RHP Market Talk
Complicated economic topics distilled into digestible and palatable investing principles.
Hosted by Natalie Picha, Partner and CXO of RHP Wealth Management.
RHP Market Talk
Markets at the Crossroads: Navigating September Slumps and Government Shutdowns
In the 50th Episode of RHP Market Talk, CXO Natalie Picha and CIO Glenn Royal, CFP®, examine September's historical market weakness and how a potential government shutdown might impact investors during this traditionally difficult month.
• How a record 911,000 job revision could signal an existing economic slowdown
• What will be the Fed's response as it faces a dual mandate challenge with sticky inflation despite employment concerns
• How concerned should we be about Fed independence?
• Our counsel to clients during times of uncertainty
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https://podcasts.apple.com/us/podcast/rhp-market-talk/id1538051530
Welcome to RHP Market Talk produced by Royal Harbor Partners Wealth Management, an independent financial services and investment advisory firm based in Houston, texas. I'm Natalie Picha, one of the founding partners and CXO, and I am joined today by my founding partner in CIO, Glenn Royal. Glenn, great to have you back.
Glenn Royal:Glad to be here. As always, Natalie. , ood to see you.
Natalie Picha:Nice to see you as well, and always look forward to these conversations. For our listeners, This is a pretty monumental moment for us. This is our 50th podcast recording and so, if you know a little bit about our team and who we are, this podcast is really born out of the pandemic, when we needed to communicate with our clients quickly. Things were shifting so so much, and it's been a lot of fun doing this with Glenn most of the time, but we've also done it with other team members. We've had special guests, and it's just been a really great way to communicate with our clients and their friends and family as well. So to our listeners, we just say thank you, please continue to share the podcast, and we jump in and we try to talk about things that will really be relevant to people Glenn, historically, and so, September is the worst month of the year for stocks. Should we be worried?
Glenn Royal:I'm always worried. Let me worry for you. You know September it's the end of the fiscal year, it's a time for going back to school. Other things are on your mind. If you're individual investors, you know things just tend to kind of wind down as we get to that October start of the new fiscal year and so, historically, september tends to be it's the worst month of the year historically and it's the last two weeks of September that are the worst performing part of the year.
Glenn Royal:The joy that we get this time around is potential for a government shutdown at the end of this month. Right, that fiscal debate goes on in Washington, largely over the rescission package going $5 billion from foreign funding that was bipartisan jointly approved in the past. So you probably I put the probability pretty high you'll see a government shutdown just on political lines. So that'll be something we address and I can tell you historically that hasn't been the end reason for markets to end or whatever. It's more government fighting. But as time goes and the longer the shutdown lasts, the more disruption you have Right. The last, the more disruption you have Right. So I think in the short run the markets are going to watch it with curiosity and just see how shortly it ends. But that is another reason. If you want to, if you think the market is a little rich and it's overextended and it hasn't had any pullback to speak of since April 2nd lows. You know September is a little heavy in here.
Natalie Picha:A little heavy. And then, of course, we just got the US payroll data marked down 911,000. So that's a record markdown. So that would be indicating a slowdown in the markets or a slowdown in the economy, but it also puts pressure on the Fed to lower the interest rates. So a slowdown in the economy but lower interest rates, what is that going to do for us?
Glenn Royal:Well, it definitely cues the Fed up. Next week's meeting the Federal Open Market Committee, you'll see a quarter of a point. There's starting to be some market chatter based on that number. Today, the revision of jobs Something in the neighborhood maybe as high as a half a point cut. So don't be surprised if you see that. It doesn't mean that we're going to be on this half a point cut cycle every meeting. But to start things out, recognizing that when you look at those labor revision numbers it's really indicative that perhaps we've been in a recession, an underlying recession in the economy with jobs, and we just haven't seen it in the numbers yet. So I think the Fed's going to definitely move to cut rates for their dual mandate of protecting employment.
Glenn Royal:By the way, that number it's a little wonky and we're starting to get numbers that come out that we're all focusing on the markets, catching the business news, but it has to do with the birth-death model which is related to business formations and Chapter 11 bankruptcies. So when you get these employment data, it comes out in surveys and it's no secret that people don't participate as much in surveys. You're not getting the quality of data. Covid era started getting us even to kind of falsify some of the responses, so they have to wait until, in this case, it's the tax data, the tax rules, that shows exactly what happened, versus surveys. So they end up kind of swearing the accounting after the fact. Now, this, to your point, was the biggest revision we've seen and it basically implies, I mean it to your point, was the biggest revision we've seen and it basically implies, I mean, it's three times greater than the average revision. That's how big a revision.
Natalie Picha:That's a lot, that's a big revision.
Glenn Royal:It does imply again, as we just mentioned, a slowing of the labor economy and that'll get the Fed's attention. So we start to have the Fed now focus on their labor mandate, but tomorrow we get inflation numbers and that's the other side of their mandate and that's still running a little uncomfortably sticky mainly, particularly in the service area. The Fed. It's a tricky spot. I can understand. You know, the reasons for lowering rates are here with us, but the reasons for being cautious are also with us and that's the inflation story.
Natalie Picha:Right, right. I think we talked a little bit about the danger of moving from an inflationary economy over to stagflation. You talked just a little bit about where we might be if we found ourselves in stagflation.
Glenn Royal:Yeah, that would suck, Natalie. I mean, just be technical about that. There's no good thing about stagflation. It's probably the worst place we could possibly be because it's very difficult for monetary policy to get out of that. But you know what could get us out of something if we were to go? There's AI, that type of technology, enhancements, so something that could reinvigorate the economy. It'll take that. But you know, stagflation nothing like we see in the 70s, which was impacted also by oil embargo, heavy union presence back then, a lot of different things. So if it's stagflation, I call it stagflation light. That makes sense, not anything that we expect heavily.
Glenn Royal:But you know, I do want to take a moment to talk about something, since we're talking about the Fed. That's the Fed independence. You know it's all in the press right now, but we have a track record that shows most recently Argentina and Turkey that if an independent Fed, particularly the US Central Bank, which is the most significant central bank in the world, whenever you start to interfere politically in rate-setting structures, there's a history that shows higher interest rates as a result of that and weaker currencies and that's being reflected as we see. Further talk about the Fed. You see gold spiking up and long bond yields going higher at the expense of shorter. So the market is kind of signaling it. It's nothing yet to be too terribly concerned about, but the signals are there and there's some inside tracks on how this could go down that the market's watching about. Putting up tracks on how this could go down, that the market's watching about putting. And look, I do want to be clear that the Fed is a political body, which it is by nature. It always has been, but it tends to try to do its best to.
Natalie Picha:Be as independent as possible.
Glenn Royal:Yeah, right, so we'll see how that goes down, but that's something that the markets are watching closely. You saw an article piece Ken Griffin hedge fund billionaire. Brilliant guy. People are talking about it, so we'll see. Stay tuned. That's the story to watch.
Natalie Picha:Yeah. Is the Fed really independent? Is it being manipulated more than it would be?
Glenn Royal:Not yet.
Glenn Royal:I mean, you can talk all about it, but if you start putting presidential allies and start loading that part of the board, you know where you would see me freaking out and throwing my clothes off around the house and my pants off.
Glenn Royal:My stuff is if in February there's 12 Federal Reserve Bank presidents right and five of those rotate to be members on the FOMC, and then there's the seven permanent members of the governors of the FOMC, so in February these 12 regional bank presidents are up for reappointment. It's their renewal and review process. If you see some shift where you get a majority of the governors up to four you've got two, three right now, possibly a fourth by that meeting and they move to fire Federal Reserve Bank presidents to put more dovish members on board, then the market would see that for what it is, and that is control or manipulation. So February is going to be an interesting time as a Fed watcher to see what goes with those bank presidents. But it's hard to even fathom that. So I doubt that's going to happen. But that's what we're watching for risk.
Natalie Picha:So stay tuned to our February podcast release, where we'll be talking about whether or not this actually comes to pass. Right, you briefly mentioned gold earlier. What is gold telling us?
Glenn Royal:It's been an interesting watch recently yeah, you know it's one it is. We can kind of step back to, going to the Russian invasion, Ukraine, the US response on restricting Russia's monetary assets and even our trade wars and different things that we have going on. So you're starting to see foreign central banks purchase more gold as a reserve in their central banks. So you've got that central bank buying coupled with concerns of inflation. Gold is a hedge to inflation. But the other thing that's also benefiting gold is the expectation of lower interest rates by the Federal Reserve. Because gold doesn't pay interest rates. It has competition from interest-bearing instruments. So when they start to reduce what the interest they pay, it favors gold. So the setup's pretty decent for gold right now.
Glenn Royal:If I get any type of risk off for whatever reason, you know there's geopolitical risk all over the world. Gold will be a benefactor of that just hitting the bed safety. So we also tried, you know, if you recall, here we tried throwing Bitcoin in as a pair trade as digital gold. Bitcoin's volatility is really not as much as it had been in the past because that institutional effect we've spoken about. So it's hanging in here. But gold is showing to be a better risk off trade than Bitcoin, at least in the early phases.
Natalie Picha:Very interesting. You also touched on something earlier, and that was AI. We know what everybody's watching right now our earnings to see. You know, are people, are the businesses? Are the companies still truly making money? What's happening? Are the margins shrinking as we have to deal with tariffs and all the other things slow down the economy? How can AI maybe protect those margins? Is that something that we expect?
Glenn Royal:You may be seeing it now and the difficulty of recent college graduates trying to find jobs. You know that's in the press everywhere right now and it's those entry-level coders, you know computer scientists, legal departments, the paralegals, things like that, even in warehouses and different things where they're using robotics to offset that entry-level labor. So that we're starting to see. But what you've seen. I was showing internally a chart from Goldman Sachs that showed profit margins. Back in 1990 for the S&P 500 company it averaged 5%. By 2024, that profit margin had grown to 12%. So margins and earnings that are what's supporting the stock market. There's healthy margins and then that expectations of future earnings growth. That's why we're doing what we're doing.
Glenn Royal:But the part that expanded this margin from 5 to 12, a big chunk of it was globalization, Cheaper labor, cheaper supply chain costs, so cost of goods sold was over 5% of that margin expansion. We also had, if you recall, interest rates were a lot cheaper than they are today during that period. So you had interest rate lower rates that had its margin that aren't with us today. Lower rates that add its margin that aren't what they said today. And then the tax rate. You had tax cuts that are permanent, so there's no future tax cut benefit. So that's kind of why now. So your headwinds of cost of goods sold, the interest expense and taxes are abating. I don't have that there now. So we're really kind of looking to AI to replace almost all of that gain in that margin expansion, and it's pretty difficult to see that happening.
Natalie Picha:So we've got to watch that, at least in the near term, right? I mean, I think AI is here, we're not getting away from it. But yeah, how much does would affect that real margin?
Glenn Royal:I've heard AI described as email at every bit as powerful as email arriving on a computer on your desk.
Natalie Picha:That's scary. My inbox is too full. I don't want more email.
Glenn Royal:Well, and so then you start to get to the use cases, and so, even in that AI story, the big expenditures from the hyperscalers, amazon's, met up, all these guys that are blowing all this money. We probably have another quarter or two before those big cap expenditures start to slow down a bit. So where we are in AI story is who's next? You know, when the Internet was built, it was Cisco building out the backbone of the Internet. Right, right, you know, nvidia is building out the backbone of AI. Who's next, you know? And then we'll be winners and losers.
Glenn Royal:So that's the big trade in AI is what software companies? Who's able to use AI? Who's able to use AI? And, frankly, there's risk for existing companies, like big software companies, that if an AI startup competitor can use AI tools to code it quicker, doesn't need a labor force, et cetera, and they can come out with the product. You know, that's the risk for these legacy software guys. So there's interesting things going on in that space and it's got our attention. Yeah, I think that's where your opportunities are going to be in that generation three and four the AI build out.
Natalie Picha:Well, let's jump to a really, you know, favorite topic of everyone's the deficits and how. The one big beautiful bill.
Glenn Royal:They changed the name.
Natalie Picha:Beautiful, yeah, what was the name change? One big, beautiful act.
Glenn Royal:And now there's something about Household Freedom Act or something I don't know.
Natalie Picha:Well, I mean I'm still stuck on OBBBA. I haven't gotten used to the new name yet, it's going to be hard to change. It's going to be a hard one to change. I'm afraid it was a $3.8 trillion deficit increase. Yes, and so the tariff story feeds right into this, because the tariffs were going to be that offset. Now we're kind of in no man's land with the tariffs right. How do you see that all panning out?
Glenn Royal:Well, last fall was probably a good example. We had a case where the Fed lowered interest rates by one percentage point, yet we saw in the market yields on the 10-year go higher by one percentage point. Why? Because of deficit concerns. So that's something you're seeing pressure on the long end of the bond market, the longer maturities, 20, 30 years because of this deficit concern.
Glenn Royal:And I think that if the tariff is, and I think that if the tariff is declared illegal by the Supreme Court, first off, I understand how important this is to President Trump and so I think he'll use every tool possible to reclaim those and other areas of legal tools, if not going quickly back to Congress to get their approval. So I don't think the market is thinking at this moment the tariffs won't come through in some form or another. Still sees that based on the pricing. But I would think that, just the nature of it, if I start focusing, if we don't have these revenues to offset the expense of the bill, it's going to expand our deficit and it's going to put pressure on that long end of the yield curve again, those rates. So that's, that's something to watch.
Glenn Royal:And then the bond vigilantes start coming back. You know, and uh, and that the irony not irony the fact of it is that if I get pressure because of the tariff reform on long rates, that's actually going to impact mortgage rates and all the things credit card rates, all these things that we know that we're trying to get down lower to, particularly for young folks, affordability of housing that could have a horrible effect. If that goes through and it starts putting pressure on rates, the Fed could be pushing on a stream with Fed funds rates. So then you get back to 2008 where the Fed has to do creative things like quantitative easing twists where they end up buying long dated bonds and increase the balance sheet of the Fed, which we've been trying to get away from. So we're kind of stuck in this cycle of monetary policy support things like that. So that's what keeps me awake at night, if you want to know. Yeah.
Natalie Picha:Well, and we've had these markets at all-time highs and you mentioned that lower interest rates could still lift equities, even though we keep bumping up against, you know, all-time high again and we're rich.
Glenn Royal:I was trying to look at showing off something the other day. As far as the forward multiple S&P, you know we're 22 times. That's historically richer of level. Just the market cap of the top of the seven largest S&P 500 companies is at record levels. 34% of the S&P 500 is from seven companies. That's the highest. Even back during the dot com, which was the last high period, it was 21,. 22 percent, we're at 34. So those companies are seven.
Glenn Royal:Companies that are really underneath it are Instagram and WhatsApp and LinkedIn, all these various great companies that were quickly bought by these mega companies. So it's a portfolio of tech that's pretty broad. They do make money, unlike that dot-com era, and should continue to make money. But that's all that. More focus on hyperscalers and their expense and what the capex they're paying and, as we expect that to drop over the next few years, what does that do to that space? So it's become critically important just because it dominates the market. The other thing earnings per share growth we've seen this year. You know we were looking for very small growth, maybe growth Q2, and we blew that out. Well, what's going to happen now, as we get into the third and fourth quarter, into next year, is analyst, expectations for earnings are much higher. They weren't low bar because of Liberation Day.
Glenn Royal:So I've got a higher hurdle, which happens in October. We'll start reporting third quarter earnings season. So that's coming up another six or seven weeks and we'll be watching that closely. Are you able to beat as much as you beat? Or if it's just a match or even doesn't even meet expectations, that would weigh on market. So earnings are what's driving it. Earnings growth expectations. You're still looking 10% and 12% the next two years out of S&P 500. So with this high multiple, high rich markets, if I have a Fed that's slowing rates and I still have that earnings growth, it'll reduce the P, we'll grow into it, we'll be fine. I'm not too terribly worried about a rich market with those backstops. So we've got to watch the earnings story in the third quarter. You'll probably know more about tariff-related impacts if there are at that time, and particularly in the fourth quarter. So yeah, it's going to be an earnings watch story. Everybody's going to be super glued to that.
Natalie Picha:Something that we've talked about internally is this particular market and this setup is really being in the balanced portfolio. Having both bonds and the equities in your portfolio right now is probably a really good place to go because of where we are in transition and there's just so much uncertainty. Can you talk a little bit about you know your expectations if the equity market goes in this direction but the bond market goes in this direction, like how that balanced portfolio should react in that kind of period.
Glenn Royal:Kind of the yin-yang.
Natalie Picha:Yeah exactly.
Glenn Royal:Well, you know, up until just the Fed's hiking cycle, there was only one side of that and it was equities. The last 15 months didn't do anything, and if you're coming new into investing in the post-2008 world, that's what you know. But we're really back to normal. We're normalized interest rate policy, so that gives me income interest rate payments, high coupon interest rate payments that I had not received in 15 years, and so the bond market is a cushioning effect. Our portfolio is set up where our duration, the sensitivity measured interest rates, is about four and a half. The bond market benchmark duration is about six. So we're shorter duration on the bond market, but our interest payments are about five and a half. And so what that tells me, if we were wrong on interest rates and they were to actually go up for some reason by 1%, our bond portfolio would still clip a positive return of about 1.5% for that year. So bonds give me interest rate protection if they were to go up, given the high coupon we have. And then the other side of that is, if the Fed's going to start cutting rates, then that's going to benefit bonds as much as equities.
Glenn Royal:So one thing I'm going to veer off a little bit here is I mean, this is just personal. I've been doing this 42 years, six major bear markets. I started to sense optimism and pessimism, fear and greed, however you want to call it. But I started to see a lot more optimism and hearing from our client base about it, mainly that S&P and really what in these experiences, when things just continue to be a little bit over their skis and still look to be good, that's when you need to worry about a black swan. You know, this morning I see where Israel attacks in Qatar, in the sovereign nation, or just expanded it in the Middle East. Is that the type of black swan? Possibly if it affected energy prices, right? So I just sense a little bit of a risk. So bonds, being a bond guy, give me comfort at night, I can sleep, I can do well.
Glenn Royal:Now, on the other hand, if I have a super high risk tolerance from a younger person, then perhaps that's not appropriate. And that's where wealth planning comes in finding that target of where you should be. But I think if you're a little seasoned in life and you're having a good 401k and your things, now's a good time to probably say you know, it's okay to step back and protect the wealth that I have. So that's really what we're about is. We're all about it's creation and preservation of wealth, those sand and sea charts that we show in every client review meeting. That shows your decline and your principle that you've taken out of the years, but your principle value. That's what I focus on. I don't care about beating the S&P 500. I just care about performing well in a diversified portfolio that when that black swan happens, it doesn't shock us as much as a peer S&P would, particularly with 35% and 7%.
Natalie Picha:Well, I think we've said it so many times in these podcasts is that you just said fear and greed. For us, it's risk management. We aren't trying to shoot the moon. That's not our goal here, because ultimately, as you said, the financial planning will tell us where someone's time horizon risk tolerance, and we talk about living an empowered life. What we mean by that is that you know the kind of life you want to live and we can back into that and help you understand. How much risk do you really need to take? Because if you don't need to take that kind of risk, then why should you? Because we don't want, as you said, the black swan to come along and suddenly find you. You know the life you thought you were going to be living is not the life you can live now because we were three years, three years to recover it takes time.
Glenn Royal:You know who's got three years. You know, in certain cases particularly, already yeah, all right, yeah, so, um, anyways, that's that's kind of I really want people to understand. My objective as a portfolio manager is to preserve and grow wealth. That's my mantra. It's everything I live for. Yeah, and so that's wealth. Exactly, as always, diversification to protect that wealth love these conversations.
Natalie Picha:I feel like you know we don't always know exactly who, which audience, we're reaching, and every month that we put the newest RHP market talk out, we get different clients that will say, oh, you said this and that that's really what I need to hear. So our conversations can be a little bit all over the place, but it seems somebody needs to hear it. So thank you again for just being brutally honest about what's going on in the markets.
Glenn Royal:You guys are really good with our clients and the wealth management team and I appreciate everything y'all do. It's a very good fit. How we all work together on behalf of our clients Works well.
Natalie Picha:Thank you. We have a lot going on. It is a great team. We are so appreciative of, certainly, our listeners, but the clients that really put all their confidence in us. So to our listeners, if you enjoy our podcast, please take a moment to subscribe. We would love it if you would leave us a rating and a review, as it's the best way for us to reach other listeners. So certainly we'd like to see our podcast gain some followers. We'd also love it if you could share the podcast with your friends and family. We're always looking to help more individuals. It's really what keeps us going every day, and you can find us on LinkedIn and Facebook for additional content.
Disclaimer:If you have any questions or want to discuss today's subjects, please reach out to us through our website at www. royalharborpartnerscom. Whether you're beginning your financial journey now or you've already taken steps towards your ultimate life goals, we're here to guide you. Experience the difference of working with a firm that empowers your life, a firm that focuses on what matters most you. Royal Harbor Partners is a registered investment advisor, and the opinions expressed by Royal Harbor Partners on this show are their own. Registration of an investment advisor does not imply a certain level of skill or training. All statements and opinions expressed are based upon information considered reliable, although it should not be relied upon as such. Any statements or opinions are subject to change without notice. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Thank you presented may be suitable for their specific situation. Past performance is not indicative of future performance.
