Inflation

We have all heard the adage… “Don’t fight the Fed.” That was sage advice back in 2022 as the Fed embarked on the most aggressive tightening cycle dating back 40 years. That year both stocks and bonds withered, ending the year down by double digits, you would have to go back to 1941 the last time both asset classes showed losses for the year when you use the 10-year Treasury as a proxy for the bond market. Now with the pendulum shifting from tightening monetary policy to “easier money” everyone is trying to understand what that means for the economy and their portfolio in the months and years ahead. Lately the narrative has shifted a bit, there is a growing chorus that believes that monetary policy and by that we are really referring to the Fed’s setting of overnight interest rates in an economy dominated by bits and bites versus the more tangible attributes of yesteryear has less impact today. Or perhaps, it’s those long and variable lags Milton Friedman was referring to as higher rates are still making their way through the economy. If that is the case it stands to reason that even if liftoff is September it may take time for lower rates to exert their influence. In this piece we are going to explore rates from a few different perspectives. One thing to make clear, we are not market timers and market rates are a byproduct of not just Fed policy, but numerous other factors, like growth and inflation expectations, fiscal policy, the state of geopolitics etc… We can use the past as a prologue have been taking and will continue to take some steps on behalf of our clients whose assets we are managing for important life goals.  Equity Investing U.S. Stocks When the Federal Reserve cuts interest rates, it typically has a positive impact on US stock markets. If that is to play out again now, making sure that your portfolio is allocated properly when the Fed is inclined to cut rates is critically important. Here are some key points on how and why this occurs: Lower Borrowing Costs : Reduced interest rates make borrowing cheaper for companies and consumers. Newly lowered rates can lead to increased spending and investment, which often boosts corporate profits and, consequently, stock prices. Increased Consumer Spending : With lower interest rates, consumers may be more prone to take out loans for big-ticket items like houses and cars. Increased consumer spending can drive higher sales and earnings for companies, positively affecting their stock prices. Improved Corporate Earnings : Companies with existing debt benefit from lower interest payments, which can improve their profitability. This can lead to higher stock valuations. Shift from Bonds to Stocks : Lower interest rates typically lead to lower yields on bonds. Investors seeking higher returns might move their investments from bonds to stocks, positively impacting stock prices. Economic Confidence : A rate cut is often seen as a proactive move by the Fed in support of the economy. This can boost investor confidence, leading to increased buying activity in the stock market. Sector-Specific Impacts : Certain sectors, such as technology and consumer discretionary, often benefit more from lower interest rates due to their reliance on borrowing for growth and consumer spending patterns. Sectors that are highly capital intensive or with significant fixed costs stand to benefit more than asset light business historically. Financials tend to see their net interest margins or “NIM” shrink as rates come down, though a protracted period with an inverted yield curve may be less make lower rates less of a headwind if the curve returns to its normal sloping relationship where longer rates are higher than shorter rates. Manufacturers could see a benefit if lower rates mean a lower dollar making their goods more competitive when it comes to global trade. Small Cap Stocks With the incredible rise of the Magnificent 7 stocks, small cap stocks have been overlooked. A change in outlook by the Fed may create an environment for small cap stocks to continue to climb. Lower Borrowing Costs : Small-cap companies, which often have higher debt ratios than larger companies, benefit considerably from reduced interest expenses when rates are cut. Lower borrowing costs can improve their profitability and support expansion efforts whether it be adding to their workforce or expanding research & development. Growth Potential : Small-cap stocks are typically seen as growth-oriented investments. Afterall, companies that are now among the largest companies in the world like Amazon, Apple, Nvidia and Microsoft all started as small caps! Lower interest rates can spur economic activity, benefiting smaller companies that may be more agile and able to capitalize on new opportunities. Increased Risk Appetite : Rate cuts can increase investor confidence and risk appetite. Investors may be more willing to invest in higher-risk, higher-reward small-cap stocks during periods of lower interest rates. Access to Capital : Lower interest rates can make it easier and cheaper for small companies to raise capital, whether through loans or equity offerings. This can help them invest in growth initiatives, leading to higher stock prices. Overseas Equities Yield differentials may narrow : Foreign capital has been lured into US assets for many years dating back to the European Debt Crisis in the early 2010s. If US interest rates look less attractive by comparison than foreign capital may be onshored and find its way into local stock markets. A weaker dollar may ease inflation and lower borrowing costs : A more common phenomenon in the emerging markets where consumption of commodities represent larger percentages of overall spending may allow for capital to be directed more productively and as foreign companies and countries often offer dollar bonds to institutional investors to hedge the currency risk the cost of that interest could drop if the local currency strengthens vs. the dollar. Foreign assets may offer a store of value : Should the dollar weaken, it stands to reason that it’s losing ground to some other currency; that relationship can serve as a hedge to offset the diminishing purchasing power of local assets. After a long run with a stronger dollar, if there is a secular shift underway that will unfold over the years ahead, having some additional exposure aboard would be valuable from both a risk and return perspective. The combination of more attractive valuations should provide a little extra incentive to increase the ex-US holdings in the portfolio, even if it is just at the margins. One thing to keep in mind, in the past monetary policy has generally been pretty well coordinated, but if that is to change in the years ahead it will be that much more important to have some professional oversight to help navigate what could result in a little more short-term volatility. Stocks historically have fared well when the easing cycle begins, though it’s not always the case, especially if the easing is in response to a shock to the economy or deteriorating fundamentals. The latter does not appear to be the case today though there are signs of continued cooling in the labor markets where with the former, a shock, well, that’s tough to predict, after all it wouldn’t be considered a shock. It’s those known unknowns or unknown unknowns, that get you in trouble to quote the late Donald Rumsfeld.

Japan is back… Where were you in 1989? It is a welcome sight witnessing the Japanese stock market get back to levels it last touched when I was wearing tube socks and playing Nintendo. In the first quarter the TOPIX was up 10.05% matching the S&P 500 torrid start to the year. But it’s not just in the capital markets that are buzzing. You could stay up late watching Bloomberg Asia during market hours but since that should be time to wind down, you won’t be disappointed taking in two of the best series on television right now… Max’s Tokyo Vice and Shogun on FX. The world’s third largest economy as measured by GDP deserves some love. Between pop culture and higher stock prices it’s a new dawn in The Land of the Rising Sun.We are in the midst of March Madness, the pinnacle of excitement in “amateur sports” it’s hard to replicate something so immersive and exciting, but I worry the combination of the NIL and sports betting has irreparably damaged the purity of the tournament. We are all aware by now that the pandemic ushered in new era of gamification and gambling providing a much-needed distraction and some excitement in those dark days of lockdowns and masks. When it comes to wagering it’s common knowledge the house always wins. All you need to do is look at the gambling stocks which have been on a tear as they quietly pick your pockets. I have my thoughts about legalizing drugs and making gambling more accessible, but rather than pontificate, I have a more compelling suggestion. On any given day, the stock market chances for an increase is no greater than a coin toss. Alas if you buy a stock or fund you get to play that same wager over 240 times a year and rather than the “house” ending up ahead in the long run you likely have a lot more to show for it.The death of Nobel prizing winning psychologist Danny Kahneman last month had me reflecting on a true intellectual giant’s contributions to the world of behavioral finance and its value to the everyday investor. Even for someone who has spent more than two decades honing my craft, I am often surprised/amused at the tricks our minds play on us when it comes to investing. Dr. Kahneman’s seminal work Thinking, Fast & Slow is a true masterpiece, but many struggle to make their way through it. Michael Lewis’s 2016 Undoing Project is a wonderful tribute to Danny and his best friend Amos Tversky, and is a really approachable read for those unwilling to commit to the intellectual density of T, F & S. Any investor would be well served to learn about loss aversion recency bias or the endowment effect to name just a few of those blasted biases.  Just when you thought people were coming to their senses and the crypto bust of 2021-2022 rid us of the daily digital data dump, here we are again with the biggest grift in modern times. I have to give it to them, despite lacking a compelling use case the Bitcoin believers have talked their way into one of the most epic executions of the greater fool theory in the history of man. Happy to have Wall Street get in on the rouse, the SEC and the sponsors of the various Bitcoin ETFs should be ashamed of themselves. Making it easier for people to lose their hard earned money is not why we are in this business and anything to “legitimize” an endeavor that has funded terrorism, human trafficking and the drug trade all for some basis points is an embarrassment. While we are on the topic of dereliction of duty, has anyone spoken with a family trying to navigate the FAFSA process this year? It’s bad enough that it costs $90,000 for a year at a prestigious liberal arts college, but to think we are making it more difficult to apply for and receive aid. You wonder why the younger generations are fed up and both sentiment levels and the government’s approval rating is at historically low levels despite a stock market at all-time highs and an unemployment rate under 4%. Applications for aid are down 57%, you read that right while the costs of college skyrocket. And those that applied were working with incomplete data. I can’t make this stuff up. We are supposed to be taking care of those in need, but we are more likely to see students take on more debt. If there was ever a better reason to start plowing money into the 529 plans now then let me know. It’s not to say we shouldn’t take the aid available to us, but perhaps it’s best to be in a position where we don’t need to count on it. George Carlin may have been thinking about another dirty word when he heard someone mutter the word inflation. It’s surely making the current administration cringe with the election less than 7 months away. While the rate of price changes have dropped markedly from their peaks in the summer of 2022, recent data suggests the victory lap for Fed which kicked off in October coinciding with this strong rally, may have been a bit premature. Coming into the year the market was pricing in 6 or even 7 rate cuts but a combination of better labor data and price stickiness has reduced the probability of aggressive easing getting under way. Just this week, on Monday, the ISM Manufacturing Survey showed we entered expansion territory in March for the first time since the Fall of 2022 and now the odds suggest just two cuts may be in the cards for 2024. It’s becoming increasingly more evident that we are in a period of fiscal dominance, I am not sure that monetary policy is having as much of an effect outside of residential and commercial real estate. The former is holding up fine in the face of limited inventories while the latter is holding on for dear life; they stare down the barrel of a gun in the form of refinancing. Always good to zoom out a little. I am not sure we will see those prices come down without a deep recession, but before we do too much hand wringing it’s important to put things into the proper perspective. For the last 30 years, dating back to 1994, CPI has average just below 2.50% including the recent the elevated inflation, that’s less than half the inflation for the 30 years from 1966 through 1995 where prices grew at a clip of over 5.4%. Magnificent 7, 6, 5 4, 3 , 2, 1… Aside from Meta and Nvidia the latter of which has somehow managed to add an 80% return on top of a truly breathtaking 2023 performance, we have seen quite the dispersion in the returns and what appears to be a case of returning from orbit for high flying Apple and Tesla. With the group trading at a forward P/E ratio of 31 times there is no room for error as they trade at 50% premium to the S&P itself over which they have a great influence given their size. What is even more amazing is that they trade at a 100% premium to the equal weight index. Something has to give, is it that Amazon, Microsoft, Meta and Alphabet starts to resent buying GPUs from Nvidia with 80% gross margins and they start in house fabrication much like Apple did with ditching Intel in 2020. Rent seeking behavior is usually short lived as competitors look to take share as well. Or perhaps it’s all that enterprise spending that doesn’t yield the earnings growth forcing multiples to contract. Much like the upcoming NFL draft there rarely is a can’t miss story out there. Much like “retired” Bill Belichick did at the helm of the New England Patriots for 20+ years, perhaps trading down and having more picks allows you to build a better roster versus needing everything to go right with your one great idea. Diversification and identifying mispricing is a consistent path to wealth even if it takes you a little longer to get there. Common prosperity or conciliatory China? Polishing off the old playbook and rebranding communism by using some more gentle words like common and prosperity doesn’t mean your people have to like it. History suggests that there is nothing common about prosperity when the state dictates distribution of resources as was the case for the 30 years under Chairman Mao until Deng Xiaoping ushered in market based reforms in the late 1970s and early 1980s. Clearly Xi Jinping’s admiration of Mao Zedong’s emphasizes his cult of personability and despotic tendencies while minimizing the fact his policies resulted in the deaths of millions of Chinese whether by famine or the Cultural Revolution. But the Chinese have had their taste of capitalism it appears they like what they experienced. While the property problem persists, efforts to cool tensions between the US and Chinese relations along with more aggressive and targeted stimulus may break the years’ long malaise. The last pre-pandemic slowdown in China required about 2 years to run its course and then set up a period of synchronized global growth from 2016-2019 a similar recovery would be welcome as trade may provide further disinflationary pressures as they compete with Mexico and India for labor and any increase in consumption is bound to help US multinationals grow earnings after the US consumer eventually slows down. We are not ready to pivot away from our view China is practically un- investible but this is modestly constructive and worth monitoring. Virtuous cycles of asset allocation based investing. Whether the calendar dictates adjusting your investment mix or there is more discipline based on drift and data, the fact we have spent 30 of the last 40 years in one heck of a bull market has meant that there has been an unquenchable demand for fixed income. At one point the bond market in the US dwarfed the stock market but stocks have caught up where both pools of capital valued at about $51TT. Globally the bond market is a bit bigger than the equity markets, $133TT to $110TT. Rates have been coming down since the early 1980s only to have increased a bit in the middle of the 2000s and again most recently. Higher rates should attract more buyers, yet $6TT is parked in money market funds. The average bond buyer has become much more price (yield) insensitive, buying bonds in something resembling rote behavior. If the market continues to go up and likely at a rate of change that exceeds the bond market, and it should given the uncertainty associated with owning stocks and the natural inflationary forces that drive asset prices higher, then we should more often than not have a bid putting something of a lid on yields and not needing to implement a Japan style yield curve control. Mark Twain’s famous quip about his death being an exaggeration seems fitting for all those folks. Please join us April 18th for our Quarterly Market Review and Outlook. Register Now Sources: Baron’s WSJ, BLS, ISMForbes, JP Morgan Asset Management Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, www.adviserinfo.sec.gov. Past performance is not a guarantee of future results.

It’s February already, thankfully. The sun seems to be on extended holiday in the Northeast. Perhaps Punxsutawney Phil will be more accurate than economists and strategists alike as this morning he indicated an early Spring is in store. As for us market watchers experiencing something akin to Groundhog’s Day would be nirvana and the first month of the New Year was a continuation of the final two months of 2023. So far, so good for February too. With the S&P logging a return of 1.68% for the month, that annualizes out to a 20% return, ahh, if it were only that easy. There has been a lot to unpack, so we’ll meander across a number of topics to share our thoughts and what we are looking at right now and in the months ahead.  Central Banks: As we have joked about recently, Federal Reserve meetings have become must-see TV. For the last 6 months, since the last hike in July, the meetings have been less about the rate announcement itself and more about trying to get inside Chairman Powell’s thought process. With markets hanging on every word and probing the quarterly Statement of Economic Projections (SEP) for any insights, it’s no surprise that two of the Fed meetings in 2023 corresponded to the most volatile trading days of 2023. The presser earlier this week augured the worst day since September when Powell seemed to take the March cut off the table. Data since then only strengthened the case for May as the lift off date for their easing cycle. That seems to be reasonable enough, in acknowledging that they have come a long way in taming inflation (rolling 6 month PCE is around 2%) they can start to shift focus to the other part of their dual mandate, which is full employment. Bringing both inflation and jobs into a more balanced weighting is a good thing and a far cry from the pain Powell mentioned in August 2022 at Jackson Hole. While Chair Powell and the Fed are the most important game in town, central banks in the UK, Europe and Japan are worth monitoring. The UK and Europe are dealing with more of the stagflation dynamic we witnessed in the late 70s, though there have been some recent signs of easing inflation. The ongoing impact of higher energy prices has more impact there where they rely heavily on imports and the fact their mortgage rates tend to be much more variable in nature have meant higher monthly payments not just for new buyers but even those who have purchased homes 5 or more years ago. In the States, it’s far more common for borrowers to term out their debt for 30 years. Many folks with a mortgage today have locked in rates of 4% or below. Monetary policy likely will have some impact over the next several years and I would expect the trough of their easing cycle to be below that of what we see in the US. The ECB seems likely to wait for the United States to move first, but they won’t be far behind. Japan has witnessed sustained inflation for the first time in more than 30 years but at a much more palatable level. They have thus far maintained yield curve control policies which suggests that they are in no rush to start raising rates. If they do it’s likely to be modest at best as with households having sizable exposure to the JGBs any drop in price brought on by higher rates may impact consumer behavior. Higher rates would also have some real impact on the carry trade, but that discussion is for another day. Labor: As the frequency of layoff announcements hitting the headlines have increased over the last 12 months the Fed needs to be very careful about how much softening occurs before it becomes difficult to reverse that trend. Fortunately after a blockbuster January Nonfarm Payroll Report, the unemployment rate ticked back down to 3.7% after rising the prior month albeit slightly to 3.8%. It’s becoming ever more obvious that so goes the labor market so goes the economy. When the unemployment rate jumps by .50% in a short period of time, it’s likely to rise another 1.00% in a hurry as we have seen in prior cycles leading to a recession. Allowing the labor market to get untethered is the quickest path to a hard landing. We have seen new weekly unemployment filings increase to 224,000 in the most recent week and continuing claims remain around 1.8MM. Hardly worrisome levels unless you are one of those impacted, but the direction itself is worth watching. It was good to see job openings surprisingly increase in the most recent JOLTS report and especially in sectors like manufacturing. Another bright spot is that the “quit rate” has dropped sharply since the height of the pandemic where workers bounced to new opportunities at an unprecedented rate speaking to labor tightness. This probably has an added positive effect on productivity as fewer new workers have to adjust to unfamiliar surroundings. Continuing the soft landing narrative the Bureau of Labor Statistics just released their quarterly Employment Cost Index which showed further moderating, which is a good sign when it comes to inflation and margins. Nominal wage growth is around 4% back to levels we saw pre-pandemic. Inflation: With CPI trending down, and PCE following a similar path perhaps the debate over transitory can be put to rest. The stickier shelter component will start to show signs of disinflation or outright deflation in the coming months as softer housing data and a glut of new multi-family housing comes online. While there has been much hand wringing over financial conditions easing (whether directly or indirectly), there is little evidence that higher asset prices are inflationary when it comes to consumption of goods or services. In the post Global Financial Crisis(GFC) world of Zero Interest Rate Policy (ZIRP) inflation consistently undershot the Fed’s target. I am not convinced this time is different. The situation in the Red Sea is worth monitoring, but that shipping lane has less impact on goods that come into the US versus other countries and the case for strong case for continued globalization means large export driven economies like China, Vietnam, Mexico and increasingly India are able to provide disinflationary if not deflationary pressures at a time when that may not be a bad thing. Consumer sentiment surveys have for the last couple of years suggested inflation expectations had become anchored somewhat higher, but some better responses over the last couple of months are encouraging. Earnings & Margins: As we are in the midst of 4th quarter earnings it would be best to describe the current numbers as “meh.” Profits are likely to be up quarter over quarter for the second quarter in a row, but have thus far come in lower than estimates going back a few months. Some of that is a byproduct of companies being very cautious and not taking on excess inventory, worried about their end consumer and some margin pressures remain. According to FactSet’s Earnings Insight as of Friday January 26th of the 25% of companies that had reported roughly 70% of companies have beat on both earnings and revenue, below 3 and 5 year averages respectively. This week we have seen some better than expected earnings from names in the Technology, Consumer Discretionary and the Communication Services sectors which have an outsized weighting on the market so the overall numbers are likely to improve but all in all it’s hardly been a blowout quarter. Given present lofty valuations, meaningful moves higher from here will need to be supported by improving earnings growth. While the consensus estimate called for as much as 14% YOY growth for the S&P 500 as recently as last Fall, those numbers have come down now to about 10% for 2024. That figure may still be a bit ambitious with GDP forecasts for the year roughly around 2% and inflation moderating. We know companies have a number of levers to pull to improve earnings from buybacks to layoffs, the former an accounting maneuver while the latter likely having more negative intermediate impact on the economy as a whole, so be careful what we wish for here. The good news is that margin pressures are likely to abate given further improvement in the supply chain, improved productivity and slowing wage growth. We may not see peak margins like we saw in 2021 however they remain historically high which makes sense in a less capital-intensive economy. Global Economy: As we alluded to the challenge of central banks all around the globe to find that happy balance on policy, it’s safe to assume some positive developments abroad would be a positive for the US economy which has run above trend for the last couple of quarters. While there was hope for an improving China in early 2023 and the possibility of a real slowdown in Europe could be avoided, that was not the case. As China continues to wrestle with a housing crisis that has been going on for nearly 10 years, structural reforms have been delayed as Xi Jinping focuses on the common prosperity initiatives which have hurt markets at home. At this point the base case should assume very little help from China in supporting global growth and that seems to be well priced in. If there is some improvement it would be welcome, though I wouldn’t bank on it. Europe, China’s largest trading partner, sees it’s trajectory far more closely tied to developments in the Middle Kingdom, they may not move in lockstep but it’s unlikely that you’d witness a reacceleration in growth in one and not the other. Fortunately, valuations abroad are far less demanding, though markets likely exceed expectations. The likelihood of lower interest rates and possibly a weaker dollar would be a positive for US investors investing abroad as well as remove some near term headwinds on emerging economies that still very much rely on dollar funding for their credit markets. In summary, a repeat of the last couple of quarters would be great where it’s been upside surprises for both the economy and the markets here in the US. As inflation continues to head lower, that’s a positive even if growth may have peaked in the 3rd quarter of 2023. Growth above trend (2%+ in real terms) is supportive of the labor market and asset prices and if some of the encouraging data regarding manufacturing is not in fact a false start we could revert back to synchronized global growth like we saw in 2016-2017. They say we’re young and we don’t know We won’t find out until we grow Well I don’t know if all that’s true’ Cause you got me, and baby, I got you -Sonny & Cher Get In Touch Sources: WSJ, Barron’s, Factset, Bloomberg, YCharts, FRED St. Louis Fed, Bureau of Labor Statistics

Your financial plan can weather times like these, make sure your emotions don’t get the best of you.

Will the Bull Market Rally Give Up the Ghost or Will We Have a Feel Good Fall? As we wind down the summer, with kids back to school and work returning to something resembling a five day a week proposition, it has become an annual ritual to discuss the traditionally volatile months that usher in the Fall. Below are the YTD returns for major averages as of close 9/12/2023: S&P 500 Index: 17.57% Nasdaq Composite: 32.64% Dow Jones Industrial Average: 4.31% MSCI EAFE: 9.78% MSCI Emerging Markets: 4.24% BBg US Aggregate Bond Index: .63% Interesting fact: Even after a bumper 2023 for the S&P 500 thus far since the start of 2022, it’s simply 1.2% higher than the Dow over the same 20+ months. While we have seen market declines for each of the last three Septembers, October, on the other hand, has been far kinder, with gains of nearly 7% in 2021 and 8% in 2022. By now we should all know that trading the calendar is hardly a recipe for sustained success, after all that would be far too easy. After a torrid start to 2023 through the first seven months of the year, a disappointing August and slow start to September has restored the universe to a more balanced level of investor sentiment. There seemed to be a building level of ebullience and with valuations full, if not stretched, the possibility of detachment from reality seemed altogether likely if not inevitable by late July. While I hate the phrase “market correction” as it implies the market is not reflecting the proper price of assets, an oxymoron if there was such a thing, periodic selling pressure can do some good. It’s difficult to put a finger on any one cause and we perfectly understand if you are somewhat spun around by all the seemingly contradictory data these last couple months. Just be happy you are not a central banker, posh room in Jackson Hole aside … With the hope of providing some clarity we thought it would be worthwhile unpacking a number of key areas of focus for the months ahead. Perhaps it will be a good sleep aid as well. Earnings: Time and again you’ll hear the phrase that earnings drive stock prices and with discounted cash flows, still the preferred method for valuing assets better, or at least, less bad earnings should see prices increase. So, with 2’Q earnings coming in better than expected, why did stocks not respond more favorably to the numbers? According to FactSet, 79% of companies beat their earnings estimates (above 5-year average) with 64% beating on revenue (below 5-year average). Earnings are down about 4.1% year over year and witnessed a decline of 7.00% for the second quarter in what is likely to be the trough in this cycle. A weaker top line suggests some softening in demand, so that’s worth watching as there is only so much you can do with cost cutting and financial engineering. Guidance for 3’Q has improved somewhat off a low base and suggests year-over-year earnings growth of anywhere from 1-3%. As we wrap up 2023, earnings improve more sharply in the 4th quarter and into 2024 where low double digits have been penciled in. Given that markets are forward looking some of that is already reflected in prices. If earnings do in fact grow at those levels, stocks can support further gains, though they are likely to be modest given higher interest rates and full valuations with the S&P 500 trading around 18.5 on a forward basis. Inflation: There has been encouraging news when it comes to the rate of price change, thus resurfacing the transitory argument, as supply chains continue to improve should demand remain at the current level there may well be some disinflation if not deflation on the horizon. The Fed’s preferred measure of inflation, core personal-consumption expenditures (PCE) came in at 4.2% in July when measured year to year, but on a month-on-month basis, prices increased at .20%, the lowest going back to March 2021. Headline inflation is likely to jump back up for August and possibly in September based on higher gasoline prices and some weather-related factors impacting food prices. Industrial metals have been marching higher based on an uptick in demand. The trend however is for inflation to continue to decline and as Fed Chair Jerome Powell stated unequivocally in Jackson Hole, that the target remains 2% even if it takes until 2025 to get there. Housing, which is measured as owner’s equivalent rent in the PCE measures, is likely to be a drag on inflation based on higher rates sapping demand for existing home sales and actual rent growth falling sharply after some catch up in 2021 and 2022 based on concessions made during the pandemic. For the August CPI release much was made of the core level being elevated yet the market shrugged off the “hotter number” mainly because it has done little to change the narrative around disinflation, looking at this data over a rolling 3 months is a better way to see whether or not there are real trends emerging versus one month’s report which is surely impacted by noise. Federal Reserve: June’s meeting brought the “pause/skip debate” but that was put to rest after the July meeting offered a 25-basis point hike, the 11th of this cycle taking Fed funds to the highest level since 2000. While the drumbeat from the various Fed governors is that they intend to take a wait and see approach, at this point my sense is that they are done hiking rates this cycle. Having adequately tightened monetary supply by hiking rates over 5.00% while shrinking their balance sheet by nearly $1TT the Fed has cooled down housing, increased the overall cost of borrowing and indirectly drained the animal spirits from the capital markets as evidenced by the decline in asset prices over the last couple of years. Hardly time to say, “mission accomplished,” a good deal of progress has been made. For the better part of the last 2 years, risk of not doing enough clearly outweighed doing too much, but several data points suggest that further tightening here could result in something else breaking (aside from a few banks) and with little appetite for a policy response from the Fed itself and nothing coming from the fiscal side, that seems imprudent. While we still wait for the lagged effect of tighter monetary policy, one place where the impact is felt more acutely and quickly is within the currency market, something I opined about last Fall when highlighting why a strong dollar was a source of concern. As the dollar has strengthened again quite a bit recently, it was on an 8-week winning streak the longest in nearly a decade and up 5% since early July the greenback has put pressure on various currencies around the world from China to Japan as well as UK and the EuroZone. While a weaker local currency can help export driven economies, it essentially means you are importing inflation at home, something the Europeans would greatly like to avoid having dodged an energy crisis last year with the invasion of Ukraine. Germany, the manufacturing powerhouse of the EU, would have benefited from similar dynamics in the past, but the weakness in China, a key trading partner, has made stagflation a real concern for the 4th largest economy in the world. More on this in a moment Labor: Another Goldilocks nonfarm payroll report for August. The combination of job gains (187K), along with an increase in the unemployment and participation rates all while seeing hours worked increase and hourly wages increase more slowly (.2% month on month) suggest a cooling labor market. This was the equivalent of walking on water and just what the Fed has been hoping for if a soft landing/no landing is possible. With inflation being front and center the last couple of years, you’d be forgiven if you forgot that the Federal Reserve has a dual mandate to control inflation and target full employment. To temper the overly optimistic tone somewhat, we witnessed a decline in available jobs and a decline in quits in the Job Openings and Labor Turnover Survey (JOLTs) suggesting employers are getting a little more cautious as are employees. While labor is historically one of the key drivers of inflation, wage growth is only modestly higher than the projected 5-year inflation rate suggesting the vicious wage price spiral of the 70s is not likely to repeat. All eyes on the UAW strike, but keep in mind their 150,000 members represent about 1/10th of 1% of the working population in the US. Larger employers like Walmart, which employs over 1.6MM Americans have actually been cutting wages for new hires as the competition for jobs has abated in the last couple months. Retail Spending: The endless debate on when and if consumers will run out of their pandemic savings has been going on for about a year and I still see the estimates ranging from $500BB to $1TT with estimates that it will be exhausted in about a year’s time. That may well be the case, and some indicators like increased credit card borrowing suggest we may be closer than we think, but healthy labor markets are able to cushion the impact here. After a .7% increase for July, only a .2% increase is forecast for August but that’s still healthy by most standards, especially for what is typically a less active month. As has been the case for much of the last decade there is a certain consumer whose demand is less susceptible to economic conditions as solid earnings from the likes of Lululemon suggest. Sentiment levels: At one point with the market within 5% of it’s all time high, achieved on January 3, 2022, the S&P has given back about 3.5% of the profits and investor’s moods have shifted. Back in July, the relative strength index (RSI) was consistently logging figures in the mid to high 70s suggesting the market had become overbought, we have drifted back to around 50, which while not quite oversold levels seem to indicate there is less froth out there. CNN’s Fear & Greed index has returned to a neutral reading from Greed a month or so ago and while the market volatility has dropped sharply there is a bias to negative skew meaning the cost of hedging has increased somewhat as stocks have given back some gains. There are some technical factors that are flashing yellow signals whether they be leading economic indicators that have rolled over and have been at recession levels for the last 12 months, granted those measures are focused more on durable goods and stocks are very close to their 50-day moving average suggesting if support is broken the next move may be lower. China: One of the biggest questions on everyone’s mind is what is going on with the world’s second largest economy where growth and trade have disappointed all year despite emerging from Covid lockdowns. With stimulus targeted more at business versus everyday consumers they did not see the inflationary effects witnessed in the West, but their economy remains far too reliant on the commercial real estate market and manufacturing, the former having been a problem since 2015 and the latter coming more into focus with supply disruptions related to the pandemic. With China accounting for nearly 20% of global GDP yet only 12% consumption according to Michael Pettis, the argument is that it’s necessary for China to focus on consumption growth over the next 10 years at the expense of inefficient GDP growth. This would entail a rather large philosophical shift where the state would essentially look to transfer more wealth to the consumer through assets sales and social safety nets, something that they have been loathe to do at this point. It’s worth experimenting with as the current path seems likely to ignite pushback against Xi’s policies and suggest this may be his last 5-year term as leader of the Middle Kingdom. This may be too logical or optimistic, it would be a boon for US companies and perhaps even the Chinese stock market, but I am skeptical they will be willing to undergo such a drastic policy pivot and undertake the needed reforms. Both China and the US need each other as the rest of the world seems hardly up to the task. A healthy level of competition can be productive, see the Space Race or DARPA versus a more hostile policy of containment which increasing the odds of further frictions adding costs but for now China looks to be worth passing on until they embrace a model that hasn’t been working for the last 8 years or so and stop scapegoating the West.  In summary, the next couple of months may remain a bit choppy; on balance the economic backdrop at home has improved and the fact monetary policy should be more consistent should mean stocks can better discount the future. Should we see any improvement abroad that should power markets back to the levels from late July if not higher. There is reason to be optimistic out there and as my 5-year-old gets excited about Halloween, I get the sense that the 4th quarter may be more treat than trick this year, but time will tell. The bigger question is how many times the costume may change between now and then. For those who endured, thanks for reading, feel free to share this and our other timely content with anyone who would benefit from our perspective. Get In Touch SOURCES: Barron’s, FactSet, WSJ, Bloomberg, FT, Charles Schwab & Co LLC The views expressed represent the opinions of Breakwater Capital Group as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed. Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website. https://adviserinfo.sec.gov/ Past performance is not a guarantee of future results. The Dow:The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chipstocks. The market index is unmanaged. Investors cannot directly invest in the above index. NASDAQ: The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers AutomatedQuotation System. You cannot directly invest in this index. S&P 500: The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to berepresentative of the stock market in general. You cannot directly invest in this index. MSCI EAFE: The MSCI EAFE Index (Europe, Australasia, Far East) is designed to measure the equitymarket performance of developed markets outside of the U.S. and Canada. You cannot directly invest in this index. MSCI Emerging Markets: The MSCI Emerging Markets Index captures large and mid cap representation across 24 Emerging Markets (EM) countries*. With 1,421 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Bloomberg US Aggregate Bond Index: is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices.

The title of this piece was taken from the opening remarks from Fed Chair Jerome Powell as he kicked off his press conference on May 3rd, shortly after the 10th (and likely final) rate hike of this tightening cycle. About 30 minutes later during the Q&A, a member of the audience asked if he had any regrets about decisions that had been made during his 5+ years at the helm. I don’t think it would be a stretch to say he probably wishes he hadn’t uttered those words to describe the banking system no more than an hour prior. With regional banks continuing to wobble it seems like it may be a little premature to do a victory lap. Though he was not alone, as Jamie Dimon shared a similar ill-timed or seemingly out of touch perspective after winning the right to pick over the carcass of First Republic Bank earlier in the week when he said this part of the crisis is over. There are plenty of axioms in the world of finance, many of which revolve around the Fed, the most popular of course is “Don’t Fight the Fed” but the one getting a little more airtime of late is that the “Fed Reserves raises rates until something breaks.” Be that as it may, it is still hard to fathom the benefit of the current approach where after 10+ years of extremely accommodative policy such an abrupt shift in policy was bound to have significant implications. Recall, it was just last March when rates were effectively zero and the Fed was just winding down its latest Quantitative Easing program. Since monetary policy has been known for its “long and variable lags” it should not come as a surprise that we are now starting to see the impact of this aggressive policy path to contain inflation. The collapse of both Silicon Valley Bank and Signature Bank seemed to be a perfect opportunity to take a step back and allow things to settle down. Rather than pause however, the Fed raised rates 25 basis points in back to back meetings even while citing the increasing likelihood of a recession later this year when they convened in March. Powell walked that back when asked Wednesday afternoon. So what’s behind the seemingly stubborn approach? While it hasn’t been explicitly cited, perhaps because it is a political flashpoint (cue Elizabeth Warren), but most economists believe Powell & Co are using the Taylor Rule and Phillips Curve as their guides with a heavy emphasis on the Non-Accelerating Inflation Rate of Unemployment (NAIRU). Are you confused yet? It’s okay, just be glad it’s not Alan Greenspan trying to explain what’s going on. In plain English, these theories posit that there is an optimal level of unemployment and that in fact very low is not necessarily a good thing. When the labor markets get too tight, wage pressure leads to higher prices resulting in inflation expectations becoming entrenched and thus the start of a vicious (the opposite of virtuous) cycle takes hold. But what if this approach is incorrect, for the better part of the last year we have witnessed decelerating inflation (albeit perhaps not decelerating enough), yet hiring continues at an impressive clip while the unemployment rate has fallen further. There have been other periods where there is limited correlation with the employment rate and inflation, see the late 1970s and early 1980s when both registered double digit levels (1982.) It’s quite evident that much of the inflation the last few years has been the result of pandemic related supply shocks but what if the Fed’s hawkish rhetoric is fueling demand itself. I’ll give you a simple example, which anyone who has been around little kids can relate to. I have a 4 year old and at that age most young people haven’t honed their skills around discretion and frankly his diet leaves much to be desired. One night at dinner time, he was eating M&M’s by the handful, concerned he would no longer have any appetite when his food was ready, I asked why he was shoveling them down so quickly to which he replied “because you’re about to tell me I can’t have any more.” And you know what, he was right, I had intended to take them away from him, but not before he was able to gorge himself on them to the point he was no longer enjoying them. I am convinced that the Fed has been ineffectual in stamping out inflation with the current monetary approach, but in fact exacerbated the problem. You only have to look at the US or Europe for the last 10+ years to see benign inflation despite negative real and even nominal rates, in Japan it’s been a 30+ year phenomenon. Assuming that people are generally rational in the aggregate, then supply and demand should be in balance much of the time. However, when you couple an environment with disrupted supply (pandemic, War) with augmented demand as people race to get ahead of potentially higher costs, you are telegraphing to them they are destined to bid up the price of goods and now services. Demand would likely have petered out independent of monetary policy, it just required a bit more patience. To be clear, I am not a proponent of lower forever, rates were too low for too long which had the potential to encourage risk taking and moral hazard while distorting asset prices. If the Fed continues to believe that long run inflation is likely to be around 2%, taking rates to 3% would have been a good place to start, but we blew through that level by the Fall of 2022 and now they have created a mess and seem reluctant to recalibrate. Instead of complex econometric models, simply picking up a 10th grade physics textbook would have offered some valuable insight. Most of us recall Newton’s 3rd law which states “For every action, there is an equal and opposite reaction.” When you raise rates faster and higher than you have in 40 years there is going to be some real repercussions. So how do we go about fixing this mess? With a recent Gallup poll showing 50% of Americans having some concerns of the safety of their bank assets , that’s an alarming statistic and means the risk of further deposit flight remains elevated. To shore up confidence, there are likely a few steps to consider: Prevent future sweetheart deals where banks are incentivized for holding off acquiring a struggling bank only to wait to swoop in after the government offers favorable terms. JP Morgan doesn’t need any extra advantage, the same goes for the other big banks. Consider banning short selling or buying credit default swaps on banks during this time of panic, in 2008 shortly after Lehman’s bankruptcy the SEC banned the practice for about 2 weeks. Recapitalize the banks through senior preferred securities, where the taxpayer stands to benefit when the situation calms down. We provided loans to the airlines during the pandemic, they survived and are doing fine now as travel has returned to prior levels.  Whether or not Powell believed that line or it was a bit of puffery can be debated. Fortunately, the US economy is sound and resilient and in the face of this challenge will emerge hardened and stronger as it has done time and again. With another solid Nonfarm Payrolls report, a housing market that has found better footing and a positive earnings picture there is reason to be optimistic even if some days it seems like the policy makers are whistling past the graveyard. Oh and don’t get me started on the folks in Washington. Thanks for indulging me with your time. Sources: National Bureau of Economic Research Bureau of Labor Statistics Bloomberg Factset https://news.gallup.com/poll/505439/half-worry-money-safety-banks.aspx Disclosure: This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice. Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website.

Financial Literacy Month is dedicated to promoting financial education and increasing awareness about the importance of personal finance. In today’s fast-paced world, it’s essential to be able to make informed decisions about money matters.  Check out 5 tips for financial literacy that will help you take control of your finances and achieve financial freedom. 1. Create a Budget: A budget is a cornerstone of financial literacy. It’s essential to know your income, expenses, and savings to create a budget that works for you. Creating a monthly budget doesn’t have to be complicated. Here’s how to ensure you’re setting yourself up for financial success: First, calculate your gross monthly income. This could include your salary, investment income, Social Security, child support/alimony, freelance work, or other income sources. Remember to calculate your net income as well, which is how much is left after taxes and other deductions. Consider your financial priorities and allocate your budget accordingly. In addition to your regular monthly expenses, you might decide to increase your general savings or earmark money toward a large purchase such as a home or car. Decide what’s important and to make sure your budget reflects those values. Finally, create expense categories for where your money is spent and track each expense. It’s important to differentiate between wants and needs. You need to pay the rent or mortgage payment, but you want a new pair of shoes or a nice dinner out. By tracking your spending, you can determine whether your budget is aligned with your priorities or if you should adjust to meet your goals. 2. Build an Emergency Fund: Life is unpredictable, and it’s essential to have an emergency fund to fall back on in case of unexpected expenses. Set aside a portion of your income every month to build an emergency fund that can cover at least three to six months of living expenses. You may want to consider setting up automatic transfers from your checking account to your savings account to make saving easier. It’s important to keep your emergency fund in a separate savings account, so you’re not tempted to dip into it for everyday expenses. 3. Invest for the Future: Investing is a crucial component of financial literacy. Whether you are investing in stocks, bonds, or real estate, it’s essential to start early and stay consistent. With many different types of investments, working with a financial advisor can help you understand your options and create a diversified investment portfolio that aligns with your financial goals. You should also educate yourself on some of the most common investment types, including: Stocks Bonds Mutual Funds ETFs 4. Manage Debt: Debt can be a significant obstacle to achieving financial freedom. It’s essential to manage your debt effectively by paying it off or consolidating it to lower interest rates. Create a debt payoff plan and stick to it to reduce your debt burden over time. If it’s been a while since you checked your credit score, now is a great time to see where you stand. Your credit score is an important metric when considering your financial health and will play a larger role when you apply for loans, especially mortgages and car loans. If you have a higher credit score, you may qualify for lower-interest debt, which will save you money. The Federal Trade Commission provides information on how to request your free annual credit report. Reviewing your credit report is important to ensure there aren’t any mistakes or incorrect accounts assigned to you. If you notice something on your credit report that doesn’t look accurate, such as a loan or credit card you do not remember opening, contact your financial institutions immediately. You can also file a dispute with the credit reporting agencies to report any false information you find. 5. Educate Yourself: Financial literacy is an ongoing process. Keep yourself informed about the latest trends, news, and tips related to personal finance. Attend seminars, read books, and follow financial experts on social media to gain knowledge and stay up to date. In conclusion, financial literacy is an essential aspect of modern-day living. By following these five tips, you can start your journey towards financial freedom and make informed decisions about your money. Remember, it’s never too late to start, and every step counts towards your financial well-being.

As we wind down April and reflexively question whether it best to “sell in May and go away” (the answer is no) I can’t help but think Warren Buffett said it best when he quipped, “ I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner, or later, one will”. While he was referring to picking winners in the stock market, it’s safe to say the same could be said of investing in the United States of America itself, where despite the constant idiocy and self-sabotage emanating from Washington, we keep moving forward. The next few weeks we’ll likely find ourselves drowning in debate over the debt ceiling which distracts from the fact the economy continues to be remarkably resilient even though we have been hearing talks of a recession for the better part of the last 12 months. It may very well be the most widely predicted contraction in history yet the odds of a soft landing are no worse than a coin toss at this point. Surely, there are some signs of slowing in the economy, the combination of a modest uptick in weekly unemployment filings and deterioration in the Conference Board’s Leading Economic Indicators are worth monitoring. But for all the handwringing over the slowdown, the combination decelerating inflation, better-than-expected earnings for the first quarter and an uptick in the Manufacturing PMIs for April versus March’s readings, are a reason to be a bit more balanced in one’s view if not just a little optimistic. Diving a bit deeper into the earnings picture, according to FactSet’s Earnings Insight, for the week ending April 21st, 76% of the companies reporting have beat earnings estimates and 63% have beat on revenue, granted it was only 90 companies that have reported and this week will better determine whether Q’1 exceeds to the upside as we hear from a number of the tech behemoths (aside from Apple who reports next week). After another impressive quarter from Microsoft (MSFT) and a $70BB buyback from Google parent Alphabet (GOOG) suggest that demand for their services remain robust which is encouraging. There has been a great deal of fuss about margin compression, but margins are likely to remain around 11.2-11.4%, right in line with their 5 year averages suggesting they have been able to offset inflationary headwinds better than mom and pop. This has been especially evident as we have heard from the likes of Procter & Gamble (PG), PepsiCo (PEP) and McDonald’s (MCD) where they have been able to increase their prices while volumes remain flat. Eventually consumers may push back against price hikes, something we are seeing more in Europe. To be clear earnings may be flat to modestly down for the quarter when comparing year to year results, but the early estimates of an 8% decline seems far too pessimistic. Next week the Fed may very well wind down the most aggressive tightening cycle since the early 1980s, as the with the market is pricing in nearly a 90% chance for them to hike by 25 basis points. This leaves the Fed Fund’s rate in a range of between 5.00-5.25% a level last seen before the Financial Crisis in 2006-2007. The cost of capital has increased markedly in just a year’s time, there will be some companies that will struggle to service their debt or rollover existing issues coming due in the months and years ahead, but higher borrowing costs should lead to more fiscal discipline and perhaps better productivity and ROI. The bond market is signaling it won’t be too long before the Fed is forced to ease, perhaps as soon as their September meeting, but in order for such a quick pivot to occur that would mean we would need to see some real deterioration in the economy as a whole and employment outlook more acutely, which doesn’t seem too obvious at present. In the long run, should the Fed stick to their 2% inflation target, with rates north of 5% policy remains a drag on the economy. If we do see inflation continue to decelerate taking CPI down into the 4s and PCE into the 3s it stands to reason they could take their foot off the brakes starting in early 2024 but unlikely before then. Pardon me if I seem like I am being overly optimistic, we can all use the occasional pep-talk and the bright spot about idiots running great companies, they eventually get fired.  Join us next month as we return our focus to wellness. May will be all about behavioral finance and ways you can improve your process around decision making and filtering. Here’s to May bringing us Spring Flowers…