Author: Eric Cramer, CFP®, CFA®
We’ve seen stock market volatility lately after an extended period of unprecedented calm.
What could cause the markets to erupt like this? Don’t believe the headlines that it was a slower employment report, or even that it was the Japanese “carry trade.” We need a softer job market to relieve some of the pressure employers face when looking for new hires. We’ve known the carry trade (borrowing cheaply from Japan and investing at a higher rate in the U.S. and elsewhere) was ending. The financial media writes these headlines because the human brain needs a “story” to process information, but those headlines aren’t necessarily the most impactful headlines or why we’re seeing such stock market volatility.
We estimate that approximately 70% of all stock market trading volume comes from split-second algorithmic trading. It’s driven by computer programs, and it happens so fast that the role of humans is only to design the trading algorithms (even that is moving to AI) and to oversee things in case the actions of the algorithms get too extreme, and someone has to pull the plug. The regulators have put so-called “stock market circuit breakers” in place to pause, or even shut down, the stock market out of fear that the algorithms can’t be stopped. Many of the algorithms read headlines, look at short-term trends (think of a few seconds as short-term), and then place trades in microseconds. Every once in a while all the algorithms gang up on the market and accelerate the pace of the ups and downs causing stock market volatility.
After months of abnormally calm markets, the most relevant headlines might actually be about how some of the high-flying technology stocks are not hitting their revenue/income expectations. Much of the run-up in tech stocks was probably driven by algorithms, but after a pretty big sell-off, value stocks are stealing the show. Value stocks have a long-term history of outperforming growth stocks, but the day-to-day flips between the two sides of the market are impossible to predict.
It is said in some circles that the Federal Reserve isn’t concerned about the markets and is instead focused on the economy, but this just isn’t true. Ever since the Tech bubble was growing uncomfortably large in the late 1990s (feel familiar?) the Fed has cared a LOT about the value of your portfolio. Ideally, some would say, the Fed would let excessive risk-taking by investors get punished. Healthy markets count on the Fed letting risk and reward be properly priced.
But just as some banks are “too big to fail,” Americans’ portfolios are too big a part of the economic health of the country to let them fail. What the Fed knows is this: if you rescue investors’ portfolios they will spend more, start more businesses, and relieve the government from spending on the social safety net. It is the ultimate “trickle-down” approach to economics and has become unwritten doctrine. The half of the U.S. population without any exposure to the stock market may suffer from the Fed’s actions in the form of inflationary swings, but the investor class gets to benefit from these policies.
The only time the Fed backs away from this approach is when inflation is way too high, which it was over the past couple of years (but isn’t anymore). The Fed went too far in stimulating the economy after the pandemic. And then it was too late raising rates and is now too late in lowering rates. The Fed has been too extreme and too late in every rate decision it has made for twenty-five years, but it has helped investors and it’s going to rescue us again. With rates as high as they are now the Fed once again owns something called the “Fed Put,” which is nothing more than the ability to dramatically lower short-term interest rates to make all risky assets worth more. This will likely start in September, if not sooner, and may even go too far.
Inflation is over; it’s yesterday’s news; it’s a distant memory. The headlines aren’t telling you this yet, but we’ve been saying it all year. This will leave the Fed free to cut rates just as soon as it shows up in the latest economic data.
Here are a few key pieces of evidence for you:
When we manage the BIP Hedged Equity, BIP Hedged Yield, and BIP Concentrated Stock strategies, we use some math to adjust our options strategies, which are the backbone of our approach. That includes referencing the price of expected volatility in the markets (the “VIX”), which recently quadrupled in one week. This means we can generate a LOT of income selling options; we think this is good for our clients. In other words, these strategies were designed for stock market volatility.
But even our primary portfolios can do better in volatile times. If the remainder of this year is volatile, it might just give us the chance to “buy low and sell high” a few times in our clients’ portfolios. Rebalancing is often discussed as a method of risk control, but it can also present opportunities to increase your return. The key principle at play is that it usually makes sense to let the markets “gap down” before buying, and “gap up” before selling.
OK, maybe you need some of your capital to avoid as much stock market volatility as possible. We do have something for you too! You might have used cash for this in the past, but our BIP Short-Term Tactical strategy relies on the extremely liquid Treasury market to offer both liquidity and yield for this part of your holdings. Bank accounts have FDIC limits that can expose savers to theoretically limitless risk for balances above those limits, so putting excess cash to work in the Treasury market where investments are backed by the full faith and credit of the U.S. government could be a smart way to enjoy healthy returns while reducing risk.
Managing that volatility so that it works for you is what having an optimal financial plan is all about. Your Personal Wealth Advisor has a full toolkit of strategies that can be customized for your situation. With all of our public market strategies built around the concept of volatility, just remember this phrase, “Volatility is Your Friend!”
We estimate that approximately 70% of all stock market trading volume comes from split-second algorithmic trading. Many of the algorithms read headlines, look at short-term trends, and then place trades in microseconds. Every once in a while all the algorithms gang up on the market and accelerate the pace of the ups and downs. After months of abnormally calm markets, the most relevant headlines might actually be about how some of the high-flying technology stocks are not hitting their revenue/income expectations. Much of the run-up in tech stocks was probably driven by algorithms, but after a pretty big sell-off, value stocks are stealing the show.
Market indexes gain and lose every day. The larger and more often these price swings happen, the more volatile the markets are said to be. The VIX measures expected volatility.
VIX is a ticker symbol for the Chicago Board Options Exchange’s CBOE Volatility Index, which measures the price of expected volatility in the stock market based on S&P 500 index options.
The “Fed Put” is the belief that the Fed will step in to dramatically lower short-term interest rates to make all risky assets worth more and buoy markets if the price of markets falls to a certain level.
This post is provided for informational purposes only. Specific investments may not be suitable for all investors and no offer or recommendation of any investment or investing strategy is intended. The opinions in this commentary are as of the posting date and are subject to change. Information has been obtained from third-party sources we consider reliable, but we do not guarantee the facts cited are accurate or complete. This material is not intended to be relied upon as a forecast or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict the performance of any investment. We may execute transactions in securities that may not be consistent with what is mentioned here. Investors should consult their financial advisor on the strategy best for them. Past performance is no guarantee of future results. All investments involve risks including loss of principal.
Author: Eric Cramer, CFP®, CPA®
Welcome to our recap of the 2024 Q2 Market Report. Eric Cramer, Chief Investment Officer at BIP Wealth, walked our clients through the current state of the U.S. economy and laid out his key takeaways from the second quarter of 2024.
In case you missed the presentation, we’ll break down the major talking points below, including the strong fundamentals we’re seeing and artificial intelligence’s role in combating inflation. You can also watch the recorded version of Cramer’s Q2 QMR by clicking the link below.
Regardless of some of the headlines we’ve seen recently, the U.S. market saw one of its smoothest quarters ever in Q2, according to Cramer. While there were individual stocks that had a rough quarter, a diversified portfolio more than likely enjoyed a smooth, consistent ride upwards. This is highlighted by the U.S. stock market finishing the first quarter up a little over 10%. Now, why is this? For Cramer, it all boils down to the strong fundamentals we’re continuing to see in the U.S. economy.
Unsurprisingly, growth stock led the charge for Q2’s market growth. However, the big news for Cramer is the continued rise in the U.S.’s share of the global stock market. With a current share of $50.7 trillion, the U.S. now controls 63% of the World Market Capitalization. This represents a 4% increase from just one year ago.
Another strong indicator of our current market health is the rate of available workers to available jobs. In 2020, for example, we saw a dramatic loss of available jobs due to the pandemic. Today, however, the number of available workers is outpacing the number of available jobs, which is great news. For Cramer, it is the backbone of his belief that we are not close to a recession anytime soon.
You may not have heard too much about this one, but we’re seeing unemployment rates among the major demographic groups in the U.S. collectively fall. This is a trend you see during a strong economic surge, regardless of who may be in control in Washington. For Cramer, the differences in the unemployment rates are about as small as he’s ever seen them. So, the rising tides have lifted all boats, if Q2 had anything to say about it.
A common piece of data that economists will use to showcase the strength of the economy is GDP. For Cramer, though, the numbers in the Weekly Economic Index are just as important. What we’re seeing is that the WEI rate is settling into a 2% rate of growth. This is considered real growth, over and above the rate of inflation. This rate is very healthy, and it could even see an uptick in the near future.
Most of us experience inflation through commodities. You may go to the gas pump and have to pay more than you did the previous visit. You may find yourself seeing higher prices on groceries. Whatever your experience may be, many of us feel the volatility of commodities through these sorts of experiences. This does not paint the entire picture of inflation, however. There is also inflation with services. When we buy things today, we’re very likely to be paying for services as often as we are goods. The chart below demonstrates how as the prices for goods have fallen, the prices for services have gone up.
So, how might artificial intelligence play a role in this world of inflation? For Cramer, there are some similarities and lessons from the past to watch out for. According to a 2023 report from Goldman Sachs, it is estimated that AI could replace 300 million jobs while increasing the GDP by 7% over the next 10 years. As a result, we could see the prices for services decrease as AI’s role in industries such as healthcare, education, and others continues to grow. This is not to say we will need significantly fewer humans in the workforce, but similar to inventions like steam engines and the Internet, AI could help us grow markets through innovation and efficiency, which could lead to deflation.
Before signing off, Cramer left us with four key takeaways from the presentation. These ranged from the rise of AI to the overall themes of 2024:
When examining your financial plan with your BIP Wealth advisor, you may discuss the current political and geopolitical conflicts.
This is easy to miss in an election year. However, our team believes that every broad measure of our economy is healthy as it currently stands.
Don’t shy away from this, though. Instead, embrace what the future of artificial intelligence may hold for financial markets.
From opportunities in public and private markets to BIP’s hedged equity investments, our advisors are hard at work to ensure our clients maintain a diversified portfolio to combat volatility.
If you’d like to speak to an advisor about your portfolio or want to learn more about how we’re engineered to perform for our clients, be sure to contact us. You can also check out the rest of our resources hub to learn more about the financial market.
This communication contains general investing information that is not suitable for everyone and is subject to change without notice. Past performance is no guarantee of future results and there is no guarantee that any views and opinions expressed will come to pass. The information contained herein should not be construed as personalized investment advice, tax advice, or financial planning advice, and should not be considered a solicitation to buy or sell any security. Investing in the stock market and the bond market involves gains and losses and may not be suitable for all investors. Indices are not available for direct investment.
Author: Eric Cramer, CFP®, CFA®
If you’ve ever gone through the financial and investment planning process, you might remember that it took some effort. But you might look back at that investment in time and feel some sense of satisfaction that you did something for yourself and your family. Unfortunately, investment planning may be extremely dangerous to your financial health. Here are the top five reasons why:
How many working people can look back a decade and say that they would have accurately predicted their current income level? Fortunes change, people lose their jobs, people get promoted, and the future is unknown for most of us. Because of this, future earnings become one of the biggest financial planning mistakes people may make. If your financial plan assumes you have a healthy income for decades into the future, but that doesn’t happen, do you expect your retirement lifestyle to be the same? Anyone more than ten years from their planned retirement needs to understand why a certain income figure was used in their plan, and they might want to make their income estimates extremely conservative just to test for problems with their plan. A good advisor may even run more than one plan, using different income levels, to examine the sensitivity of the plan to this input. Another technique used for people approaching retirement is to assume that all income ends in the current year. This helps establish what your “worst-case scenario” may look like and every year of additional income just makes things better.
Life expectancy is a tricky thing for anyone to predict. The best investment planning probably assumes a very long life expectancy, because outliving your money is the biggest risk most people face. Avoiding “superannuation” is the main motivation for many people to engage in investment planning, which is why some planners may suggest using a life expectancy that you only have a 10% chance of achieving. This doesn’t mean that this estimate is more accurate, it simply provides a more prudent way to think about how to plan.
If your investment planning doesn’t address the concept of investment expenses, then you may need to ask some questions. Another big financial planning mistake you can make is not taking into consideration what you’re paying in fees and even taxes on investments. For example, your stock broker may start to crank out financial plans that use index returns to predict portfolio returns. But the reality may be that your investment accounts become full of high-cost mutual funds, annuities, and other fee-laden investment products that may not be able to quickly adjust to market shifts. It isn’t unheard of for an investor to pay more than 2% in total investment expenses (and sometimes much higher) while relying on a financial plan that assumes there are zero investment expenses. For a $1 million portfolio, that’s $20K per year that doesn’t compound. If you don’t think investment expenses are a big deal then consider this: at the end of 2017, the average annual return of the MSCI ACWI IMI Global Equity Index for the prior ten years was only 4.97. And the Bloomberg-Barclays U.S. Aggregate Fixed Income Index return over that decade was only 4.01%. If your portfolio was paying an extra 2% in fees then, depending on your allocation, you may have barely kept half of your returns. At the end of the day, your investment expenses really do matter.
Taxes are boring, yes, so let us tease you with this idea: if you own an actively traded mutual fund, and it realizes short-term capital gains (from selling stock it owned less than a year), then the fund has to distribute those gains to you along with a tax on the investments. Your investment planning advisor may not see it coming, and there may be little you can do to stop it. To make matters worse, the distribution that hits your account will now be taxed at your highest marginal rate (because it’s a short-term gain). On top of this, distributed short-term capital gains cannot be offset with realized capital losses. So, if your super stock-picking mutual fund was up 20% in a big year, but sold most of its holdings to reposition, maybe you had 10% distributed to you at a tax cost of around 4-5%. Suddenly that terrific 20% turns into only 15%. The big pothole here is when a fund has a down year, but still sells some winners, and you pay investment taxes on a negative return! It’s happened before and it will surely happen again. Will you make this common financial planning mistake?
Some investors won’t need Social Security to have a terrific retirement, but for most of us, it will at least play an important role. And here’s the thing: Social Security has its risks. It’s not hard to be cynical about this program run by the Federal Government, but in the interest of giving respect where it’s due, the Trustees responsible for running this giant entitlement program write some of the best financial reports you will ever read. They have been telling us for years that there are major Social Security risks ahead, and it’s getting closer to reality. In the 2023 Annual Report, it was estimated that in all likelihood the program will exhaust itself by 2033. At that point, they estimate, benefits will have to be cut by 23% to match annual tax collections. We can’t know how our current and future politicians will address this problem, but if your investment planning isn’t assuming a cut to your currently legislated benefits, you may be counting on money that you will never receive.
At BIP Wealth, we focus on holistic wealth management to help our clients fortify long-term success and avoid the common financial planning mistakes you read about above. To learn more about our services, check out our What We Do page. If you’d like to get in touch with one of our wealth advisors, feel free to contact us!
How do I estimate future earnings?
Although it is very difficult to accurately predict your future earnings, it may be helpful to create more than one investment plan to determine what your financial situation could look like in different scenarios.
What is superannuation?
Superannuation refers to a retirement savings system in which individuals set aside a portion of their income during their working years to fund their retirement. It is commonly known as a pension or retirement fund.
What is an investment expense?
Investment expenses refer to the costs associated with managing and maintaining an investment portfolio. These could include advisor fees, taxes, and operating expenses.
When do you pay taxes on stocks?
Taxes on investments like stocks are typically realized when you sell them for a net gain or loss.
Is Social Security at risk?
In a recent estimation, it was said that Social Security could exhaust itself by 2033, resulting in a 23% benefits cut.
This communication contains general investing information that is not suitable for everyone and is subject to change without notice. Past performance is no guarantee of future results and there is no guarantee that any views and opinions expressed will come to pass. The information contained herein should not be construed as personalized investment advice, tax advice, or financial planning advice, and should not be considered a solicitation to buy or sell any security. Investing in the stock market and the bond market involves gains and losses and may not be suitable for all investors. Indices are not available for direct investment.
