt limit increase will be a separate bill that can be passed through reconciliation (Republicans cannot filibuster); however, the debt limit will not be suspended but only increased, meaning the big spending bill will be delayed. We are watching closely. We consider a default unlikely, but then the political climate is not conducive.

Keep up to date with the rising risk of Evergrande in China and more every Wednesday at 3:30 p.m. C.T. And to learn more about this week’s Weekly Market Insights, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

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Disclosures:

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

The opinions in this material do not necessarily reflect the views of LPL Financial.

LPL Financial does not provide tax advice. This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.

Hurricane Ida caught the news, as it left millions of people without power in New Orleans only 16 years after Hurricane Katrina. Natural disasters are great tragedies, but ultimately, we will focus our discussion on the effect on the economy.

Let’s start with the broken window fallacy, penned by French Economist Frederick Bastiat. This fallacy disproves the myth that the destruction of property is beneficial to the economy. So in a situation where there’s destruction, we may not see a change in GDP, but we do have a society with less wealth. So, therefore, we don’t measure the economic activity that is unseen.

Natural Disasters

When we look at natural disasters, hurricanes are one of the most consistent and significant ticket items. However, we do have a property and casually for these disasters because they are tragedies. But let’s take this and compare it to the same scenario from Frederick Bastiat, the seen versus unseen.

When you look at the New Orleans economy, it’s going to look like it’s been stimulated by GDP because there is a transfer of money that has been sent to replace the infrastructure that Hurricane Ida has destroyed. So, this is the “seen” part. But what we won’t see is the money that the property and casualty companies would have used and saved for other investments to fund future catastrophes, where they would have to payout. So, therefore, we are not losing our spending as an economy but all the innovation that would have come from the property’s investments.

Storm Costs

Another thing that happens a lot whenever hurricanes come about is the severity of storms and that storms are getting worse. It is likely not the severity of the storms driving these costs up over time; we are developing areas in our communities.

So if, if we had a storm come through and it’s across the beach, and there’s no development whatsoever, we’re not going to account for all the different changes that happened in the environment because there was no economic component. So, therefore, as our economy continues to grow, the additional infrastructure increases.

Florida

So let’s analyze Florida because hurricanes are typically the most significant event that we see in Florida.

We can look at the population growth for Florida and see 1960 Florida is not the same as present-day Florida. When we talk about the electoral college, Florida has a significant influence. It’s one of the most populated states in the country, but not the case in the 1960s. We can see that the population since the 1960s has increased. So you may be thinking the population increases everywhere, so why Florida?

Well, we can see how the population influences Florida as the house of representatives increases over time. In 1944 they had six representatives; by ’64, they had 12, and in 2004 they had 25. This number is likely to go up with the number of people continuing to move to that state. But all the increase in population means that beaches that were empty before now have all kinds of infrastructure surrounding them. So whenever a hurricane comes through, there are more places to hit and what’s driving the increased costs.

Infrastructure Spending

Infrastructure spending has been moving slowly, and there has been a lot of going back and forth with politics. Janet Yellen wanted to get the $3.25 trillion passed before the infrastructure bill, but the Senate has now approved an additional $550 billion in spending. The extra $550 billion is set to be voted on September 27th.

Although natural disasters come and go, our economy can take the hit for longer. Keep up to date with the effects of Hurricane Ida on our economy and more every Wednesday at 3:30 p.m. CT. And to learn more about this week’s Weekly Market Insights, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

The opinions in this material do not necessarily reflect the views of LPL Financial.

When analyzing stocks, there’s more to evaluate than simply revenue, valuation, and industry trends (i.e., fundamentals). Of course, these factors are essential, but they don’t always show up in the market price. That’s why we also do what’s called technical analysis. You’ve probably heard me refer to technical analysis as reading tea leaves because the process involves a level of subjective prediction based on historical data.

Chris Arends, our Portfolio Analyst, has even more confidence in technicals. He considers technicals “astrology for adults”! We joke, but we do spend a lot of time analyzing technicals. We know that factor investing does work, and a lot of times, reading the charts and technicals will get us a particular element in the market and a signal through the noise.

Let’s jump in and look at the different asset classes we typically review during technical analysis.

Performance of Asset Classes on a Technical Analysis

Looking back to August 20-24th, we see crude oil rebounding quickly. But then, if we look at a seven-day window, we can see that the Russell 2000 is positive, and the NASDAQ composites are up — as well as gold and the core bond. Therefore, there is a quality bias to these types of asset classes.

S&P 500 Large Cap Index

Looking at the images above, you’ll notice how the S&P 500 is moving on the left chart. A point and figure chart are on the right, which is an excellent way to see where support levels are. So, for example, you can see the July bottom was at 42/30, and in June, it was at 41/60. One thing to note is that the S&P 500 is one of the few indexes having a breakout while also making new all-time highs.

Russell 2000

Now, let’s review the Russell 2000 small-cap. You’ll notice it doesn’t have a quality factor like other indexes. We can see that it had been trending up for quite some time and had significant outperformance, but it’s been a flat line since April.

Another way to think about this is by dividing the Russell 2000 by the NASDAQ 100. Whenever the Russell 2000 (purple line) moves up, it outperforms the NASDAQ 100. Then, when it’s moving down, the NASDAQ 100 is outperforming the Russell 2000. We can also compare it to the interest rate on the 10-year treasury (on the axis). As you can see, we start below 1%, move up to 1.75%, and then back to 1.2%. The trend that we notice here is when interest rates move up, the Russell 2000 outperforms. Then, as interest rates decrease, the NASDAQ comes back in.

MSCI EAFA compared to the S&P 500 Sector Weighting​

Next, when we look at international indexes, we analyze demographics and other characteristics besides the value growth aspect. But you want to be cautious about entering any global indexes because of low price to earnings. So, let’s look at the exposure breakdown of the broad index of international developed companies compared to the S&P 500 based on the sector below.

First, cash or derivatives are being minimal on the amount of money they hold. Then, we can see that the EAFA holds 4.68%, while the U.S. holds 11.26% in large-cap. If we go to the biggest holding in the international index, we can see its financials at 16.74%, while the U.S. is 11.12%. Therefore, there is a significant overweight relative to the U.S. markets towards finance. On the other side, if we look at information technology, the S&P 500 has almost 30% waiting while the EAFA has less than 10%.

One Belt, One Road

In the last couple of months, it has become a tough market in China, which makes up about 30% of the emerging market benchmarks and indexes. Some excellent companies look innovative, but as soon as they start looking too good, the communist party overpowers them. This isn’t a political issue but rather geopolitical. The real question is, is China investible?

Also, the problems occurring in Afghanistan have a significant impact on the market. China has been working on the ability to create this “one belt, one road.” Historically, the red line represented the Silk Road until the west became a maritime superpower. Then, England went through and built the Suez Canal, where they could control trade. Now, China is trying to make inroads into reopening that Silk Road. But, then, with the power vacuum in Afghanistan, we’re starting to see them approach the Taliban as the U.S. leaves.

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To learn more about this week’s Weekly Market Insights, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

The opinions in this material do not necessarily reflect the views of LPL Financial.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested directly. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

Active, Passive, or Sales Pitch? The GWS Stance on Active vs. Passive

The efficacy of active vs. passive investing is one of the oldest debates in the books. But it’s not that simple — and, often, these terms are just used as part of a sales pitch. At Gatewood Wealth Solutions, we are neither active nor passive; we are agnostic. Instead, we use strategies we discern that are better for our clients based on their specific situations and goals.

Why isn’t this as simple as it sounds? Think about it: we’ve all heard people say, “I’m a passive investor.” But what do they mean by that?

No One Is Truly “Passive” When It Comes to Investing

If you mean, you’re not doing much, that makes a lot of sense. Passive investing is a set-it-and-forget-it type of strategy. But what is typically represented by having a “passive strategy” is that you have no opinion on different markets — that everything will average out over time, and the time and cost of underwriting that is not going to bear any fruit. Like any strategy that gets market exposure, it will work at the end of the day! And there is nothing wrong with it. You, at a minimum, will get the market minus fees; you may just not get the best performance.

Even then, everyone has a different “passive strategy.” For example, let’s say you decide just to buy an index — the S&P 500 — as your “passive strategy.” Already, you’re saying, “I believe these U.S. large-cap companies are my best investment option, so why would I buy anything else?” You have an opinion and are taking an active tilt.

Plus, with a strictly S&P 500 portfolio, about 25% of your holdings are going to be in just a handful of stocks. So your portfolio is going to be dominated by Apple, Microsoft, Google, and other big names that may or may not form the concentration that you want. And, in a rising rate environment, those technology stocks could drastically underperform the rest of the stocks in the S&P.

This strategy also begs the question: is index-buying genuinely passive? Suppose you’re employing a truly passive strategy. In that case, you should have a market-weighted approach — meaning you’re taking into account the percentage of Apple, for example, versus all the other investments out there. Under that methodology, you would have a minimal position in Apple, emerging markets, international markets, available commodities, precious metals, private equity, venture capital, and bonds. So, no one truly is a passive investor.

The Paradox of Passive

If markets are reasonably efficient, it’s not necessarily wrong to passively invest — meaning you’re not going to pay for the underwriting and due diligence. But then you have the paradox of passive investing: If the market is efficient, meaning stocks are rationally priced and trading at a fair price given all known information, where are we getting that information? Active investors. They’re the ones behind the scenes trying to move the stocks to do the rational thing. If everyone were to invest passively, active investors would have a bonanza to do due diligence.

Given this paradox, we see cycles of active vs. passive being popular strategies. At first, there may be a surplus of active managers since there’s so much excess return through underwriting. Once stocks get to more efficient prices, though, there will be fewer excess returns, meaning stocks will start to underperform the benchmark. At that point, more capital will flow back to passive strategies, and there will be more movement in stock prices that are no longer efficient.

Knowing this cyclical nature of active vs. passive trends, we build these cycles into our portfolios. We use active managers at some times and passive at others if we’re in a period where there’s a better opportunity to maintain the market.

Again, because of how we view the active vs. passive debate, we’re agnostic. We’ll use ETFs if they have a basket of stocks that we want at a meager cost on the internal management fee vs. a mutual fund. We approach our fund decisions with the mindset of, “What basket of stocks — whether it’s an ETF or active manager — are working well? Which help us get to where we want to go?”

Digging into the Data

Whatever is doing well is doing well for a reason — and is likely to keep doing well until there is some type of narrative change. That’s why we monitor performance so closely.

We believe an agnostic strategy is still an excellent approach to management, despite what looks to be a very efficient market. The benchmark typically ends up in the second quartile, so some funds are doing slightly above average.

Then, if we look at the three, five, and ten-year, there’s a lot of consistency in what was doing well in 2017 and what continued to do well going forward. There’s a sleight of hand used in our industry about a passive approach and the assumption that you can’t outperform the market in the long term. We see 25% of the companies are consistently in that top quartile, and we haven’t come across the page where the benchmark is in that top quartile.

Again, whatever is performing well will maintain momentum until there is a change in narrative. The main point is the sectors that do well will continue to do well — and if you over-allocated those sectors, you would have been in the top quartile of those funds.

Everyone is doing a form of active management. We all have some type of opinion; no one is buying a proper passive portfolio. We are happy to provide you with more performance data to further demonstrate our portfolios’ efficacy; just contact your advisor.

Of course, there is no right or wrong when choosing a path to invest in, but at GWS, we try to give you our data-driven view of economic theory. Our goal is to dig deeply into market behavior to inform you better to make actionable decisions to achieve your goals.

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To learn more about active and passive investing, be sure to listen to our recap video on our YouTube channel and SUBSCRIBE!

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

The opinions in this material do not necessarily reflect the views of LPL Financial.

The Delta variant-induced rise in Covid-19 cases is still capturing headlines, although we haven’t seen a significant increase in the number of deaths occurring. A few states have mandated masks with a potential lockdown, but this is mainly political. Nevertheless, if hesitation around the prevalence of the Delta variant persists, we would expect a significant impact on the market.

As we keep an eye on Covid-related market behavior, it’s also essential to evaluate market changes in the context of seasonality. Let’s dive in.

Significant Data Growth by Season

Nearly 300 out of the S&P 500 companies reported data on earnings this month. Eight-eight percent of those companies have beaten their revenue expectations, and 87% have exceeded their earnings expectations. So we have revenue growth of 23.1% and earnings per share at 85.2%, starting to explain why the market has been up.

Let’s examine each season more closely. We can immediately see the differences in appreciation of value, specifically in July. However, August, September, and October are historically rough months. For example, August’s maximum/minimum return is down 14% and up 7%. In contrast, October has the lowest minimum historical return of 21.76%. Therefore, we are getting into the months where we need to be more cautious.

The Goldman Sachs chart above shows how many days have gone by since the last 5% pullback in the S&P 500. Currently,184 trading days have passed since the previous 5% S&P 500 drawdown. This marks the 15th most prolonged period without a meaningful pullback and is significantly above the historical average of 97 days. However, historically speaking, we are due for a correction.

Variables Impacting the Market

You’ve heard us mention that our GWS investment committee is becoming a little more cautionary in the market, especially heading into August, September, and October. The spider graphs above capture the reason why. In addition, these graphs reflect several vital points within the market that demonstrate the probability of having a market pullback, correction, or sell-off.

Money supply has been declining, and the yield curve is still positive, but it’s significantly lower than last month due to declining interest rates. Regarding the bullish percent index, few companies make highs relative to lows because consumer spending has been down. Lastly, housing and manufacturing are still positive, while transportation has remained constant.

Money Supply

In 2020, we saw a massive spike in money supply (green line). As a result, the annualized growth rate was about 60%. However, today’s money supply (red line) and the S&P 500 (dotted line), which historically are tracked together, are beginning to trend down, slowing the growth rate.

Then, when we look at the yield curve, we are beginning to see a decrease in growth. When a yield curve gets close to negative or almost zero, it is a significant indicator that the economy doesn’t have enough cash relative to all the projects they put in place when the money supply was growing before.

If we don’t have that correction in money supply, it could be detrimental to the market. We see the effects of high inflation in energy and food items especially. Energy is up to 10% annualized, where food and all other things are around 5%.

To learn more about how seasons affect market behavior, be sure to keep an eye out for our recap video on our YouTube channel and SUBSCRIBE!

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For detailed performance metrics, please don’t hesitate to contact your lead advisor. And, in the meantime, be sure to keep up to date on Gatewood Wealth Solutions through our daily 3x3s and our weekly market insights on our YouTube, LinkedIn, and Facebook accounts.

Disclosures:

Economic forecasts may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Therefore, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All performance references are historical and are no guarantee of future results. In addition, all indices are unmanaged and may not be invested directly.

Securities and advisory services are offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. All investing involves risk, including possible loss of principal. No strategy assures success or protects against loss.

The opinions in this material do not necessarily reflect the views of LPL Financial.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.