Economy
The closely watched 10-2 Year Treasury Yield curve has inverted which has historically been the gauge of a recession possibility in the post-war era. This comes after the Fed put forth the highest rate hike in several decades (75bps) in response to the runaway inflation that is affecting many Americans. While the inversion was brief it is the best gauge of a recession and many economists are jumping out in front and calling for a recession. However, the hike was enough to calm bond markets' expectations of future inflation as 5-year break-even rates in TIPS spreads signaled 2.63% inflation which is as close to Q3 last year as we have seen since.
Finsum: There is a slight possibility that this won’t signal a recession because there has been so much inflation risk in 10-year yields, as that comes down investors could still expect above-average expectations at the 2-year horizon.
There hadn’t been a shortage of interest in ESG until the economy's most recent swell in volatility which has given investment firms like Goldman pause in their considerations. They have drastically moved up the rejection rate for bonds that satisfy their ESG interest which is now hovering around 30%. Their rejection rate had trended upward as a result of tightening standards, but they are facing additional pressure from buyers who are concerned about greenwashing along with the macro risk present in the economy. They are more incredulous with seemingly glowing reports as people are concerned that companies might not be as green as they appear.
Finsum: Companies not tightening suit on ESG might face some discomfort when regulation inevitably tightens.
Direct indexing is driving many headlines but investors want to know the brass tax: if they are really worth it compared to ETFs. ETFs' advantages over direct indexing are their ease of use and flexibility because they trade like stocks. They tend to have lower fees than a strategy like direct indexing as well, but hiccups happen and an ETF could make a mistake when tracking the underlying asset. Direct indexing investors own the stocks that make up the index, this gives huge advantages when it comes to tax loss harvesting. Moreover, it gives a different level of flexibility by customizing risk exposure. There are two big drawbacks, the first being this is essentially an active management strategy that requires careful attention and rebalancing. Finally, fractional shares can vastly limit your brokerage options.
Finsum: The biggest component appears to be tax-loss harvesting, if you can get enough alpha here direct indexing could prove viable.
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Advisors have been rapidly increasing their use of model portfolios to better address clients' needs. More astounding is that despite market volatility their inflows are up over $350 billion in the last nine months. Morningstar launched a list of their best model portfolios and taking the top of the list was BlackRock's long-horizon ETF with a Gold rating. Shortly after was BlackRock Target Allocation ETF, and then a slue of Vanguard models. Core, CRSP, Russel, S&P, and Tax-Efficient Vanguard portfolios also got the highly touted gold rating from Morningstar. They also praised BlackRock's team and their highly respected research processes. These are all great options for those who want to add models.
Finsum: Target date funds are some of the most intuitive models for clients and the easiest to implement.
With inflation running hot and the Fed well into a tightening cycle yields are beginning to look attractive to income investors, which means the underlying value of bond funds could start to turn around. The second half of 2022 could be ripe for a comeback for an asset class that has had a dismal year and here are some bond funds to look out for. AGG is a prime example of broad exposure to the market with a very safe asset allocation with extensive holdings of treasuries and high-grade corporate debt. Vanguards Total Bond ETF is another example similar to AGG but has more international exposure, but almost exclusively in on investment grade debt. TIP is another ETF with especially great inflation protection measures given the exclusive focus on treasury inflation-protected securities.
Finsum: Leaning into debt has the added benefit of a volatility cushion in these trying times.
Cryptocurrencies are no stranger to volatility but the latest fluctuations could prove terminal at least for the companies. Goldman Sachs downgraded Coinbase Global to a sell this weak as the stock tumbled by almost 10%. The new price target according to GS is $45 which is a far cry from the +$300 it traded at after it IPO’d. While bitcoin, Ethereum, and the rest of the asset class may survive the slowdown companies supported, or rather supported by, crypto might not make it. Bitcoin has lost 55% of its value which is putting lots of pressure on the revenue streams of the company forcing layoffs and other drastic measures. Just recently Coinbase cut nearly a fifth of its workforce in order to weather the brunt of the storm.
Finsum: This might not prove fatal for bitcoin but could for the companies relying on the asset, even international troubles and inflation aren’t lifting up the asset class yet.