Q1 2023 | Putting the Quarter-in-Perspective | Part Two: Interest Rate Hikes & Bank Failures

Stories of historically atypical interest rate hikes, and multiple bank failures, concerned many advisors in the early days of 2023. Join us for the second (and final) part of our discussion with Casey Dylan, CIMA®, Consultant, and the host of Unfiltered Finance, Tom Romano, Head of Strategic Relationships, as we discuss some of the more prominent news events, and their effects, during Q1 of this year.

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Transcript:

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Let's let's

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shift a little bit to some of the headlines that we saw because there was

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there's quite a bit. It felt like it was a very long quarter. Yeah, and you

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know as we did see some positive results, but can we

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talk a little bit about just in general some of the headlines that we saw and

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then specifically I want to take a dive into inflation

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and then the banks because that was

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a really big headline. We got a lot of a lot of calls regarding that look

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there there were

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Striking headlines around things like

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shocks to sort of economic surprises on

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job numbers to what was going on with the FED

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to Banks not just near the United States but

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internationally and yet what you see is kind

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of, you know markets do what they do in in any given day. They respond

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to that but they are quick to incorporate the news

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and get back to pricing on other kinds of things. And

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so I would say as a micro dosage of

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what the ride is for investors. It's

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this it's if you can sort of

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take in stride that there are going to be lots of headlines and

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that there may be short-term Market reactions headlines over the

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longer term that kind of gets filtered out on

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the upside and downside right and what you get back

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to is. Hey one of my paying for right I'm paying for some kind

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of future earnings or I'm lending with some expectation that

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I'm going to get paid and income stream based on that and that tends

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to drown out the short term noise and now

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you're back to factors of how much did I pay did I

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get my earnings did I not is

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We're upside to that right and markets are kind of a weighing machine

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in that sense. Right? They're weighing those earnings. They're weighing those

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cash flows in the future. Right? So I would say

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lots of lots of news lots of scurrying

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around the news.

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You know at the end of the day we're sort of where we started one

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of the headlines and one of the things that we've been getting a lot

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of questions about I'm talking about is is inflation. I know we've spent some time

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already today talking about that. We did

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see US inflation ease a little bit but there

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might be some pressures coming up. So if you don't mind commenting on that, that

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would be great. Yeah, you bet. I think it's helpful to kind of

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take a step back and look at

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With the onset of the pandemic right everything kind

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of shut down and then when we went to reopen things back up

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factories didn't necessarily open up, especially in

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places like China right for some time. Right and the the

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supply chain was suddenly

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constrained and so we

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had a hard time getting Goods, right but there was a lot

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of demand because we were at home, you know person stuff and so

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as you have demand shoot up but supplies constrained

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price shoots up, right? That's just sort of Economics 101

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and we saw that and at the time, you know, the Fed was quick

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to say, hey, look we think this is transitory think eventually things

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settle down we get manufacturing back online. We work

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out the bugaboos associated with the supply chain

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and those the price pressure doesn't inflationary pressure should come back

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down over time and in large respect

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this seems to have proven that out right?

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I think what really got the fed's

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attention and started them down the path.

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Of really dramatically raising rates was

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the fact that well while goods were

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sort of starting to come back down. It was

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inflation associated with services that was going up. And

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in fact, what we've seen is good coming down

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the the overall inflation of

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the CPI number or that PC number coming down from its

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highs last summer, but while that's been happening underneath

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Inflation associated with Services has continued to

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go up.

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And so even if we're at a point now where the latest inflationary readings

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are half of what they were.

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Just a year ago this time.

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Services inflation is up and continuing to go the wrong direction. Right? And

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so the the FED has said hey, look

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first of all, we don't look at kind of the overall CPI number. We don't

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that's not how we measure it. We're looking at these underlying statuents and

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they prefer the the pce as

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opposed to CPI, but they're all just kind of ways of measuring, you know

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inflation in the economy. And so

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one of the ways that we've looked at

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this for a very long time is core CPI, right? We're stripping out the

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volatility of energy and food because those tend to move around so much and then

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you know, we've been introduced to this concept that not

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only is it core CPI, but it's core Goods CPI and

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course Services CPI. And so the FED now is very focused

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on core Services looking at Services minus

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services for energy and food and what

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we see are again our sort of troubling Trends

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around services and housing

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in terms of the impact that that

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has now pushing.

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Up or holding up those inflation numbers and if they

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continue on the wrong direction, that's what the fed's concern about and the

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the whammy that potentially comes

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from if Services costs go

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up at some point that starts to impact Goods costs as

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well. Right? And so if you look at this where the the white

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bars are coming down, right the the concern

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is that Services cost the cost of producing goods

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and delivering them right is going to impact the the cost

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that gets passed through and goods start to come back up and there's sort

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of a double double impact of inflation if

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you will and that's what I think the FED is incredibly concerned about

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and and why they say look we're gonna ratchet rates up

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and we're gonna keep them up there long enough until we're convinced that we've we've

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stamped this out and brought it back down to a level that's

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livable because the last thing you want to do is take your foot off the pedal.

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And then suddenly have a Resurgence of these

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inflation Air Forces which that we've saw

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in the 70s, right if you think about what we've we've

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seen this show before the early 70s the FED raising

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rates taking their their foot off the brake, I guess and then

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Resurgence of inflation in the late 70s stagflationary

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environment and it took the volcker FED in the 80s

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taken rates to places. We'd never seen until recently right to

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to stamp that out. And so I think the FED

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is taking a lesson from history and said we don't want to repeat those mistakes.

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We're gonna stay on this until we're sure right absolutely and

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speaking of the fed and it says been a very fast pace

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in terms of Ray hikes. Yeah

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historically exactly exactly so

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they they have meant business and I

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think Market participants repeatedly made

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the mistake of not taking

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the FED at its word.

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Right and and equities markets have

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definitely gotten well ahead of the FED particularly at

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the end of last year and maybe potentially the beginning of this year bond markets

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now are pricing that the FED

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will pull back and yet the FED is saying no. No, we're we're

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gonna raise rates and we're gonna keep them there longer and that's

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you know, we have no expectation that we would

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pull back from that anytime this year. Right? So the market

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participants are our forward looking forward pricing, but

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they seem to not be taking the FED at its word. I think that's pulled

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back a little bit in February and March we started to

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see Market participants kind of get their arms around.

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Actually be coming and we see you know

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investors like hedge funds really sort of looking at volatility

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Bets with the expectation that hey this

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may get a little more turbulent before it gets better. Right? So

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there's a lot of sort of now Market positioning

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for the fed me

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actually do this and we may see an economic pullback,

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but that may not necessarily mean the FED response to

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it. Right? I think again as we look forward the

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the way that I would think about this as an investor as a the

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stock market is not the economy, right? The

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markets are definitely driven by

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interest rates and fed movement

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and yet

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Much like headlines the markets take that

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news and stride it gets built into prices and there

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may be short-term volatility associated with this but if you look out over

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time, you know, what what do we see going back to

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you know, as long as we have records 1926 and Beyond

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right Imperial heads when interest rates

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go up interest rates go down inflationary environments disinflationary environments

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recessionary environments across all of those things markets

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tend to produce a return

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of you know, seven to ten percent average annual

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you don't get that every year but you get on average over time and it's

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paying you for those cash flows so much like,

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you know, the all the comments that we've had prior to

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this.

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As investors, it's important to sort of take in its Stride

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Right put some blinders on there may be volatility associated with

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this ride. You will get wet on this ride. Right but we

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promise you'll come out in the other side, right and when you do,

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you know, the markets will get back to doing what they

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do, which is you know, paying you for putting Capital to work

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in there. So so that I would say again we watch these

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things. We we sort of especially working

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in the industry. It's a incumbent upon

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us to have some product prognostication about where this could

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be headed at the end of the day what we think matters very little it's

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what actually happens and we build portfolios to

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be as robust as we can because Anything Could Happen. Yeah, that's that's fantastic.

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And that's a really good way of putting it. We don't know what's

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happening, but we're

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We're invested in a way to endure what's to come? Right? Exactly. So

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one of the headlines that we we spent

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a lot of time talking to advisors and investors alike is the

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the notion of the banks and we saw from Silicon Valley

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and First Republic and a few others.

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I think it's a it's a risk reward story. But I also think

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this is the diversification story there. I'd love to hear your thoughts. Yeah. Well, yes,

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I think

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the the situation with the banks

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has a lot to do with other stuff, right? Yes, the

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the banks were quick to come out and say well this

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is a consequence of how rapidly the FED is

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raised interest rates. And this is potentially impaired the

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asset base of these Banks and there's no question right over the

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course of 2022. You saw the asset base

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drop significantly across banks in

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general because right so, you know first principles,

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what is a bank do they take money in when they

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take that money in as a deposit? It's a liability to them. Right?

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So they take that liability and they got to go match it up

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with an asset and they do that either by making loans and if

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they can't make enough loans, then they got to go buy bonds treasuries.

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For instance, right? Yes. That's the old against the

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liabilities. So if you if you've got a bank that

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has a bunch of bonds that they're holding as an asset

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and the value of those bonds dramatically drop. They've lost

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a lot of money against the liabilities that

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are still where they are, right and

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So that's that's the the challenge for

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the financial.

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sector and it no surprise the financial sector

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was sort of the worst performing sector for the first quarter in large

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part because of these Dynamics

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It was a part of what happened at svb. It was a catalyst

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for the bank run that followed but the bank

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run followed because of the unique dynamics of

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svb, correct? Right and the the failure

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of silvergate was

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function of crypto and had as

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much to do with FTX the failure of FTX, which

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was a Ponzi scheme, right? So you have

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a lot of kind of very unique situations Signature Bank,

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very crypto focused right First Republic the

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very very heavily on

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the asset side writing interest only mortgages

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right in to a degree that other

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Banks didn't have some unique characteristics of these Banks which cause

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them to be sort of the canary in the coal mine if you will right

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and Credit Suisse just

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Has struggled for years, right? And this was

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just the nail in the coffin form. The concern is are they

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the canary in the coal mine or are they just being punished because

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the malfeasance and poor management?

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And I think the answer is a bit of both, right? So the the

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fed and other institutions got

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together and said, hey, we got a backstop this thing to keep any contagion

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from spreading and assure depositors that

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they're deposits are safe, even if the value of the bond the assets

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that these banks are holding have dropped down. We the the government

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are going to step in and and backstop not just

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your 250,000 but everything right that was

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the strong message that they sent and that sort of seem to

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work, right it calm markets. Thanks for still being sort of reviewed and

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I would say look there's there could be more to this story. There could be

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other shoes to drop in time. Right? So you'll continue

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to watch it. I think as in as a person

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who has money at a bank, right am I rushing to pull my money

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out? No, I'm fairly confident that you know,

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we're we're gonna survive this right now.

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Did I say the same thing in 2008 when when I

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really thought hey, man, the whole financial system could go down.

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These Banks had collapse in Mass. I don't think we're anywhere

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near that I think banks are much healthier than than they

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were then and I think the issues that they have have to do with treasuries and

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the FED has said look, we're gonna step in and provide as much liquidity

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as necessary for the banks. So this becomes

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a potential issue down the down the pike, right? If

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in fact the FED has to step in and provide the

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Surplus liquidity to the treasury market,

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why might they have to do that?

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Well, if for some reason we default on the debt ceiling for instance,

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right that could be very problematic and the FED

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might have to take aggressive steps in a way that we've

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never seen before to step in and try and provide Surplus liquidity

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specifically to the treasury market. That would

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be a complete roll reversal of where we've been right? That's that's

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taking the quantitative tightening off the table and now we're back to quantities, right

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so so could things come down the bike that

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would cause a, you know, real dislocation to

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banking to markets sure it could happen

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again. Who knows right? Everybody's got a crystal

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ball.

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Nobody's usually right spot on about what's gonna happen, but

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it's a potential risk that you want. Hey, look this might happen, but

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we'll survive.

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Yeah, no, absolutely. And as you said before, I mean, it seems like the markets

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have.

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sort of shrugged off those headlines because we've seen some pretty decent returns

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and in q1, but I think you know in

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Let's let's go back to the text docs, right? I mean that's what's really

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leading the charge here, isn't it?

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well

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I think there are a lot of Dynamics at play.

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But underpinning all of that is risk and reward right?

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I mean that at the end of the day, it's that simple

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what are the risks and what are the rewards and how much am I

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willing to pay for those rewards? And am I underestimating those

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risks? Right? So everything is sort of a function of those things

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and so I would say look in equities. The the

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tech stocks is a risk, right? There's there's certainly reward

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there's upside there. We're seeing it in terms of markets, but I think there's risk

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right in fixed income. There's potential

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risk associated with the yield curve

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and what happens with the fed and raising rates in areas,

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like financials. There's risks

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right associated with that. I think the key

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takeaway for that for anybody looking at

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it is

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Broad diversification not just in

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one geography not just inequities not just in fixed income

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across factors as much as you

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can broadly diversify the more robust your portfolio is to

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stand up to any of those unique risks.

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And so I would I would say.

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That that would be where I would encourage investors to

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sort of keep their heads.

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I it's always challenging when you have tech stocks doing

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as well as they are because they drive

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markets you want to be there. You want to participate in it.

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There's a a benefit socially to

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holding names that people are familiar

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with and talk about right if you think about the

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fomo experience that people have

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missing if you're missing out, right? Yeah, my next

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door neighbor. He's he's got Google and apple and they're tear on

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the cover off the ball. Never mind. What happened last year right now, I gotta you

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know, keep up with the Joneses on that water cooler. Alpha

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is what I call that. Yeah water cooler Alpha and I would just

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say hey look at the end of the day. We're people right if we

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were autonomous, you know Vulcans. This would just be

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economics and math and we can figure it all out reality is

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we're people and you got to build a portfolio you can live with right as

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our as our good friend Phil Henry says, you

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got to build a portfolio you can live with and then live with it, right? I think

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that's absolutely true. And so you have to take into account.

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The the investor psychology associated with this that's

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why I think momentum is such a

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powerful factor to build into your portfolios

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because momentum picks up

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these like when tech stocks going to run you end up

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owning things like Apple and Google and because they

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are demonstrating positive momentum, right? So you you're picking

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up some of that you're participating in that upside and I

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think as a as an investor, that's that would probably be enough for

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me, right? It's a modicum of the things that I everybody else

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is holding that that's working but it's also stuff that's not working

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because eventually that circles around and that becomes the thing

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that's worth. I don't have to try and time it. I'm just holding it and I'm

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waiting keeping my powder dry in that area so that when it

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does I benefit that that's how I would think about it look again

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tech stocks are

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The amazing thing about markets is they run longer than you think they should right. They're

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fueled by stuff. Sometimes you don't understand and and

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in many cases, I think the

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tech stock Dynamic is is part

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fairy dust, right and you know,

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we watched it run for a decade and drive markets, you know

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for you know, double digit returns for years because

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that happen again, of course, it could right. I'm not

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gonna tell you again. I am cautious about the

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dynamic being set up looking very similar to

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the dynamic that we saw at you know, 2019 2020.

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Yeah. No, absolutely and you know that seems like that tech

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store keeps popping up. I started my career in the late 90s and that was the

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whole story and then I saw a lot of portfolios.

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A lot of people see their portfolios blow up but because of overexposure to

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to technology and they having a

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balanced portfolio Diversified across multiple asset classes regions geographies.

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That's that's the best course of action at the

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end of the day. So yeah, I think I go back to the the E-Trade

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baby, right if you remember the E-Trade baby so easy

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baby. Yeah that was born right on the text actually and then

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they they put the baby away for a while baby's back right now. I was

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a little bit older now, he's out of the wedding, you know hanging out

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with this guys and gals but to

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me that a Hallmark of a caution, right because

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the reality is it's it's easy but

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hard right it's not you know, it's not

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difficult to say. Hey look broadly based diversification sit still it's

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incredibly difficult to do. Yeah, right and that's where

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the real benefit of working with financial professionals comes in because everybody

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thinks they can do it everybody. They're gonna be Spock

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and devoid of emotion, but then the moment of truth comes

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The market drops 40% and you're looking at like am I gonna

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be able to retire? Right and the fear grips hold and it's

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2 am and you're thinking what do I do? Right. That's

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when you need to have that dispassionate third party

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to pick up the phone and say I want to sell everything. They whoa. Let's

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revisit right like is anything changed? Oh the

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market drop 40% right has anything in your life changed right?

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Maybe that's not the best course of action. Let's take a beat having that

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dispassionate a third party to keep you from blowing yourself up

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at that exact moment is invaluable. Yeah

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and making sure you have the right mix between stocks bonds

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and maybe even Alternatives depending on the investor and if someone

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can't sleep at night, it's not necessarily that they should take action,

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but they might be in the wrong asset allocation for

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their

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The risk, you know their ability to accept right? Yeah,

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it could be that often. What I've

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experienced is when it's that it's because the client wanted

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more Tech right in their portfolios or more of what's

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working, right? And then when that's no longer working, they

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can't sleep at night, but cautionary Tale the other

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piece of that is we're surrounded by the news 24/7

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right? It's just and it's always the whatever

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bleeds leads right? And so it's this constant

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drum beat of kind of negative stuff. And I think that investors

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need a voice.

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That that they trust to say. Hey, yeah. No I

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saw that too. Yes, that bank went out of business. Here's

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why we shouldn't Panic here, right? Yep. We

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see all that. Here's why we're gonna stay the course. Here's why we're not gonna Panic. Here's

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what let's you know, our long-term goals are and we're in good

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shape to hit those. I think that sort of calming reassurance

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helps people get back to sleeping at night. Yeah. No,

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I agree Casey as always. It's a pleasure talking to you.

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Thanks for joining us great having you here and I want to thank all of

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our listeners and these feel free to access other podcasts

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that we have done and they can be

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accessed anywhere you get your podcast. So thanks everyone and we

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will see you next time symmetry Partners LLC.

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