Pure’s Executive Vice President & Chief Investment Officer, Brian Perry, AIF®, CFA®, CFP®, and Senior Investment Strategist & Financial Advisor, Brian Fahey, CFA®, will provide updates on the economy and financial markets.
Outline
- 0:00 – Introduction & Webinar Overview
- 0:19 – Iran, the Strait of Hormuz & Global Energy Markets
- 3:24 – Global Stock Market Performance: Who Won & Who Didn’t
- 8:20 – AI’s Role in Driving Market Returns
- 16:29 – Corporate Earnings: Not a Tech Bubble
- 21:23 – Global AI Investment: Beyond U.S. Mega-Cap Stocks
- 25:25 – Q&A: Iran Deal, Oil Prices & Strategic Reserves
- 28:09 – Q&A: SpaceX IPO & Index Inclusion
- 31:51 – Inflation, the Fed & Interest Rate Outlook
- 44:36 – Portfolio Strategy: Rebalancing, Bonds & Risk Management
Transcription:
(NOTE: Transcriptions are an approximation and may not be entirely correct)
Kathryn Bowie, CFP®: Welcome to our webinar to discuss the halfway point and the market updates with Brian Perry, Executive Vice President and Chief Investment Officer, and Brian Fahey, Senior Investment Strategist and Financial Advisor, both at Pure Financial Advisors. Brian and Brian, take it away.
Brian Perry, AIF®, CFA®, CFP®: Let’s start with one of the really big topics that is going on in the financial markets, which is energy and its impact on the global economy and financial markets.
And then we’ll slide over to AI from there, and then corporate earnings. Those are really three of the main drivers of financial markets lately. So, Brian Fahey, can you talk a little bit about just at a really high level what’s going on setting aside the politics or the nuclear aspirations of Iran in the war, just from a strictly oil and energy perspective, can you talk a little bit about what it all means?
Brian Fahey, CFA®: Persian Gulf is the source of some of the most productive and easiest to access oil fields on planet Earth. Unfortunately, all those tankers have to go through the strait, which Iran showed that they can close that pretty quickly. 20% of global energy production flows through that strait.
And obviously, the markets were pretty nervous there for a while that might create ongoing economic issues. Energy’s still vitally important to the global economy. Thankfully, Through different kind of negotiations, other energy-producing countries were able to increase production. Saudi Arabia has a pipeline that can bypass– They actually have two pipelines that can bypass the Strait, so we’re able to fairly well navigate the decline in energy availability.
Certain countries did experience a little bit more disruption than what we did because actually the US is a net energy exporter through all the fracking that’s been going on for the last thirty years or so. At the moment, it appears that we’re gonna get some type of resolution-ish maybe as soon as Friday, maybe not.
Who knows? But the direction of travel is encouraging. Energy prices have fallen pretty substantially. I think the next slide shows the volatility that we’ve seen over the last… well, since March. When we did this slide at the beginning of the month oil had come off of its highs. It was about ninety-three bucks a barrel for WTI, which is the energy price that we worry about here.
Right now it’s at about seventy-six. Before the war started, we were at about fifty-five. A lot of the energy guys are worried about overproduction, so the idea that we’re producing more than we needed and energy prices were below where US energy pro-production needs to be profitable.
We’ll probably stay somewhere around the seventies and kinda drift down as more clarity is gained from what’s going on in, in the Persian Gulf. But by and large, the global economy’s been able to navigate this pretty well, mostly due to what’s going in-on in the AI world. So I think if somebody had told you at the beginning of this that energy– that the strait was gonna be closed for, what, however long it’s been, a few months, ninety days or so, that you would expect equity markets to take it on the chin.
But equity returns have actually been pretty strong. I think most of us would be happy with the year-to-date total that we had through the beginning of this month, and that’s just over six months of returns.
Brian Perry, AIF®, CFA®, CFP®: It’s interesting there. Well, well, I guess a couple things. Maybe we can dive into the stock market returns.
But before we do just going back to energy, and we see these various spikes and drops, and I believe the all-time high in oil is somewhere around $150 a barrel back before the 2008 financial crisis. But I know that oil prices and energy prices in general impact different parts of the world and the different parts of the economy a little bit differently.
C- can you talk a little bit about that and how maybe you mentioned briefly the US being a net energy exporter. Are there any particular parts of the world that maybe suffer more from higher energy prices? And how have they managed to combat that?
Brian Fahey, CFA®: Yeah. So the ar- areas of the world that are most sensitive to prices of energy are Europe and Asia.
They don’t ha- neither one of those areas has a huge amount of energy production, particularly Asia. Europe was able to get a little bit of extra supply from Russia. I’m sure they’re not super happy about that. But they were able to navigate it okay. The central bank there did decide to increase interest rates, I believe that was last week to try to offset the inflationary impacts of higher energy costs.
But they were able to navigate it fairly well. When you look at Asia, it’s really the countries that have lower GDP are the ones that suffered the most. So if you’re looking at, like, Pakistan Malaysia, Indonesia, those kinds of countries really suffered. India to an extent as well. There’s reductions in, certain schools and certain countries cut from five days a week to three days a week to save in energy use.
Certain countries didn’t have cooking oil to preserve it so they could put energy in their oil and, sorry, gasoline into cars. So there definitely was what they call demand destruction, meaning energy that would normally flow to certain areas of the world wasn’t making it or was making it at such a high price that it wasn’t economical for those countries to use it.
So not to say that there wasn’t impacts, but it was in areas of the world that aren’t gonna move the needle for equity investors. People definitely felt the pain, but it was areas of the world that are developing which is usually where the pain is felt when you ha- go through these big energy spikes.
Other thing to keep in mind-
Brian Perry, AIF®, CFA®, CFP®: I think that some people were choosing to drive their car instead of cook their food. I- if so, that explains some of the traffic I’ve seen in Southern California.
Brian Fahey, CFA®: Yeah. Yeah. I mean, certain areas of the world did have to make tough choices, But that is slowly, hopefully, gonna get back to normal.
It’s gonna take time though. I mean, there’s reports that different countries have to go through and make sure the strait’s completely free of mines. You still have the owners of shipping companies that probably don’t wanna send their very expensive, laden-with-oil tankers through the strait till they know it’s absolutely safe for their ships and their crew.
Boats are not in the right place. Boats that should be, or tankers that should be in the Persian Gulf or maybe in, in Asia, or maybe they’re in Europe maybe they’re sailing around the Horn of Africa. So it’s, it will take time to get energy supplies to where they need to be. It’ll also take time to build back those reserves that have been used for the last 90 days.
So don’t expect energy prices to get back to 55 bucks a barrel in the US, immediately, but the direction of travel is certainly in that direction.
Brian Perry, AIF®, CFA®, CFP®: It does seem to me that just given the ease with which Iran was able to close the straits and just the knowledge that if they were able to do it once, they could likely do it again there could very well be an energy under an Iran Strait of Hormuz put in the market in the future where maybe all else being equal, whatever the price would’ve been on oil in a future state will be a little bit higher just because of that knowledge or that risk that Iran can close it if they become unhappy.
Brian Fahey, CFA®: Yeah. Yeah, for sure. I mean, when a $20,000 drone can stop a tanker with hundreds of millions of dollars worth of oil the energy market is gonna need to be compensated for that risk, and the way that’s gonna be done through economic channels is higher energy prices.
Brian Perry, AIF®, CFA®, CFP®: So y- with that energy in mind, and you mentioned some of the countries or areas more at risk being Europe and emerging markets.
And we have here the stock performance both year to date and then since March 1st. And it shows that the European indexes were y- the weaker performers. That’s on top of last year where they were among the best performers. So last year for those that don’t recall, Europe significantly outperformed the US.
The US had a really good years from a stock market perspective, but Europe did even significantly better. This year, Europe’s lagging a little bit. But it’s interesting, a lot of the emerging markets are in Europe as well as Eastern Europe, or excuse me, Eastern Europe as well as Asia and emerging markets which led the way last year, leading the way again this year almost in the face of higher energy prices, right?
When you see some of these Asian emerging markets doing well. And I think I know what you’re going to say as far as the reason why, but can you comment on that?
Brian Fahey, CFA®: Yeah. I mean, the, at a high level, the higher your return, the closer you are to AI. That’s what it is. So there’s quite a few AI related or infrastruc- AI infrastructure related companies in the MSCI or Emerging Markets Index, and it’s those companies that are really driving that index higher.
So it’s companies that we’ll get to. But essentially, the hundreds of billions of dollars coming up on, $800, $900 billion worth of AI investment from just the big six companies in the US All that capital expense from those guys is revenue to the entire AI supply chain. So whether that’s, SK Hynix Samsung Alibaba, all these guys that are building out a AI infrastructure or providing the materials for AI infrastructure, they have huge demand, and that’s coming through with much higher revenue, much higher earnings, and that’s what investors are focusing in on.
They’re not focusing in on, state-owned banks in China or other smaller pieces of the EM index. They’re really focusing in on the thematic theme of AI build-out. And the closer you are to that, or the more names in that theme your index has, the better you’re doing. So you s- definitely see that with EM.
To an extent, you’re seeing it with the Russell 2000 as well. There’s a lot of names in there that make printed circuit boards, they make optics, they make broadband cables, just real staple kind of goods that historically or call it for the last 10, 15 years have been kind of value-oriented companies that don’t rove- move around a lot, they don’t see a lot of revenue growth.
But with the AI boom, they’re seeing just a blockbuster growth. Like a month ago or so, we wrote a note about Micron, which is a US company based out of Boise. Previous to this year, they’ve never made more than 12 bucks a share in a calendar year. This year, they’re gonna make $80, and next year they’re supposed to make 100.
So it gives you a sense of how much extra demand the AI boom is really fueling. And again, when you look at these returns, it’s the closer your index is to those themes, the better you’re doing
Brian Perry, AIF®, CFA®, CFP®: You know, and it’s interesting, Darren, you just pointed out, to see the smaller companies it seems like it’s been a l- a couple minutes, but outperforming some of the bigger companies as the AI boom does trickle through.
And then we see that on the sector side as well here, where you get technology. I mean, again, this is just March 1st through June 1st, so this is not year-to-date. Mm-hmm. And again, a lot of this is a reversal of what we saw at the start of this year, and certainly last year. But tech certainly leading the way in the last three months.
So can you maybe comment on that? And then also on again, this is one timeframe, but what returns might have looked like if we were looking, let’s say, over the last 12 to 18 months?
Brian Fahey, CFA®: Mm-hmm. Yeah, I mean, the theme is pretty consistent even over the last 12 months. Tech, and this is specifically for the S&P 500, but if we were doing it on the MSCI All Cap or the global stock market, the theme would be the same.
Technology is really driving the global equity market higher. We’re all more familiar with the S&P, but it’s really those tech names, not necessarily the Mega Cap seven that have driven things for the last couple of years, but the kinda ancillary companies like the ScanDiscs and the Western Digitals of the world that are making memory.
They’re making the physical things that are gonna go into data centers, and they can’t make it fast enough, and they’re charging higher prices because of that. Those are the guys that are seeing just blockbuster earnings. And it’s spreading away from just NVIDIA to some of the other chip makers, and those guys are making money hand over fist.
And that, in turn, is driving their stock prices higher. The rest of the market, I mean, I think honestly, if you were to ask me at the beginning of the year, “Hey, there’s gonna be a war in Iran. Energy markets are gonna experience a lot of volatility. 20% of global energy price or energy supply is gonna get taken offline.
What, how do you position a portfolio?” I think the classic answer would be you’d buy the things that have done the worst. You’d buy defensive sectors. You’d buy healthcare. You’d buy consumer staples ’cause everybody’s still gonna need toothpaste and toilet paper. And you’d buy utilities ’cause everybody still needs energy, and energy company or utility companies tend to pay dividends, so you can get some return that way.
But if you had done that, even if you thought you had the crystal ball and you knew when the war was gonna start, you would’ve done terrible. And the people or the investors that were rewarded were the ones that looked through that and decided, “Hey I think this AI boom is running full bore. I just wanna participate in that.
Anything that happens in the short term is immaterial.” Which sometimes the market does that, sometimes it doesn’t. But I think it just underlines the fact that even if you know what the headlines are for tomorrow, having a concentrated portfolio may or may not work out ’cause the markets can react in pretty unexpected ways.
Brian Perry, AIF®, CFA®, CFP®: Yeah, and it’s interesting. I remember seeing a stat at the beginning of this year where everybody knows how well NVIDIA has done over the last, handful of years. And last year just did so phenomenally. Was up I forget exactly what the number was, but, doubled or tripled. It was something like the 50th best performing stock in the S&P 500, let alone even in, just in the whole country or the whole world, right?
So even in a year where these stocks that everybody knows get the headlines and are, quote unquote the superstars the reality is a lot of times they’re not the superstars. They’re just the most well-known all-star, if you will, and that there’s other… Th- they might be an all-star, but there’s some other company out there that’s doing the Michael Jordan, if you will.
Brian Fahey, CFA®: Yeah. I mean, in one of the holdings that we have in our portfolio, I was looking at data the other day, there’s a company that makes printed circuit boards that hasn’t done anything for 10 years, and all of a sudden now it’s up 500% in the last 12 months. So, the idea that you do want diversification within your portfolio ’cause you can’t predict the future, buy the whole sta- haystack, not just the needles, I think really resonates as we go through this challenging timeframe.
The other thing that I think should resonate is the idea that you’re seeing a lot of maybe froth develop in the tech space. Maybe it’s a good idea to consider rebalancing because these companies that have done poorly for the last six months as investors have focused in on just one theme, well, that pendulum will swing back the other way.
Maybe it happens tomorrow, maybe it doesn’t happen for a year, but it will ’cause that’s how markets work
Brian Perry, AIF®, CFA®, CFP®: Yeah, there are some and we can talk more about it maybe in a bit, but there are… Hi- history doesn’t repeat, but it rhymes, right? And there are some hallmarks back to the 1990s where if you substitute the internet for AI and all the excitement around it and the heavy investment and, a rising tide lifting all boats related to it, we’re definitely seeing some hallmarks of that now.
The biggest companies are also super profitable, so not worried about whatever it is, Microsoft becoming the next pets.com or whatever. But there is definitely a a mentality right now it seems like among certain segments of the investing public where, “Hey, if it’s related to AI, I’m gonna throw money in it,” and it’s super easy just to make 10X my money in a short period of time.
And the reality is, it’s not that easy to make money that quickly, and it’s even harder to keep money in that method.
Brian Fahey, CFA®: Yeah. And that second part, I think, is the most important piece. Like, y- it’s seemingly easy to find these names that pop 25% a day because they, are making shoes that are somehow have AI related to it.
But that stuff doesn’t last forever.
Brian Perry, AIF®, CFA®, CFP®: Heck, maybe we should rebrand as Pure AI, right?
Brian Fahey, CFA®: Maybe.
Brian Perry, AIF®, CFA®, CFP®: So, at the end of the day and I’ve heard it said, this isn’t original to me, but everybody talks about the stock market or the bond market. But the reality is it’s a market of stocks and a market of bonds, and what that refers to is that ultimately they’re not numbers on a screen.
These are companies that are doing things, right? Whether it’s Microsoft selling software or funding AI, whether it’s McDonald’s selling cheeseburgers or, whatever company selling cars these are companies that are making something, and their underlying performance is what ultimately drives the market.
Now, in an environment like this, there’s a lot of hype and a lot of excitement and a lot of forecasting or extrapolating into the future that’s contributing to that. But ultimately, when you buy a stock, you’re buying a future earnings stream, and that keyword there being earnings as the driver of the market.
And so, so maybe if we turn our focus to that where earnings are and how they’re doing.
Brian Fahey, CFA®: Yeah. Earnings are doing great. It’s a short answer of it. Which I think, you know- For anybody that lived through or is right about the tech bubble and sees what’s going on in AI, there’s a tendency to reflect what happened in the past and where we are today.
But these charts are here to show this is not the tech bubble. These companies are actually making a lot of money. That’s dependent on building out AI, and hopefully that works out accordingly. It may or may not, so, maintaining your risk in a way that you’re comfortable with is important.
But the idea of maybe the economy slipping into a recession, in the near term, it’s not terribly likely when earnings are doing as well as they have. Y- there are forecasts in here, that’s what the dashed vertical line is which are subject to revisions. Analysts were marking up their expectations very heavily in the first quarter probably the fastest they have since we were coming out of COVID, which is pretty unusual kind of mid-cycle.
Usually, you don’t see really significant upgrades in earnings unless you’re coming out of a recession. You really have that base effect of low earnings from the recession, and then things recover. To see that in a kind of mid-cycle where we are now is pretty unusual. So there is actual dollar bills chasing, AI tech stocks infrastructure, an economy that’s doing pretty well.
So I think, the idea that we’re in the ninth inning of this probably is not accurate. And there is underlying earnings that should give us a little bit of confidence or actually a significant amount of confidence that we’re not built on sand. We have actual economic reasons for stocks to be relatively close to where they are.
Brian Perry, AIF®, CFA®, CFP®: W- what’s interesting is I don’t think anybody would debate that AI is going to be incredibly impactful, and, opinions vary pretty strongly on whether it’s a good thing, a bad thing, or something in between. The trick is not so much saying that, “Oh, AI’s gonna be very impactful.”
It’s who is it gonna impact and who are the winners gonna be, right? Because could have said the same thing with the internet. It was clear in 1998 that the internet was transforming our lives, but which companies were gonna be the next Amazon and which were gonna be everybody else that isn’t Amazon, right?
And I think that’s the case today. And the statistic I always go back to and y- you mentioned the cars, and I made the joke about driving and traffic in s- in Southern California or Seattle for that matter, or a lot of places. I think anybody that’s been on the road recently would agree that the auto industry has been tremendously successful.
There’s lots of cars out there. And, if you looked back 100 years ago and you said, “Hey, the auto industry is the place to be. It’s gonna transform our lives,” 100% correct. The fact of the matter is there have been more than 2,000 car makers in the United States, and only two of them, to the best of my knowledge, have never gone bankrupt or been acquired, right?
So it’s one thing to say that the auto is gonna transform America. It’s another thing to say, “Hey, I’m going to pick the winner,” because the reality is almost everybody picked the company that wasn’t the winner. And I think that the internet is the same thing, where there were winners and losers.
Social media in the mid-2000s, right? There’s a lot of people that maybe own Meta from a low price, which is great, but there’s people that bought MySpace, and that didn’t work out as well. And AI will probably be the same thing, whether it’s Anthropic versus ChatGPT or whatever. Some of these companies that are very popular right now will do phenomenally, and others will, be names that will never re- They’ll be in the dust heap of history, even as AI continues to transform our lives.
And I just think that’s important to remember as, in some cases, portfolios become increasingly concentrated, that predicting a trend and predicting the winners of that trend are not the same thing.
Brian Fahey, CFA®: Yeah, and it’s the ultimate winners of AI probably haven’t even come to the public markets yet, and then not even including OpenAI and Anthropic.
The companies that ultimately win out of AI are the companies that can use AI and build either, a product or service in a much more efficient way than was done previous. And I don’t think we’ve found that company yet. So I think the ultimate winner of AI is not even on anybody’s radar yet.
Brian Perry, AIF®, CFA®, CFP®: Yeah.
Brian Fahey, CFA®: And I think the other aspect with AI is, especially compared to, say, the tech bubble, is with the tech bubble you had a lot of just software. Obviously there was optical cables get put up around the world, but it wasn’t necessarily CapEx heavy or investment heavy. AI is not that way.
Like, you’ve– we’re seeing it now with hundreds of billions of dollars of investment from the big six hyperscalers. Like, this is not just, I can make together make a software package in my garage. This is, you need real substantial investment to get some of these off the ground, and I think that’s a key difference between where we are now with AI and previous technological developments.
Brian Perry, AIF®, CFA®, CFP®: Yeah. Agreed. Maybe we’ll do one more slide, and then we’ll we’ll take some questions. I think so if you have questions out there, please submit them and we’ll try to answer them. I think a lot of the focus from a investor standpoint on AI or on whatnot is in the US.
But as we looked at a couple slides ago, emerging markets last year were up more than 50%, and this year up, what was it? 25, 30%, whatever it was have been the best performer. European markets and Japan and whatnot did great last year, were among the best performers. Haven’t done quite as well this year but have still posted solid returns.
So whether it’s stock market performance or AI is really not just a US-centric story but a global story, and may- maybe we can turn and just comment on that a little bit.
Brian Fahey, CFA®: Yeah, and I think this kind of goes in, in step with how the AI theme has developed because a couple of years ago when OpenAI came out, investors really focused on that phase one, those mega cap companies, and that absolutely 100% drove performance globally.
It was the S&P. It was the only game in town, and within the S&P, it was these guys. Nothing else did much in ’23, ’24. As that’s developed and as the cycle is found its legs and more investments going into these data centers, you’re starting to see that theme change. So just to point out, those mega cap techs Mega Seven companies have really driven returns to the S&P for a number of years.
They started to stumble a little bit last fall, but year to date, the Mega Seven, Mega Cap Seven they’re actually down one and a half percent year to date. So the S&P is up, according to my little screen at the moment, about 8.5% this year. But those companies that really drove the market for years and were the only game on planet Earth in terms of equity performance, this year they’re flat.
They’ve been really flat since the fall. So now we’re starting that second phase, and as Brian said, a lot of the names or a lot of the revenue is going to overseas firms. So it’s not just US, it’s not just a handful of names. We just picked four out of some of the ones that have done particularly well and happen to be in the S&P, but that’s the
You can find good names in the NASDAQ, you can find good names in the Russell 2000, and obviously you can find names in the emerging market space. And that’s starting to drive emerging market out-performance. Historically, emerging markets are really dependent on commodities and finance, so it’s, mining copper and that kind of thing.
That really hasn’t been the case for probably 20 years, but now you’re seeing the big companies out of South Korea and Taiwan that are making the goods that are going into these AI data centers really lead really the global market. Emerging markets were up really significantly last year, and they’re leading the pack this year.
And it, again, is just a kind of a handful of names, but those, that’s the reason why emerging markets are doing so well this year. Europe is doing okay, right, 6% for six months. Not a bad return historically, but they don’t have a lot of those big AI names. They, really they have ASML, which helps put together the goods or the hardware that makes chips.
But that’s only about 2%, I think of the European index. The other names have done pretty well that we have listed here, but they’re much smaller weighting in the index, and that’s part of the reason why Europe is lagging relative to especially emerging markets, but also the US. Where we go from here, as Brian pointed out, we don’t know.
A lot of those companies that are winners today won’t necessarily be the winners tomorrow, as we show with the Mega Cap Seven. And quite frankly, probably the biggest winners of AI are companies we don’t even know about today. Maybe they’re private, maybe they haven’t been founded, maybe it’s Brian’s kids starting something in a garage.
Who knows? But I think there’s a certain level of shouldn’t under- you shouldn’t go into this thinking that you know who’s gonna be the winner because things are gonna develop really quickly. Let’s
Brian Perry, AIF®, CFA®, CFP®: let’s take a break and see, Catherine, do we have any questions?
Kathryn Bowie, CFP®: We do have some questions.
So, we’re gonna start with how’s the soon to be potential end of the Iran deal with Trump going to affect our economy? Do you have ideas of what that’s gonna look like potentially short-term and long-term?
Brian Fahey, CFA®: I mean, with energy prices falling substantially as they have over the last couple of weeks, seems like things are getting better. I think we’re getting to that phase where markets need to see actual proof. So, more than a couple of tankers leaving the Strait a day is what the market’s gonna need to see.
We’ll probably see US energy prices stay around where they are now, call it 75 bucks a barrel, and hopefully slowly drift down to mid-60s and potentially lower. But I think we’ve got the easy gains, and moving forward we need to start seeing proof and, actually see oil leave the Gulf.
Kathryn Bowie, CFP®: Well, and on that note, someone else said, “Well, once the Strait opens and oil is flowing, will not the price of oil increase as countries replace their strategic reserves, creating a much higher than normal demand on crude oil?” Like, what do you think of that?
Brian Fahey, CFA®: Well, the nice thing about strategic reserves is you don’t have to buy oil immediately.
You can delay that as energy prices s- normalize. But I wouldn’t expect, like the US strategic oil reserve, which I think is at, like a 40-year low, they’re not gonna try to refill that tomorrow. Hopefully, they refill it over the next handful of years. But Brian pointed out earlier there’s probably a little bit of a premium in energy prices because of all the uncertainty and conflicting narratives and lack of clarity.
So you will probably see oil drift lower, but that’s, maybe there’s a little bit more of the normal volatility in that drift lower.
Brian Perry, AIF®, CFA®, CFP®: I also think it’s a really good question because it points out that it… This is never quite as simple as if A, then B, then C, right? It’s like, there’s a pretty easy to make a chain of causality of, hey, if the Strait opens, then more oil flows, then oil prices fall.
And the reality is whether or not that pre- that scenario comes true where, hey, oil prices actually go up because countries are rebuilding their strategic reserves, it’s certainly a possibility, right? Or something else could come along. And so it’s never, to Brian F.’s point earlier, just knowing what the headlines are doesn’t tell you what’s going to happen, and that’s what makes potentially timing things so difficult, right, is that there are plenty of instances where you could read the newspaper and from tomorrow and still not know what the market’s going to do.
Kathryn Bowie, CFP®: Exactly. And then another question. What indexes have changed their logic to include some of the most recent and planned IOS, and how do you adjust as the changes, as this changes their historic records?
Brian Perry, AIF®, CFA®, CFP®: So they’re referring to one company in particular, I think, is SpaceX. And yeah, and then potentially some coming IPOs from Anthropic and ChatGPT.
I’ll let Brian handle that ’cause we’ve done quite a bit of research and been tracking that pretty closely.
Brian Fahey, CFA®: Yeah, this has been annoying. We have done a lot of research on it. I’m a little tired about talking about SpaceX. It’s probably the first time in 20 years I’ve actually had clients ask, like, clients that never touch an individual stock asking about SpaceX.
My father-in-law was asking me about SpaceX the other day. Like, all right, we’ve kinda jumped the moon on this.
Brian Perry, AIF®, CFA®, CFP®: Well, that’s the goal. That’s what the company is built for, right?
Brian Fahey, CFA®: Yeah, no kidding, right? So the big one and the largest index provider is the S&P 500. They did not change the rules. So if you own anything that’s tied to the S&P 500 Standard & Poor’s, you’re not gonna see SpaceX, you’re not gonna see Anthropic, you’re not gonna see OpenAI, should they choose to IPO this year, until they meet the Standard & Poor’s rules.
What are those? You have a one-year seasoning period. You have to have a cumulative four-year quarter of profitability, and you have to be m- profitable in your most recent quarter. Those are the key risks or key g- gatekeepers for getting those names into the S&P 500. SpaceX is miles away from getting any of those, even if it w- had its one-year seasons, seasoning period.
It just doesn’t have the profitability to get into the S&P. They could change that, but as of now, it’s not gonna happen anytime soon. The indexes that did change the rules, we have the NASDAQ, so that, SpaceX will be in the NASDAQ after f- 15 trading days. The, anything tied to the Russell within five trading days, so that’s, I guess it’s in now.
And then the CRSP index, which is owned by Morningstar unfortunately I don’t remember exactly when that goes in. I think it’s around five to 10 days. Some of the Vanguard indices do follow the CRSP index. Really for ETFs, most of the indices in- mostly in the- ETF providers just use whatever the cheapest index is.
Vanguard obviously likes to keep their fees as low as possible, so they use the CRSP, not because they think it’s better than somebody else, but because it’s the cheapest licensing agreement they can get. So those indices, and it’s not all Vanguard funds, it’s just Vanguard funds that are tied to the CRSP, will see SpaceX.
So Russell, CRSP, and Nasdaq are the- your main indices, if you’re using ETFs, that you need to be aware of, are gonna give you direct exposure to that whether you want it or not.
Brian Perry, AIF®, CFA®, CFP®: As we’re going through this, just as a reminder too probably some of the people on here are already clients, but for, reach out to your advisor if you have questions on anything that we’re discussing or if you want to know more details on anything that Brian F or I are saying.
If you’re not a client we do offer a free financial assessment for folks that come to these, where we’ll let you meet with one of our certified financial planners, and they’ll give you thoughts on, everything that we’re covering today. If you have specific questions, “Hey, what does AI mean for my portfolio?
What does, how globally invested should I be?” Down to, moving beyond even what we’re talking about today, what’s your tax situation now and in the future, Social Security timing, et cetera. We usually charge several hundred dollars an hour to meet with folks, but for people that come here we do waive that fee.
So if you’re interested, I think Catherine will probably put up a link later. So again, if any of this prompts questions or you just want a second look at your finances feel free to, to sign up for that or talk with your advisor. This is the other big story, right? We’ve had Iran and oil and the war there, and then we’ve had AI, and then we’ve had corporate earnings.
The other impact of Iran is inflation, right? And we’re coming into the year, there was talk about the Fed cutting interest rates and I’m sure that we’ll get to this. Now inflation looks a little higher and a little stickier than we anticipated. So maybe can we start talking about that, Brian?
Brian Fahey, CFA®: Yeah. And apologies, the slide is a little dated. We had a CPI release last Wednesday. So the blue line, which is headline, which includes everything, should be at 4.2 core, which just excludes the things you need to live, like food and energy printed at 2.9. Obviously elevated a little bit below expectations.
The market wasn’t totally spooked by this. But clearly the the travel is in the wrong direction. The Fed would prefer to see inflation right around two. That’s a core or CPE, depending on the details of it. So really that red line, it excludes volatile food and energy. But clearly they’re- Inflation was moving higher before the war started, and obviously higher energy prices ac- are accelerating that.
Still probably have some feed-through from higher energy prices into certain goods and services, but inflation’s moving in the wrong direction. And you can make a case the Fed might be in a position where they need to do something about it
Brian Perry, AIF®, CFA®, CFP®: Yeah, and this is just another way of looking at it, right, where this is what people think is gonna happen.
So more of a forecast and same deal where it’s looking at inflation moving higher, right?
Brian Fahey, CFA®: Yeah. So the reddish line is the University of Michigan survey. So this is what, you and I or anybody whose service in the survey would expect inflation to be over the next five years.
Generally, consumers expect inflation to be higher than what actual realized inflation has been. Reason why I bring this up is part of… Economists don’t have great models for predicting inflation. Maybe that’s why we went through the, transitory phase after COVID. But part of what we understand inflation to be is what consumers expect inflation to be.
So if you’re a consumer, like we all are, and you expect inflation to be particularly strong for the next year or so, you might rush out to buy goods today because you think it’s gonna be more expensive than if you wait to buy it in a year, which means you have more demand, which means companies in turn decide, “Well, if I’m selling more than I can make, I should raise the price.”
And then you get this feed- feedback loop. It’s not as bad now as it was, say, in the ’70s because very few people have their wages tied to, say, a COLA where you get your wage growth is indexed to inflation. But it is something that the Fed is gonna look at, and when you see these big divergences where consumers expect inflation to be a lot higher than what the market is thinking, the Fed is gonna notice that and maybe be a little bit more hawkish, meaning they want rates to stay where they are, maybe even move them up a little bit to kinda bring in those expectations.
Because if they do become unanchored and everybody thinks prices are going to the moon, that just accelerates that, that process where you buy things faster than you would normally because it’s gonna be more expensive in the future. So we are on the cusp of having some inflationary issues that are a lot easier to just not let get out of hand
Brian Perry, AIF®, CFA®, CFP®: Yeah and of course the challenge is that the other pillar of the economy, and there’s lots of parts of the economy, but the twin pillars of inflation and then the job market and how much money people have in their pockets jo- job market’s not looking as things get more expensive employment’s not looking great, right?
And so this almost points to, what’s the average person to do if the cost of everything you wanna buy is going up, but your job prospects or income prospects are going down. That’s not a great combination, is it?
Brian Fahey, CFA®: No. I mean, I will say that the employment picture’s looking a little bit better on the margin after the last few prints, and it is challenging to understand really…
And under normal circumstances, it’s hard to understand in real time where the labor market is, but right now it’s maybe a little bit harder because of the net migration issues that we’re having. So we probably are seeing net more people leave the US than come in, so you have a smaller job pool, so it does through, throw the mar- numbers off a little bit.
But recent reports are suggesting that the labor market’s starting to accelerate, or at least not get worse which does put some inflationary pressures. But even if the job market is getting better, what we all care about is what you have in wages, and wages are not growing at the same pace of inflation.
So even if you’re working harder, at the end of the month you have less purchasing power, and that doesn’t feel good. And that’s, part of the reason why consumer sentiment surveys have been in the toilet for, call it a year or so. You could say it’s low response rates, you could say it’s partisanship, but I think at the end of the day, it’s just the fact that wages for most people are not keeping pace with the cost of living, and that’s really irritating.
Brian Perry, AIF®, CFA®, CFP®: Well, and that shows in some of people’s balance sheets too, right? So we just looked at sort of the income side or the income statement side of people’s finances. This is more the balance sheet side.
Brian Fahey, CFA®: Yeah. So if your wages aren’t growing at the same pace as the cost of living, you either take out more debt or you don’t save, and that’s what we’re seeing so far really just on the savings side.
I think the appropriate comparison is really where we were post-financial crisis but pre-COVID, so in between those two lines. Ideally you want savings to be somewhere in the 5 to 7% neighborhood so that, most people can either pay down debt or they c- have a reserve if things go sideways.
But we’re at, 2.5%, which isn’t too far from where we were coming out of COVID when all of a sudden we could travel again and use those savings that we’d built up during the COVID years, which again reinforces the idea that wages aren’t keeping pace with the cost of living 70% of the economy is consumers.
This still matters, so, I mean, we spent half an hour talking about AI which is still, a big piece of what the market is doing, but the underlying health of the economy is driven by what you and I do day to day. And the consumer, in aggregate, is dealing with a little bit of stress. But longer term or kind of bigger picture there’s still runway there because the balance sheet, how much debt you have to income is where it should be right around, call it, 10% or so debt to income, disposable income.
So it’s not a great picture, but it’s not a really super concerning picture.
Brian Perry, AIF®, CFA®, CFP®: Well, that, that’s good to hear, too. And, and what you mentioned on the labor market potentially picking up or at least stabilizing is a good thing, right? Because as we shift to the Fed it’s really hard if you get job market weak and then inflation high.
That’s tough, right? Because you’re between a rock and a hard place from a policy perspective. If you get both indicators or both segments moving in the same direction, whether that’s weak or too strong, right, either way, at least there’s one policy solution that, that c- you can put in place as opposed to having to choose your poison.
Brian Fahey, CFA®: Yeah. I mean, stagflation, when you have high inflation and high unemployment, that’s the worst possible outcome. That’s bad for everybody and bad for all asset classes. Thankfully, we’re not in that. We have an okay job market. Inflation is an issue. The Fed knows how to calm that. But what we’re really trying to show here, and this is a segue into fixed income, is at the start of the year, the market was really expecting rate cuts.
So right now we’re at three and three quarters or so and at the start of the year, the market was expecting two-ish rate cuts, bring us down to about 3.3. Economy is okay, we just need a little bit of a tailwind to keep things going. Well, we kn- the Fed just met and they’re not doing anything, but they did make some hawkish statements.
The equity market’s not really enjoying it right now. But we’ve gone from expecting cuts to now expecting a hike. It was middle of the road, do nothing, maybe one hike, but after today it appears that a hike is more likely than not. But when you have the big s- change in expectations on what the market thinks is gonna unfold over the next year, fixed income is really where you’re gonna see that reflected in pricing.
So if we flip over to the fixed income returns, this is through the beginning of the month, not much to see, especially when we’re comparing that to what’s gone on in the equity market. The best performing asset class in fixed income or sub-asset class is- Treasury inflation-protected securities, so things that are adjusted by the rate of inflation but are also maturing within the next five years, so you don’t have a lot of interest rate risk which is part of a tips return.
So that’s w- where you’re getting returns. Everything else, investment grade, mortgage-backed securities, you’re getting less than cash. So because the expectations have changed so much in the last six months or so you’re seeing that pressure be- really being expressed in fixed income.
Also, one thing to note is when the s- ceasefire or the end of the Iran war was supposed to end Friday when that came out, equity markets rallied hard. Fixed income market didn’t do anything. So, if there’s really a lasting impact of energy prices coming lower and lowering inflation, the bond market is really skeptical of that.
So the bond market is saying rates probably have to stay high because the economy’s doing decent. You’ve got a lot of uses of debt. I mean, NVIDIA’s doing a debt offering. Bloo- or, sorry, Google did one. Meta’s doing one. Obviously, what’s happening with SpaceX shows you that there’s plenty of liquidity in the financial markets, and one way to, to fix that and to keep, kinda take the punch bowl away for, to use an old term is to increase interest rates, and that’s what you’re seeing being reflected in the fixed income market
Brian Perry, AIF®, CFA®, CFP®: You know what?
I think it’s the one thing I would add on there and I think is important for people to consider is, right, what you’re trying to accomplish. If your sole goal as an investor is to get the, make the highest returns possible, and you don’t care about the journey along the way when you look at those stock market performances versus the bonds, it’s like, well, yeah, it’s pretty easy to pick how to invest.
But the reality is I’m gonna guess most of the people on this call are not an endowment with a perpetual life expectancy, and at some point you’re gonna wanna spend your money. And if your portfolio falls by 60, 50, 60%, you’re not gonna sleep well at night, right? And so that’s where the bonds come in is most people have some bonds in their portfolio.
The percentage varies depending on their cash flow need, as well as their risk tolerance their stage of life, et cetera. These returns are not exciting compared to stocks if you look at so far this year. But if you looked at your portfolio in, let’s say, the early days of March or the late days of February at the start of the war, those stocks were falling pretty rapidly.
So, the year-to-date performance masks the fact that markets did okay at the start and then did really poorly really quickly and then have rebounded strongly, right? Where bonds have just plodded along in a boring fashion and, similar to last year, right, where you had Liberation Day in the spring with the tariffs the stock market fell pretty sharply to where we almost had a bear market in the course of about a month.
Bonds again just plodded along. And so, if you’re somebody that wants to spend down your portfolio that’s where you draw from during those times is from the bonds, right? If you’re somebody that’s going to rebalance your portfolio, that’s where you sell some of the bonds to buy some of the stocks while they’re on sale.
And so, while returns are one consideration from an investment, there are other things you wanna look at as you build out your portfolio.
Brian Fahey, CFA®: Yeah. And I think you always want your money to be working for you, not the other way around, and you wanna be able to sleep at night. And if you go through a planning process, whether that’s through us or on your own, and you need 5 or 6%, a big part of your portfolio should be fixed income, and it’ll get you to that 5% hurdle rate without a lot of volatility.
And I think to your point, Brian, most people want up and to the right, not up and to the right sometimes and down to the right sometimes, and then maybe back up and then somewhere in between. If you want nice, steady returns without a lot of volatility, you have to use fixed income. It comes in a lot of different flavors.
You don’t have to just use treasuries or investment-grade corporates or junk bonds. There’s a way to put together a portfolio that can generate the returns that, that you need without a ton of volatility. And then the other aspect is when things go sideways in the global economy, which we’ve seen a lot of in the last handful of years, you do want that balance in your portfolio for no other reason than to sell when times are bad so you can buy equities that have fallen off a cliff.
So th- that’s the rebalancing effect, which is really important
Brian Perry, AIF®, CFA®, CFP®: Yeah, 100%. And so that kind of segues us to some of the tools that are available. And maybe we’ll just touch on these super quick the 60-second view, and then we’ll take any questions, and obviously we can dive more into specifics on some of these.
But, as we look at the current environment on a go-forward, maybe just touch briefly on each of these, Brian.
Brian Fahey, CFA®: Yeah, and I- this kind of gets back to the earlier part of the presentation, showing how well tech has done relative to everything else. Depending on how you’re getting your equity exposure, that might have moved your overall allocation to be much more aggressive than where you started the year.
Y- it’s a good idea to try to stay pretty close to your target allocation over time. You can’t predict things. Like we showed, if, even if you knew what the war was gonna, that was gonna happen, you, it would’ve been really impossible or really challenging to figure out which equities would have outperformed
in that environment. So even knowing tomorrow’s headlines isn’t gonna guarantee you returns. So staying to that allocation that you’re comfortable with over the long haul is really important. And when you get these periods where you’re getting outsized performance from a sub-asset class, you really wanna review everything and make sure that’s not dragging you into a more risky portfolio that’s gonna cause trouble later down the line.
One of the things that we’re pretty excited about or that we bring up quite a bit is having non-correlated assets, so things that aren’t gonna be tied to equity markets or fixed income markets because both have their challenges when you’re thinking about things that could go sideways and you’re planning for, say, retirement or a big purchase.
So having something in your portfolio that’s gonna generate returns that’s not dependent on what the energy market is doing or what interest rates are doing can be pretty useful in, in certain quantities For single stock exposure, I think one of the things that we’ve seen quite a bit over the last handful of years is people have put money into an individual stock, maybe it’s Nvidia, maybe it’s something else, but it’s really gone gangbusters for a number of years, and now they have a really good problem, which is a big part of their net worth is tied up in one company, and you have that really concentrated risk.
There’s a lot of different ways you can use to to deal with that, whether it’s using options or it’s using individual stocks to build around it. But if you have that risk and it’s more than, say, 5 or 10% of your portfolio, it’s a good idea to consider what your options might be, especially if it’s in a taxable account and you have to deal with the impact of paying that capital gains tax.
The last piece is try not to move drastically. Sometimes the market will move drastically on its own accord. When you have these booming equity markets and names that are going up by, triple digits, that’s a dramatic change, and you need to try to adjust that back to a, in a portfolio that you’re comfortable with.
But, the opposite is also true, and we talked about this more around the start of the war when things were not as good as they are now. Just because risk is increased doesn’t mean you wanna suddenly become even more fearful ’cause you’re not gonna participate in the rebound. So generally, don’t move too much, and if the market forces a big movement in your portfolio, consider rebalancing.
And depending on where those assets are that need to be rebalanced, particularly if it’s in a taxable account, there’s strategies that, that you can use to make the tax bill a little less impactful.
Brian Perry, AIF®, CFA®, CFP®: We’re happy to meet with you free of charge to give you thoughts on anything we talked about today, as well as your taxes, the tax strategies.
We can have our CPAs look over your tax return or see what your situation is in the future. If there’s any tools or strategies to help save you some bucks, keep some money away from Uncle Sam, as well as cashflow planning, cashflow decisions. Again, free of charge if you want. And if you’re a client, then please reach out to your advisor if you have questions on any of this.
They’re the best point of contact to dive deeper on anything we talked about.
Kathryn Bowie, CFP®: So thank you all for being here. Brian and Brian, thank you for all of your information, all of your expertise. We really appreciate. There’s so much to learn and so much to talk about. We could do this for hours, but we appreciate you.
Brian Fahey, CFA®: Thanks, Kathryn.
Kathryn Bowie, CFP®: Thank you. You
Brian Fahey, CFA®: all.
Kathryn Bowie, CFP®: Have a great day
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