Is your Portfolio really diversified? Inflation Perspective & Other Economic News for the Week Ending 11-19-2021

The big news this morning Monday Nov 22 was Biden decision to renominate Fed Chair Jerome Powell to another term with Lael Brainard as Vice Chair. Increasing fears of further COVID lockdowns and remarks by two Federal Reserve officials last Friday resulted in a flatter Treasury curve from lower longer dated yields. Both Fed Vice Chairman Richard Clarida and Fed Governor Christopher Waller voiced concerns that continually high inflation may recommend the Federal Reserve consider accelerating the tapering of asset purchases.

Oil fell meaningfully last week, and particularly on Friday, as crude oil prices shuddered from the dual effect of governments threatening to release crude oil reserves from strategic petroleum reserves as well as from Austria being the first western European country to re-impose widespread lockdowns.

Last Tuesday had two meaningful economic data releases in the October Industrial Production and Retail Sales reports. Both were up more than consensus expectations

Inflation Narrative

You cannot listen to any media outlet and not be hit over the head by the inflation narrative. Yes, prices have gone up but keep in mind that some increases are due to a few temporary conditions. Housing which accounts for 30% of the inflation calculation is higher simply because people made the choice to not pay their rent with the money the government sent them and to use it on items that they could normally not afford. Landlords still had to pay their banks on the mortgages they held so many had to reach into their personal savings to make ends meet. The skyrocketing prices in homes was mostly due to companies like Blackrock and Zillow buying up homes at above asking prices Zillow tried to flip them by making improvements but found out that using algorithms to predict housing prices was a lot harder than they thought. Blackrock is simply renting these units which is also contributing to the increase cost of housing. There is a labor shortage which has led to a rise in salaries for skilled labor, but they supply shortage is not as bad as the media has presented. We can see this by the Baltic Dry index. (The index provides a benchmark for the price of moving the major raw materials by sea) decline by more than 50% since the beginning of October. Corporations have increased their prices even though their cost of goods have not risen significantly. But people are paying the higher prices since the narrative is that we should buy now since supplies may have it tomorrow and have just accepted the higher prices.

Perhaps many people have already purchased their Holiday gifts and that the expected sales for Q 4 will be lower than the consensus. We still feel that prices will level off by mid-2023 and with Labor being the big challenge for skilled labor.

The 4% retirement rule

For many years actually decades the financial industry has used the 4% rule as a rule of thumb for budgeting /advising client on exactly how much of their retirement savings they should spend. For the last 10 years interest rates have been extremely low compared to the rates in the 80’s and 90’s even the early part of the 21st century. For a long time, advisors have stuck to a rule about portfolio construction with retirees being in a 60 /40 blend or even lower ratio of equities. The first thing that everyone should realize is that every investor is different and that a rule of thumb is not a hard and fast rule. Your advisor should have a clear understanding of your needs and constructed your portfolio to generate the income you would need to retirement. The problem for many is that their investments have been place in index or ETF funds that reinvest dividends and the funds distributes them. If you are not familiar with the underlying holding of your portfolio its time to understand them. By the time you retire you should be in a fairly conservative investment model one that you can calculate your annual income. There is no reason for you to have to sell positions each quarter to generate income. By the time you reach retirement your portfolio needs to be hand held not on auto pilot because your advisor is too busy

Get involved and if you do not understand something ask or seek out the answer.

Are you really diversified?

Advocates of passive portfolio management claim that you cannot beat the market all the time and hence having a diversified portfolio that is broad based is the best way to achieve growth. Modern Portfolio Theory claims that there are two types of risk idiosyncratic (single company) and Market Risk (systemic). You can reduce idiosyncratic risk by diversification but you cannot reduce /avoid Market risk. This theory has its flaws especially when most of the fund companies use market cap in the structure of their funds. Market cap weighting is simply taking the money you invest into a fund and distributing it to buying more shares of the largest companies and less of the smaller ones When the market is rising it is generally driven by these companies and the incentive is to raise the value of the fund. But cap-weighting suffers from the irreparable flaw of overweighting a handful of supposedly overvalued high-tech stocks. But that reasoning is flawed simply by the fact that you are not diversifying your portfolio. Having a fund that is heavily weighted in a handful of stocks is not diversified, in fact it is bringing the risk of your investment to a whole new level because the rest of the companies in that fund do not have enough weight to offset a decline by even one of the overweighed companies failing. When we see large shift in the value of the market it is typically driven by a handful of companies. 11 companies account for 30% of the S&P 500 25 account for 50%. So, while the ride is good in an up market and everyone is happy because these companies are performing and driving valuations of specific funds when a downturn occurs the same holds true these stocks will account for the same weight in a decline, Now the biggest risk to investors are redundancy. Many index funds or ETF will have over lap and that over lap increases your risk when the market declines. If your portfolio is made up solely of index funds and ETFs, take a hard look at the underlying companies in those funds. If you don’t you may be in for a bit of shock when the markets drop.

The Information Technology sector

This is our last segment on the 11 sectors that make up the U.S. economy.

The Information Technology sector includes software and services, technology hardware and equipment (e.g., mobile phones, personal computers), semiconductors and semiconductor equipment.

Information technology is a highly concentrated sector, with just a handful of companies representing more than 50% of the sector’s weight—including the two behemoths Apple and Microsoft. While those are typically the primary driver of sector performance, impacts related to COVID-19 have been broad-based and positive for much of the sector, increasing consumer demand for PCs, gaming hardware, software, personal devices and online payment services (although at the expense of traditional credit card services by Visa and MasterCard)—though consumer tech demand may fade after the COVID-related surge. It is this sector that has allowed companies to survive during the pandemic to work from home and to hold meeting via zoom. But the question will the momentum continue?

Following a dearth in capital spending, there are signs that investment in cloud and networking equipment is picking up, which could persist if the economic expansion continues.

Also, the ongoing rollout of 5G wireless infrastructure is likely to accelerate—increasing demand for telecommunication components and semi-conductors. A significant short-to-intermediate risk is the supply chain issues, which is proving to be significantly problematic for sourcing semiconductors.

Longer term, a trend away from globalization and pent-up demand for productivity-enhancing technologies are likely to improve the already solid financial position for much of the sector. Counterbalancing the strong fundamentals, investor optimism about future growth potential has pushed valuations to well above the historical average; higher interest rates can weigh on investors’ perceived value of future earnings. Additionally, there are rising legislative and antitrust risks for some of the largest companies in the sector. Finally, strong price momentum during the COVID crisis has faltered in recent months.

Positives for the sector:

5G rollout and onshoring trends are themes that support fundamentals.

Generally strong balance sheets and earnings growth potential with low funding costs;

Financial services technology and surging online retail sales are supporting cloud computing infrastructure and software;

Long-term growth tailwinds, as businesses enhance productivity with tech investment.

Negatives for the sector:

Valuations are very stretched relative to the historical average, making higher interest rates a significant headwind. If we look back to 1999 with the tech bubble, we seem to be in the same place right now

Most of the performance in the NASDAQ and S&P have been driven by the weight of Technology companies. There is a huge concern that we may enter into another significant correction

Capital expenditures are weak but have an improving outlook—particularly with the prospects of technology infrastructure spending.

Semiconductors are in short supply amid very low inventories and strong demand.

The sector is highly concentrated in a few stocks.

Risks for the sector:

Potential antitrust suits in the U.S. and Europe;

Reversal of the 2017 corporate tax cuts that had benefited the sector.

The Week Ahead

A holiday-shortened week is packed with key data releases. Today kicks off with U.S. existing home sales, followed by flash manufacturing and services PMIs on Tuesday. Before the Thanksgiving holiday arrives, the U.S. will see one of the busier days for economic news on Wednesday. Minutes from the October FOMC meeting may provide insights into how the tapering discussion played out, along with expectations for this year’s final meeting in a few weeks given the departure of two of the more hawkish committee members. Markets are also anticipating President Biden’s decision on the next Fed chair. After U.S. GDP skidded to 2% in Q3 from 6.7% the prior quarter, the first revision is expected to be adjusted up to 2.2%. Calls for more aggressive monetary policy changes may escalate if the Core PCE Price Index surges as CPI did earlier this month. Durable goods orders, new homes sales, and revised consumer sentiment announcements are also on the calendar. Overseas news will be dominated by manufacturing and services PMIs from Australia, Japan, the UK, Germany, and the rest of the Eurozone. The end of the week is quiet, with U.S. markets closed Thursday and shuttering early on Friday

This article is provided by Gene Witt of  FourStar Wealth Advisors, LLC (“FourStar” or the “Firm”) for general informational purposes only. This information is not considered to be an offer to buy or sell any securities or investments. Investing involves the risk of loss and investors should be prepared to bear potential losses. Investments should only be made after thorough review with your investment advisor, considering all factors including personal goals, needs and risk tolerance. FourStar is a SEC registered investment adviser that maintains a principal place of business in the State of Illinois. The Firm may only transact business in those states in which it is notice filed or qualifies for a corresponding exemption from such requirements. For information about FourStar’s registration status and business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov/