(New York)

The market seems to be in a tussle with itself. On the one hand, some investors are feeling bullish on the economic outlook, while many others feel the recovery is losing momentum. The data isn’t helping because it seems to validate both sides. For instance, jobs recovery numbers have been strong (disappointing somewhat today though) and the overall dip in output is not as bad as many expected. Metals prices, like silver and copper, have been rising, a leading indicator of growing economic activity. However, consumers seem to be hurting with real income dropping tangibly because of the end of government stimulus checks.

FINSUM: It increasingly seems like a k-shaped recovery is taking hold on the sector level. Certain areas of business are doing very well, while others like airlines, retail and more are doing poorly. This appears to mirror what is happening in consumer spending, where the upper middle and wealthy are surviving fine, but the middle and lower classes are getting hurt badly.

(New York)

Goldman Sachs is stressed about the election. In particular, they are concerned about what a contested outcome could mean for stock prices. Because of that, they think the debates which started this week have the potential to be an “important catalyst for investors to assess risks”. The debates have the possibility of swinging the election strongly one way or the other, which means they can be tipping points for investors. “One way to lower the odds of a contested outcome (that brings noise and volatility) is via a large margin of victory that cannot be undermined”. That said, according to the bank’s strategists, even a big win could have risks: “Although undoubtedly under the clean-sweep scenario there is the negative implications for risk assets to be considered, stemming from a Democratic legislative agenda including higher corporate taxes and increased capital-gains taxes”.

FINSUM: Goldman is making it abundantly clear that they think most paths for the market lead lower—likely until the end of the year. With Trump now having COVID, that makes uncertainty even higher.

(Washington)

There has been a lot of speculation that with Biden leading in the polls, Reg BI may be likely to get scrapped next year. Now obviously no one has great insight into how the election will go, but according to former regulators, even if Biden gets elected, it seems unlikely the rule would get scrapped. According to a former regulator at FINRA, the SEC has both cultural and structural barriers to overturning the rule. The SEC is run by a group of five commissioners, no more than three of whom are allowed to be from one party at any given time. Furthermore, while the White House does appoint a head of the commission, the group likes to set its own fresh agenda, and therefore largely sets its own objectives. According to Thomas Selman, a former vice president for regulatory policy at the Financial Industry Regulatory Authority, to “reverse it right away, it's just not something they have an appetite for”.

FINSUM: No one is certain how this will play out. However, in our view the most likely path is not getting rid of the rule, but rather much stricter enforcement of it. The rule itself leaves much to enforcement discretion, so that seems an easier avenue than scrapping and re-creating a new rule.

(New York)

Any advisor can tell you that while Modern Portfolio Theory (MPT) has a lot of strengths, it also has many shortcomings as it relates to investor psychology. For instance, Modern Portfolio Theory asserts that multiple aims can be achieved within the same portfolio, but this does not mesh well with how investors think about money—where each account has its own life purpose. Secondly, risk is an area of major disconnect. Portfolio Theory looks at risk in terms of historical standard deviations of volatility, whereas humans think of risk in more life-relevant terms: what I my portfolio does earn enough to pay for my child’s tuition? This is where goals-based investing comes in, as it focuses on how portfolios can be constructed—and reported on—in such a way as to match investor psychology about the life goals they are trying to achieve.

FINSUM: MPT has been revolutionary for quantifying risk and return profiles, but for many it simply does not resonate on the “human” level needed for some advisors to motivate and connect with their clients.

(Washington)

Reg BI was technically implemented three months ago, but it is still a little bit of an unknown quantity. More than just the shortness of its tenure, the fact that the SEC has explicitly said it is going to be light on enforcement during COVID means the pace of adaptation and understanding has been slower. Well one interesting aspect is emerging—the rule seems to give brokers a huge legal advantage when they get sued. According to a panel of top industry lawyers, the “informed consent” part of the rule means that Reg BI essentially creates a buyer-beware trap for clients. This will make it very hard to prevail over an advisor in a dispute. According to a law professor at Georgetown “If you take the recommendation, that becomes consent … The commission uses words that will live a long time on the defense side. When there has been full and fair disclosure, informed consent is present where the customer affirms by accepting the recommended action”. The language of the rule is claimed to be so obtuse that most clients will never read or understand it.

FINSUM: This was hinted at by those that opposed the real, but the scale of the advantage for brokers is only now being realized. That said, the effectiveness of Reg BI will largely come down to enforcement, which will likely shift over time.

(New York)

Goals-based investing is an important approach for advisors to consider for their clients. More than just the idea of aligning a portfolio and its reporting with a client’s life goals, goals-based investing has the power to potentially transform the way a client thinks about their money and their portfolio. When it comes to saving and investing, clients constantly struggle with the trade-off of short-term sacrifices for long-term benefits—should I buy this flashy new car or have a better retirement? By focusing their finances and investing on the specific goals they have in mind (e.g. buying a vacation home) it becomes much easier to make that short-term sacrifice.

FINSUM: Goals-based investing makes a lot of sense with basic human psychology. Knowing I am saving for a vacation home makes it a lot easier to forego the new car purchase.

(Washington)

2020 has seen both the implementation of the SEC’s new Reg BI rule as well as the introduction of a new DOL Fiduciary Rule proposal. While both have faced opposition on all sides, it was uniformly less intense than the scorn the first fiduciary rule received. That said, Morningstar is reporting that plans are underway to scrap the new Reg BI rule, which only became official in June. More specifically, Biden is planning to scrap both rules if he takes office. That is obviously still a very big if, but the process is quite clear. Biden would appoint a new head of the SEC, who would then scrap the rule. Or, the Dodd-Frank act could be amended to make clear a full fiduciary rule needs to be in place.

FINSUM: There has been plenty of talk about Biden potentially scrapping the new DOL rule. However, very little has been said about him getting rid of Reg BI, likely because it would have been implemented many months before inauguration. Therefore, this is a significant change that many advisors and firms are not aware of.

(New York)

Now that many signs are pointing to an improving US economy, some investors think it is time to shift out of growth stocks and into more cyclical sectors. That said, cyclicals—which rely on consumer spending improvements—are going to be a hard place to invest because of the highly variable recovery path for different sectors created by COVID. With that in mind here are a few places to look: transportation (excluding airlines), such as the iShares Transportation ETF (IYT); or infrastructure, like the Global X Infrastructure Development ETF (PAVE); ecommerce and home entertainment, such as the Amplify Online Retail ETF (IBUY); or housing, either through single names like Home Depot and Lowe’s, or a broader homebuilders ETF like the SPDR S&P Homebuilders ETF (XHB).

FINSUM: We find homebuilding to be a very interesting opportunity. One of the reasons that the real estate market has held up is that homebuyers are typically those higher on the socio-economic ladder, whose incomes are much less likely to have taken a hit from the pandemic. Therefore, the growth trajectory for that whole sector looks strong.

(New York)

The better the economy gets, the more banks seem like a good buy. Banks have been rather severely beaten up over the last several months, largely missing on the price recovery of so many other stocks. This is primarily because of two factors—ultra-low interest rates, and the potential for losses on their loan portfolios. However, it is increasingly appearing like loan losses may not be nearly so severe as forecast, and that billions of Dollars set aside to account for such losses may now be released onto earnings over the next couple of quarters.

FINSUM: Two considerations here. Firstly, the idea of loan losses flowing back to the bottom line and causing upside surprises at earnings time sounds great, especially within the longer-term perspective that banks are a good macro bet on the recovery. The downside risk here relates to an article yesterday in BuzzFeed that accused banks (using obtained data on potential fraudulent activity in client accounts) of not following regulations related to money laundering. That could obviously turn into a big mess, but as yet it is unclear if that is a material risk.

(Washington)

After the shock of the last rule and the relatively benign impact of the SEC’s Reg BI, most advisors are taking the new Fiduciary Rule from the DOL in stride. There has not been nearly the outpouring of upsettedness as the first time around. However, within the mostly mundane-seeming rule, there is some little-noticed language that could cause difficult issues, say compliance professionals. Specifically, in the preamble to the rule proposal, the DOL said it had changed how it interprets the old 1975 five-part test for fiduciary status. According to David Kaleda, principal, Groom Law Group, “So, this is another attempt by the DOL to state that, ‘Whatever you think advice may be, it may be more than that’ … Advisers and broker-dealers need to think about whether their day-to-day interactions are within the five-part test”.

FINSUM: This is another hidden surprise in this rule that could become much more complicated. It almost seems the DOL snuck some vague language into the current version of the rule in order to give themselves broader latitude for enforcement later on. This makes sense too, as it was the same approach the SEC used with Reg BI. Vague language makes it harder to find loopholes.