Geopolitical conflicts could create further headwinds for the markets. While the economy has seemed to weather these headwinds so far, potential "shocks" to the market could still occur, according to Brian Jacobsen, Chief Economist at Annex Wealth Management. He joined Yahoo Finance to discuss these ongoing conflicts and how investors can best position their portfolio in case of these shocks.
Jacobsen advises to take a look at energy given the kind of impact these events can have on the oil market: "When we look at the energy sector, we do think that actually that area is slightly undervalued relative to the cash flow that those companies can generate. So if you haven't gotten exposure to energy, you might want to take a look there. " He continues, "That's one of the positions that we have taken with our client portfolios, is to overweight energy, because that is one of the bigger risks out there to the broader market."
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Video Transcript
- All right, as rate cuts come into view in 2024, the investor vibe has been one of optimism lately, the Fed's dovish pivot pushing major indices higher into year end. Market is calling for six cuts, and the Fed is pricing in three, but the truth may lie somewhere in between. At least that's what our next guest is saying, and for more of this, we're joined by Brian Jacobsen, Annex Wealth Management chief economic and strategist.
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Let me just ask you, what's your take on all the bullishness that we've seen in the market recently? With not just the Mag Seven. It's not just them anymore. We've seen since late October the entire market kind of just enter this very bullish period of the year.
BRIAN JACOBSEN: Yeah, thank you, and I think you actually teed up this entire segment very well with that chart that you showed about the seasonality. We do believe that plays into it. If you think about the tax loss selling that sometimes goes on, and then you get that repositioning as you go through December and into January, people trying to clean up their portfolios a little bit, and so I think some of the seasonalities do play in. Those seasonalities oftentimes are driven by tax considerations, so I don't think it's just a figment of our imagination.
But a big thing too is, remember, we did have a market correction going from the end of July until about the end of October. The stock market was pricing in a type of earnings recession, so some further weakness. Now, when I look at the quarterly earnings numbers, expectations are actually fairly low for this earnings season relative to trend line growth. Now, we can discuss about whether or not longer term earnings expectations are perhaps too high, but at least in the near term, it does seem like the market was kind of sniffing out a double dip kind of earnings recession back in October, and we've just seen a recovery from there.
BRAD SMITH: And so when you think about some of the risks that we laid out going into next year, where do you land in the camp of a hard recession, mild recession, perhaps soft, and how would that ultimately influence some of the larger moves or impact some of the catalysts that we're anticipating to still permeate over into 2024?
BRIAN JACOBSEN: Yeah, that's a great question, because there is still, I think, a general feeling that we are going to have an economic recession. So as an investor, I always want to try to distinguish between an earnings recession and an economic recession. And if we look at history, oftentimes they do move together. You can get a general decline in economic activity, negative earnings per share growth as well, but over the last two years, we've actually had a couple earnings recessions already.
And so as a result, businesses seem to have cleaned up their balance sheet and their operations. Haven't really overextended themselves as much as maybe what they had in previous economic cycles. So even if we do get somewhat of a soft landing or a bumpy landing, so kind of a mild or mini recession, companies are likely in a position to ride through that relatively unscathed.
So here on our investment committee, we actually are still fully weighted with equities. We're not overweight or underweight, but up to a full weight, expecting that businesses would be able to ride out any sort of weakness that we do see in the labor market that emerges in 2024.
- Now, Brian, shifting gears a little bit, beyond the Fed, what are some of the key issues that investors should consider heading into the new year? And I'm thinking specifically geopolitical concerns. They're continuing. Monday, yesterday, the US conducted retaliatory airstrikes on Iran-backed militias in Iraq, and this was in response to a drone attack that injured three US military members. Can risk like these or something even greater that we might not be able to anticipate right now really derail this rally?
BRIAN JACOBSEN: Yeah, I do think that is really what it would take is some sort of shock to derail this rally, and it is likely something that's stemming from the Middle East, especially with oil supplies, if there were some major disruption. So far so good in terms of oil supplies, but we have had a few close calls in terms of whether or not those shipments would have to be rerouted or completely cut off. That is probably one of the bigger risks here.
Now, what we have seen is that demand for oil has been falling, a lot of that due to weak growth in China. And so I think that is one of the kind of key things to really watch is what is going on there. Now, how can you maybe position a portfolio for that type of eventuality? When we look at the energy sector, we do think that actually that area is slightly undervalued relative to the cash flow that those companies can generate.
So if you haven't gotten exposure to energy, you might want to take a look there. Sometimes you get it through the different funds. You can do it outright in the companies as well. But that's one of the positions that we have taken with our client portfolios is to overweight energy because that is one of the bigger risks out there to the broader market.
BRAD SMITH: Brian, so help us balance that with this thought or the tenor that's permeating right now of buy on the dips, rally on, versus the percentage of your portfolio that should be kind of positioned in order to outlast some of the exogenous risks that you mentioned a moment ago.
BRIAN JACOBSEN: Yeah, so the way that we kind of structure things, and I don't think it's unique to us, but is to think about it in terms of buckets. Kind of a goals-based approach where, think about what is your cash flow needs for the next three to six months, and have that in some sort of liquid investment, money market accounts, things like that.
And then think about precautionary balances as far as if there is a market drawdown, and we know that market drawdowns eventually do turn to recoveries, some take longer than others. And so what is the likely horizon over which you would need to kind of ride out a market downturn. Let's say it's 6 months or maybe it's 12 months, then have that in shorter term fixed income investments.
And then the rest of it, maybe you can breathe a little bit easier, not get so emotional as far as what you have for the rest of the allocation. So for each individual it's going to be very different as far as what their resources are and their attitude towards risk, but kind of think about it in those terms. What do you have in your liquidity bucket, your precautionary balances bucket, and then the rest you can invest for growth.
- Yeah, Brian, just one-- we've got a minute left, so, here, I'll give you the floor. Anything we haven't covered so far that you'd like to tell investors as we think about the new year?
BRIAN JACOBSEN: Oh, yeah. Thank you for that. So we're kind of thinking about in terms of better opportunities for the year ahead. A lot of people are really excited about fixed income, and I think that's OK to be excited about it, but remember, it is mainly for income and for diversification. We saw a major move lower with yields when we went from 5% to about 3.8%. How much more can you squeeze out of that in terms of lower yields? Maybe down to 3.5%, 3% on a good day.
And so when you think about fixed income, these huge gains that we've seen over the last two months, I don't think that's really a prelude to future big gains ahead. It's more about the coupon that you can clip off of the fixed income. So don't get over your skis with fixed income necessarily.
BRAD SMITH: Brian Jacobsen, who is the Annex Wealth Management chief economist and strategist. Brian, thanks so much for taking the time here with us this morning. Happy holidays.