All content presented in this article is for informational purposes only. Materials presented should not be interpreted as a solicitation or offer to buy or sell a security or the rendering of personalized investment advice, which can only be provided through one-on-one communication with a financial advisor. The content reflects the opinions of Hesperian Wealth LLC (HW), which are subject to change at any time without notice. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All information or ideas provided should be discussed in detail with a financial, tax, or legal advisor prior to implementation. Any inclusion of third-party data should not be construed as an endorsement by HW of the source of the data and is included solely to expand our clients’ access to independent research and data related to investing and capital markets.
This article includes mentions some of HW’s primary methods of investment analysis: Fundamental and Cyclical analysis.
Fundamental Analysis involves analyzing individual companies and their industry groups, such as a company’s financial statements, details regarding the company’s product line, the experience, and expertise of the company’s management, and the outlook for the company’s industry. The resulting data is used to measure the true value of the company’s stock compared to the current market value. The risk of fundamental analysis is that the information obtained may be incorrect and the analysis may not provide an accurate estimate of earnings, which may be the basis for a stock’s value. If securities prices adjust rapidly to new information, utilizing fundamental analysis may not result in favorable performance.
Cyclical Analysis is a type of technical analysis that involves evaluating leading indicators, recurring price patterns, and trends based upon business cycles. Economic/business cycles may not be predictable and may have many fluctuations between long-term expansions and contractions. The lengths of economic cycles may be difficult to predict with accuracy and therefore the risk of cyclical analysis is the difficulty in predicting economic trends and consequently the changing value of securities that would be affected by these changing trends.
Any indicators or analyses of past market performance shown in this article are hypothetical and do not reflect the performance of any actual client account managed by HW, any past decisions made by HW, nor the total fees and expenses that would have been paid by a Hesperian client account, which include Hesperian’s investment management fee in addition to the operating expenses and fees of the underlying funds and other investments.
Any reference to a market index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indexes are unmanaged vehicles that do not account for the deduction of fees and expenses generally associated with investable products.
Investing involves substantial risk, including the potential loss of principal. HW makes no guarantee of financial performance nor any promise of any results that may be obtained from relying on the information presented. HW may analyze past performance, but past performance may not be indicative of future performance.
Investment Commentary—Second Quarter 2023
For those investment management clients interested, in this quarter’s investment commentary I try to briefly summarize my market views and then provide supporting charts and comments as optional extended reading:
Hesperian Investment Views in a Nutshell
Recession Risk Is High
I’ll start by sharing an updated version of a graphic I’ve used before. Here, I’ve organized the various leading recession indicators I look at into broad categories and show you which are concerning, which are neutral, and which are benign. It only takes a majority in the concerning camp to indicate a high probability of recession. In the next 12 months, I would not be surprised to see an economic downturn. How severe it will be is anyone’s guess.
Sometimes even the most reliable recession indicators still only give you 12 to 18 months advance notice. During the interim, many investors grow impatient and finally conclude well-known leading indicators have stopped working—usually just before they prove themselves again. That’s probably why they still work. It takes time for things to develop. I try to remember something the great investor JPMorgan supposedly said, “I made a fortune selling too soon.”
US Stocks vs. International Stocks
Valuation: International Stocks Are Cheaper
The model shown here developed by Nobel Prize–winner Robert Shiller indicates US stocks are trading at a high level (~30x) relative to their normalized earnings power. While international stocks, mostly domiciled in Europe and Japan, trade nearer their historical average level.
The US Dollar Is Overvalued and Falling Too
The US dollar appears overvalued (significantly so in some cases) compared to most developed-market currencies (see the accompanying chart). The US dollar has also been falling lately. If foreign currencies continue to appreciate vs. the dollar—and they have plenty of room to run valuation-wise—international stocks get an extra return boost as their values are translated into even more US dollars. So this is another facet of international’s overall attractiveness.
Recession Threatens but US Stocks Have the Momentum Back
Tempering our conservatism is the fact that stock markets, especially in the US, are driving higher despite valuation and other risks. Prices are telling us our valuation and economic concerns should be modulated—for now.
To Sum Up
US stocks are expensive. International stocks are cheaper (and have shown early signs they might start to outperform US stocks). Plus, the US dollar appears expensive. And foreign currencies are starting to appreciate against it. Recession risk seems high. The only thing in favor of US stocks is their prices are still driving higher in absolute terms. But the US market has been driven by a tiny group of stocks. It’s not a good sign historically when stock leadership is so concentrated. On top of that, there’s likely a bit of an AI investing mania going on centered in the US.
Since we must take risk to generate the returns we need in our portfolios, my thinking favors the cheaper alternative—international (whose cheapness may provide greater cushion in a downdraft). A conservative stance in general to stocks also seems justified, though not too conservative because I consider price momentum seriously, especially when it conflicts with other evidence.
Bonds Are Back (Sort of)
A portfolio of short-term bonds can yield over 5% today, come with a bit of capital appreciation potential, and offer potential tax advantages for certain clients.
But even longer-term bonds have gotten much more attractive, in my view. In this chart, you’ll see that their yields are closer now to where the trailing 10-year GDP growth rate says they should be (the most reliable predictor of interest rates I know of).
Bottom line, Treasury bonds in particular again offer potential deflation/recession protection. If you are a capital appreciation–minded investor, that’s the primary role bonds should play in your portfolio.
Adding Trend-Following Strategies Can Improve Portfolios
Trend-following has not fared well this year so far. But they’re not supposed to work when everything else is. Last year, as bonds and stocks crashed, they put in a great year.
This chart plots the long-term performance of an index of trend-following funds (not investable, but I believe representative of the strategy broadly) vs. US stocks and a portfolio mix of the two. The portfolio benefits (higher return, lower volatility, and lower maximum drawdown) reveal themselves visually. And importantly, the funds we recommend in this space have tracked the hypothetical index, nay beat it, over their existence.
Real Estate: Unattractive At Current Prices
A few clients have expressed interest in eventually investing in real estate, perhaps a residential rental property. The time may come, but right now, real estate looks unattractive to me. I use a proprietary calculator to model the real estate return on investment for clients. And the numbers for a typical residential home, at least in California, don’t exactly excite me. Even accounting for the tax benefits and leverage too, the expected annual after-tax return is only in the 4% to 6% range. It’s almost entirely dependent on decent home price appreciation and a long-term holding period.
This won’t always be true, but the potential rental income is too low and the mortgage expense is too high to justify today’s prices for most properties, in my opinion (for investment, that is). Are you close to making a real estate investment decision? Let’s schedule a strategy session to run the numbers.
I'm Available for a Portfolio Discussion
I think we’ve touched on pretty much every major asset class. If you’d like a more detailed portfolio review, my virtual door is always open. Give me a call or send me an email. Do you have your money working hard for you? If you’re not satisfied, let’s build you the appropriate portfolio. Set up a time to talk.
Until we speak again, enjoy the summer. And let me know how I can be of further service to you in your financial life.
Eric R. Figueroa, CFP®
eric@hesperianwealth.com
(916) 546-5203
Find a Time to Meet
All content presented in this article is for informational purposes only. Materials presented should not be interpreted as a solicitation or offer to buy or sell a security or the rendering of personalized investment advice, which can only be provided through one-on-one communication with a financial advisor. The content reflects the opinions of Hesperian Wealth LLC (HW), which are subject to change at any time without notice. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All information or ideas provided should be discussed in detail with a financial, tax, or legal advisor prior to implementation. Any inclusion of third-party data should not be construed as an endorsement by HW of the source of the data and is included solely to expand our clients’ access to independent research and data related to investing and capital markets.
This article includes mentions some of HW’s primary methods of investment analysis: Fundamental and Cyclical analysis.
Fundamental Analysis involves analyzing individual companies and their industry groups, such as a company’s financial statements, details regarding the company’s product line, the experience, and expertise of the company’s management, and the outlook for the company’s industry. The resulting data is used to measure the true value of the company’s stock compared to the current market value. The risk of fundamental analysis is that the information obtained may be incorrect and the analysis may not provide an accurate estimate of earnings, which may be the basis for a stock’s value. If securities prices adjust rapidly to new information, utilizing fundamental analysis may not result in favorable performance.
Cyclical Analysis is a type of technical analysis that involves evaluating leading indicators, recurring price patterns, and trends based upon business cycles. Economic/business cycles may not be predictable and may have many fluctuations between long-term expansions and contractions. The lengths of economic cycles may be difficult to predict with accuracy and therefore the risk of cyclical analysis is the difficulty in predicting economic trends and consequently the changing value of securities that would be affected by these changing trends.
Any indicators or analyses of past market performance shown in this article are hypothetical and do not reflect the performance of any actual client account managed by HW, any past decisions made by HW, nor the total fees and expenses that would have been paid by a Hesperian client account, which include Hesperian’s investment management fee in addition to the operating expenses and fees of the underlying funds and other investments.
Any reference to a market index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indexes are unmanaged vehicles that do not account for the deduction of fees and expenses generally associated with investable products.
Investing involves substantial risk, including the potential loss of principal. HW makes no guarantee of financial performance nor any promise of any results that may be obtained from relying on the information presented. HW may analyze past performance, but past performance may not be indicative of future performance.