Financial and Economic News: October 25, 2023Oct 25, 2023
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First up, in this week's market update, Wall Street grappled with a touch of turbulence as the bond market stirred up some uncertainty. Specifically, we saw the S&P 500 navigate through its longest five-day slide this year, but still closing above the critical 4,200 support level. On the flipside, the Nasdaq 100 outperformed, with tech giants like Microsoft and Nvidia demonstrating impressive resilience.
Now, how do we explain what's happening? The rollercoaster ride can be largely attributed to the Federal Reserve's anticipated interest rate hikes and increased government bond sales to cover their deficits. So, while the bond market experiences some heightened volatility, it's important to remember that uncertainty is a natural part of financial markets.
The good news is that, in the face of rising interest rates, the equity risk premium, represented by the S&P 500's earnings yield relative to the 10-year rate, remains relatively stable. If we zoom out, historical expectations of a 10-year Treasury rate above 6.5% tipping the balance might not hold true in our current economic landscape, because it's possible that the stock market will weather this storm without a major setback.
If you're wondering if its a good time to start investing, my take-home message is this: regardless of when you start, when investing in companies, it's crucial to assess their financial health, competitive position, management team, growth prospects, and valuation to make informed decisions and manage your risks effectively. And on the whole, by staying informed about market trends, conducting thorough research, and considering your investment time horizon, you can create an investment plan that is rigid and resilient.
Treasury Bond Yields
And since we’re on the topic of treasuries, the recent surge in the 10-year Treasury yield, breaking the 5% barrier for the first time in 16 years, marks a significant turning point in the financial landscape. This spike is closely linked to the Federal Reserve's strategy, which involves maintaining higher interest rates and even contemplating further hikes should concerns about inflation arise. This shift in the Fed's monetary policy is a key driver behind the rising yields.
We've recently seen the Fed has signaled its intent to maintain elevated interest rates, but say they remain open to hiking rates if the economy's resilience raises concerns about inflation. Why, though? Well, to finance growing budget deficits, the U.S. government is increasingly selling bonds. As a result, bond investors are being asked to purchase a larger quantity of Treasury notes and bonds. This surplus of bonds, coupled with the Federal Reserve's consistent rate hikes and balance sheet reduction, has led to the evident upswing in yields. Now, because the U.S. budget deficit has expanded, partly due to rising interest costs and the Fed is not fully replacing maturing Treasuries on its balance sheet, this situation is expected to result in an estimated increase of $1.5 to $2 trillion in outstanding debt for 2024, compared to about $1 trillion this year.
Here's the part that matters though: what does all of this mean for individual investors and the broader economy? Unfortunately for regular folks, higher yields translate to increased borrowing costs, affecting mortgages and loans, meaning it might be time to diversify and explore possible new investment avenues at this time. On the broader economic scale, the rise in yields may act as a check on economic growth, something the Federal Reserve welcomes to counter rising inflation. Mortgage rates have already climbed, making debt servicing costlier, and stock market fluctuations tied to higher yields can dampen consumer and business confidence.
In a nutshell, the 10-year Treasury yield surpassing 5% is a major milestone with widespread implications. It's crucial to navigate this changing landscape with open eyes and understand the intricate interplay of interest rates, economic factors, and the Fed's policies.
The Future of Money Managers
In other big news, the asset management industry, which oversees an impressive $100 trillion, is also in some hot water as of this week - marked by significant fund outflows and the possible end of a prolonged bull market. When we zoom in, the reality is that about 90% of asset managers' profits since 2006 have relied on market upswings rather than new inflow from client acquisition, and if the proverbial penny hasn't dropped yet, let me clarify: the result is a precarious situation, especially if we're expecting another bear market soon.
See, traditional mutual funds have lost ground to cost-efficient passive alternatives, which now constitute about half of US mutual funds and ETF assets. And because we've seen interest rates rise consistently over the last several quarters, cash has become the more attractive investment option. For context, prominent firms like T. Rowe, Franklin, and Invesco have experienced a combined exodus of more than $600 billion in client funds since 2018, trending instead towards cost-efficient passive strategies. Even industry leader BlackRock hasn't remained untouched, seeing clients withdrawing a net $13 billion from long-term investment funds over the last three months through September. The big take-away here is that this trend underscores a pivotal shift in investment preferences, with passive investing gaining substantial ground due to its cost-effectiveness.
Beyond finances, the asset management industry's performance has global economic repercussions too, and how it adapts can influence economic stability, impacting job markets, stock prices, and overall financial security. Despite the challenges, asset management firms, led by a new generation of CEOs, seek innovative ways to stay ahead in this ever-evolving landscape, and in my opinion, when the rules are changing so rapidly, that's the safest move to help you stay in the game.
Next up, it's no secret that a growing number of American car owners are facing the highest delinquency rates on their auto loans in nearly 30 years. The culprit? Rising interest rates that are making new car loans more expensive. These financial challenges come at a time when the broader economy is showing mixed signals, especially when it comes to consumer spending.
Fitch Ratings recently reported that, in September, a staggering 6.11% of subprime auto borrowers were at least 60 days behind on their loans, marking the highest rate since they started collecting data back in 1994. Now, what's the big picture here? These high delinquency rates tell a story of financial strain for many Americans, which, in turn, indicates potential challenges for consumer spending. When people find it hard to meet their car payments, it often means they have less money to spend on other things like shopping, dining out, and leisure activities. This, of course, has a ripple effect on local businesses and the job market.
So, for those of you who are dealing with these financial hurdles, it's crucial to be proactive. Start by taking a good look at your financial situation – know your income, expenses, and debt. Create a budget to help you manage your finances wisely. And if you are struggling with debt, it might be worthwhile to consider a loan restructuring or temporary payment reduction to help ease the pressure. In these uncertain economic times, it's vital to know how to adapt when you need to, and prepare for potential changes in the financial landscape, and most importantly, to look after your financial well-being.
Jamie Dimon Calls Out Central Banks
Next, Jamie Dimon, the CEO of JPMorgan Chase, has thrown some serious shade at Central Banks over his thoughts about our economic future. This week, while speaking at the Future Investment Initiative summit, he reminded us how central banks got their financial forecasts utterly wrong not too long ago. According to him, this should give us all pause to reflect on their otherwise rosy outlook for the next year.
Dimon isn't entirely convinced that central banks and governments around the world are fully equipped to handle the economic consequences of rising inflation and slowing global growth, he even shrugged off the idea that further interest rate hikes would be a game-changer, noting that it's time to brace ourselves for potential fluctuations. Ray Dalio, the CEO of Bridgewater Associates, also chimed in on the same panel with a gloomy forecast for the global economy in 2024, citing a slew of risks, including sky-high public debt and ongoing global conflicts.
So, what's the takeaway from all this? It's a reminder that we need to be cautious and realistic about our expectations. Central banks may not have all the answers, and economic challenges are ever-present. As investors and businesses chart their course in this complex environment, it's crucial to stay adaptable, prepared for unpredictability, and considerate of the global issues that could impact our financial landscapes.
Black Rock Revives Target-Date ETF’s
And last but not least, I’ve already mentioned them a few times today, but BlackRock, the world's largest ETF issuer, is reentering the target-date investing arena with a twist - this time using exchange-traded funds (ETFs). They've introduced a suite of 10 funds that gradually shift investments into safer assets as investors age. These new ETFs cover retirement dates from 2025 to 2065, filling a gap in the market as they are the only target-date strategy available in an ETF wrapper.
Interestingly, this move comes approximately a decade after BlackRock ceased its passively-managed target-date ETFs in 2014. With ETFs now accounting for $7 trillion in assets and the mutual fund industry experiencing outflows, BlackRock aims to tap into the changing landscape.
The motivation behind launching these ETFs is to attract investors beyond company-sponsored retirement plans, as those plans typically use pre-tax dollars and don't require the tax efficiency of an ETF. And perhaps more interestingly, this is an opportunity for BlackRock to reach more investors, especially with the expansion of ETFs into the retail market and zero commissions, making digital access to markets easier than ever.
Individually, this offers investors a new option for retirement planning with the potential for tax efficiency. On a broader scale, it reflects the growing influence and popularity of ETFs in retail markets and the changing preferences of investors and regulators in target-date strategies.
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