Observation Deck

Views from the Investment Policy Committee

4th Quarter 2022

Purpose

The Observation Deck is a series of pictures designed to communicate points of view and to stimulate discussion and debate, it is NOT a set of recommendations

Our commentary is not the result of any single data point or graphic, it is a reflection of the weekly conversations within the Investment Policy Committee and a set of perspectives that are derived from many observations accumulated over varying time frames

Slides that are included in the Observation Deck are a subset of the scores of data points and graphics that the Investment Policy Committee views each week in assessing the status of the business cycle and the health of financial markets

We hope that you enjoy the Observation Deck and recognize that the views and opinions expressed are capturing a moment in time and are subject to change without notice

Observation #1 – Caught Behind the Curve

The Federal Reserve Open Market Committee has found itself behind the curve in 2022. The expectation for “transitory” price pressures has evolved to an urgency to address “entrenched” inflation. Using the blunt instrument of interest rates as its primary tool, the Fed must arrest economic activity in order to achieve its price stability mandate.

The PCE Price Index is released each month in the Bureau of Economic Analysis (BEA) Personal Income and Outlays report. The BEA uses the current dollar value of PCE’s to measure the price inflation or deflation that occurs from one period to the next.

In 2012, the PCE Price Index became the primary inflation index used by the Federal Reserve when making monetary policy decisions.

Observation #2 – Demand v Supply (Consumption)

The Bureau of Economic Analysis (BEA) reports the total value of personal consumption expenditures (PCE) collectively every month. The PCEs are broken down by goods (blue line) and services (gold line), with goods split between non-durable goods that have a life expectancy that is less than three years and durable goods that are pricier items that last longer than three years.

The BEA uses the current dollar value of PCEs to calculate the PCE Price Index that shows the price inflation that occurs from one period to the next. The PCE Price Index is the preferred measure of inflation used by the Federal Reserve in setting monetary policy.

The PCE Price Index is released each month in the Bureau of Economic Analysis (BEA) Personal Income and Outlays report. The BEA uses the current dollar value of PCE’s to measure the price inflation or deflation that occurs from one period to the next.

In 2012, the PCE Price Index became the primary inflation index used by the Federal Reserve when making monetary policy decisions.

Observation #3 – Demand v Supply (Labor)

The Bureau of Labor Statistics (BLS) collects immense data on the status of labor from a variety of monthly surveys conducted across employers and households. When we extract specific data points from these surveys, we can view the Employment Gap through the lens of Job Openings (dark blue), Unemployed persons looking for work (orange), and the Labor Participation Rate (green).

The Employment Cost Index (ECI), published by the Bureau of Labor Statistics (BLS), is a quarterly measure of the change in the cost of labor. Data is collected from approximately 5,900 private employers and 1,400 state and local governments.

The ECI (blue line) is a composite of the Wages and Salaries Index (red line) and the Benefits Index (gold line) and can be further separated between private industry and government. Data can be viewed down to the industry and occupational level within the details of the report.

Observation #4 – “Sticky” v “Transitory”

The Consumer Price Index (CPI) measures the changes in prices paid by consumers for goods and services. Released by the Bureau of Labor Statistics each month, the CPI-U is based on prices of food, clothing, shelter, fuels, transportation, medical services, drugs, and other goods and services that people buy for day-to-day living. The Urban Consumer group represents approximately 93% of the US population.

Core CPI (red line) excludes the more volatile prices of food and energy. The Shelter Component (blue line & columns) of CPI is a measure of housing (rent of primary residence & owners equivalent rent), housing at school, and lodging. Shelter is considered to be “sticky” inflation and the largest component of CPI.

The Global Supply Chain Pressure Index (GSCPI) tracks the state of global supply chains using data from the transportation and manufacturing sectors. The Federal Reserve Bank of New York updates the index on the fourth business day of each month.

The GSCPI integrates a number of commonly used metrics to provide a gauge of global supply chain conditions. It employs data from the Baltic Dry Index, the Harper Index, airfreight costs from indices at the US Census Bureau, and components of the PMI Surveys.

Observation #5 – Pace Matters

In Conjunction with the Federal Open Market Committee meetings, Federal Reserve Board members and Federal Reserve Bank presidents submit their projections of the most likely outcomes for real gross domestic product (GDP) growth, the unemployment rate, and inflation.

“Appropriate Monetary Policy” is defined as the future path of policy that each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy the mandate to promote maximum employment and price stability.

The Merrill Lynch Option Volatility Estimate (MOVE) Index captures bond market volatility, much like the CBOE Volatility Index (VIX) does with the stock market. It measures Treasury rate volatility through options pricing.

The MOVE Index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options which are weighted on the 2, 5, 10 and 30-year contracts over the next 30 days.

Observation #6 – Growth is Slowing

The Weekly Economic Index (green line) is a set of ten high frequency indicators of real economic activity, scaled to align with the four-quarter real GDP growth rate (gold line). It represents the common component of series covering consumer behavior, the labor market, and production. The NY Federal Reserve Bank designed the WEI to be a real-time indicator of activity in the US economy.

The WEI (green line) is instructive for investors in assessing the status of the economic cycle as it leads the Commerce Departments reporting of estimated real GDP growth (gold line) by as much as nearly four months time.

The Conference Board Leading Economic Index (LEI) for the United States is a composite index designed to signal peaks and troughs in a business cycle. The LEI is a composite average of ten leading indicators. It is constructed to summarize and reveal common turning point patterns in economic data in a clearer and more convincing manner than any individual component – primarily by smoothing out some of the volatility that occurs in the individual components from month to month.

Observation #7 – Slower Business Activity

The ISM Report on Business is based on a national survey of purchasing managers tracking changes in the Manufacturing and Services sectors. They have the properties of leading indicators and are convenient summary measures showing the prevailing direction and scope of change. Values above 50 signal expansion and below 50 indicate contraction. The further from 50 the faster the rate of change indicated.

The manufacturing “new orders” (light blue line) can be a good leading indicator of the manufacturing “output” (dark blue line) in the economy, and the services “business activity” (light orange line) often leads the services “output” (orange line) index.

The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of 10 seasonally adjusted components. It provides an indication of the health of small businesses in the US, which account for roughly 50% of the nation’s private workforce. The survey is conducted monthly (since 1986), and each component may be viewed as an independent index with commentary.

Observation #8 – Slower Housing Market

Most mortgages are pooled, packaged (in a process known as securitization) and sold to investors as mortgage-backed securities (MBS). The price that investors are willing to pay for an MBS bond is a primary determinant of the mortgage rate that originators are able to offer consumers. MBS prices are highly correlated with the prices of US Treasury bonds and reflect the level of interest rates demanded by investors to compensate them for maturity risk, inflation risk and credit risk.

Low interest rates tend to increase demand for property, driving up prices, while high interest rates generally do the opposite.

The NAHB Housing Market Index (HMI) is based on a monthly survey of the National Association of Home Builders members designed to take the pulse of the US single family housing market.

The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next six months as well as the traffic of prospective buyers of new homes. HMI readings above 50 reflect a generally favorable market view and outlook.

Observation #9 – Listen to Markets

The US Treasury yield curve is a line chart that depicts the yields of short-term US Treasury bills compared to yields of longer-term Treasury notes and bonds. The chart shows the relationship between the interest rates and the maturities of US Treasury fixed-income securities, also called the term structure of interest rates.

A normal or up-sloped yield curve indicates yields on longer-term bonds may continue to rise, responding to periods of economic expansion. A flat curve may imply economic uncertainty and fear of a slowdown. An inverted yield curve corresponds to periods of economic recession, where investors expect yields of longer-maturity bonds to become even lower in the future.

Investors in corporate bonds assume not only interest rate risk but also credit risk, the chance that the corporate issuer will default on its debt obligations. Credit ratings published by agencies such as Moody’s, Standard & Poors, and Fitch are meant to capture and categorize credit risk.

The credit spread is the difference in yield between a corporate bond and a government bond at each point of maturity and reflects the extra compensation investors receive for bearing credit risk. In terms of business cycles, a slowing economy tends to widen credit spreads as companies are more likely to default, and an economy emerging from recession tends to narrow the spread.

Observation #10 – Headwinds Persist

S&P 500 Price Index on a trailing 3-year time horizon versus the 50-day and 200-day moving average of the index.

Stocks love profits. The long-term path of a stock market follows the investor expectations for higher earnings. Periods of earnings uncertainty are often met with market declines. But, as the outlook for profits improves, markets tend to look past the trough and toward the renewed earnings trajectory.

Methods for valuing the stock market are plentiful, from using a simple Price/Earnings Ratio to employing a more complex model that contemplates future cash flows and discount rates. A wide variety of methods are used by investors everyday.

The P/E ratio is used by investors to determine the relative value of a market against its own historical record or to compare markets over time.

Strategic Risk Profiles

9/30/2002 – 9/30/2022

Long-Term Moderate Growth

9/30/2002 – 9/30/2022

Market Timing

Control Your Retirement

Disclosure

This document is for informational purposes only. It contains views of the Investment Policy Committee (IPC) of Vigilant Wealth Management (Firm) and does not serve as advice or recommendation. The views and opinions expressed in this document are subject to change at any moment and without notice.

Any performance data quoted or expressed in graphs and commentary represent past performance and is not a guarantee of future results. Investing involves risk and you could lose all or a portion of the value of your investment portfolio. The value of your investment portfolio and your investment return will fluctuate based on changes in the value of your portfolio investments. In the future, your investment portfolio may be worth more or less. This document does not represent the investments that may or may not be held in your investment portfolio.

Please contact Vigilant Wealth Management if there are any changes in your financial situation or investment objectives, or if you wish to impose, add or modify any reasonable restrictions to the management of your account.

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Certain information ©2020 MSCI ESG Research LLC. Reproduced by permission; no further distribution. This report contains certain information (the “Information”) sourced from MSCI ESG Research LLC, or its affiliates or information providers (the “ESG Parties”). The information may only be used for your internal use, may not be reproduced or re-disseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. Although they obtain information from sources they consider reliable, none of the ESG Parties warrants or guarantees the originality, accuracy and/or completeness, of any data herein and expressly disclaim all express or implied warranties, including those of merchantability and fitness for a particular purpose. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such, nor should it be taken as an indication or guarantee of any future performance, analysis, forecast or prediction. None of the ESG Parties shall have any liability for any errors or omissions in connection with any data herein, or any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages.

Observation Deck

Views from the Investment Policy Committee

2nd Quarter 2022

Purpose

The Observation Deck is a series of pictures designed to communicate points of view and to stimulate discussion and debate, it is NOT a set of recommendations
Our commentary is not the result of any single data point or graphic, it is a reflection of the weekly conversations within the Investment Policy Committee and a set of perspectives that are derived from many observations accumulated over varying time frames
Slides that are included in the Observation Deck are a subset of the scores of data points and graphics that the Investment Policy Committee views each week in assessing the status of the business cycle and the health of financial markets
We hope that you enjoy the Observation Deck and recognize that the views and opinions expressed are capturing a moment in time and are subject to change without notice

Observation #1 – Growth is Slowing

The Purchasing Managers’ Index Series are monthly economic surveys that provide an advance signal of what is happening in the real economy. They track activity variables such as output, new orders, supply times, employment and prices across key sectors.
The Series cover 30 countries and 86% of global GDP. The PMI is a diffusion index with values above 50 signaling expansion and below 50 indicating contraction. The further from 50 the faster the rate of change indicated.
The Composite (black line) accommodates the activities within the Manufacturing (blue line) and Services (orange line) sectors.

The ISM Report on Business (ROB) is the collective name for two monthly reports, the ISM Manufacturing ROB (blue line) and the ISM Services ROB (gold line), published by the Institute for Supply Management. The ROB is based on a national survey of purchasing managers where respondents indicate each month whether particular activities have increased, decreased, or remained unchanged.
The ISM ROBs are diffusion indexes with values above 50 signaling expansion and below 50 indicating contraction. The further from 50 the faster the rate of change indicated. The ISM Indexes are considered one of the most reliable barometers of the US economy.

Observation #2 – Source of Growth is Reversing

The Bureau of Economic Analysis (BEA) reports the total value of personal consumption expenditures (PCE) collectively every month. The PCEs are broken down by goods (blue line) and services (gold line), with goods split between non-durable goods that have a life expectancy that is less than three years and durable goods that are pricier items that last longer than three years.
The BEA uses the current dollar value of PCEs to calculate the PCE Price Index that shows the price inflation that occurs from one period to the next. The PCE Price Index is the preferred measure of inflation used by the Federal Reserve in setting monetary policy.

Observation #3 – Inflation is Peaking

The Consumer Price Index (CPI) measures the changes in prices paid by consumers for goods and services. Released by the Bureau of Labor Statistics each month, the CPI-U is based on prices of food, clothing, shelter, fuels, transportation, medical services, drugs, and other goods and services that people buy for day-to-day living. The Urban Consumer group represents approximately 93% of the US population.
Core CPI (red line) excludes the more volatile prices of food and energy from the headline CPI (black line)

The Consumer Price Index (CPI) measures the changes in prices paid by consumers for goods and services. Released by the Bureau of Labor Statistics each month, the CPI-U is based on prices of food, clothing, shelter, fuels, transportation, medical services, drugs, and other goods and services that people buy for day-to-day living. The Urban Consumer group represents approximately 93% of the US population.
Core CPI (red line) excludes the more volatile prices of food and energy. The CPI may also be viewed through the lens of Goods (dark blue line) and Services (orange line) to further identify the source of price pressures on the consumer.

Observation #4 – Labor Gap Should Narrow

The Job Openings and Labor Turnover Survey (JOLTS) is a survey conducted by the Bureau of Labor Statistics to measure job vacancies. Each month, the BLS surveys a wide variety of employers across geographies asking quantitative and qualitative questions about their businesses’ employment trends, job openings, recruitment, hires, separations and layoffs.
The Bureau of Labor Statistics (BLS) publishes a monthly update to the US Labor Participation Rate which measures the percentage of all people of working age who are employed or are actively seeking work. It offers additional perspective when used in conjunction with the monthly unemployment numbers from the Nonfarm Payrolls Report and Household surveys.

Observation #5 – Fed is Behind the Curve

In Conjunction with the Federal Open Market Committee meetings, Federal Reserve Board members and Federal Reserve Bank presidents submit their projections of the most likely outcomes for real gross domestic product (GDP) growth, the unemployment rate, and inflation.
“Appropriate Monetary Policy” is defined as the future path of policy that each participant deems most likely to foster outcomes for economic activity and inflation that best satisfy the mandate to promote maximum employment and price stability.

Observation #6 – Risk Shifting from Inflation to Growth

The US Treasury yield curve is a line chart that depicts the yields of short-term US Treasury bills compared to yields of longer-term Treasury notes and bonds. The chart shows the relationship between the interest rates and the maturities of US Treasury fixed-income securities, also called the term structure of interest rates.
A normal or up-sloped yield curve indicates yields on longer-term bonds may continue to rise, responding to periods of economic expansion. A flat curve may imply economic uncertainty and fear of a slowdown. An inverted yield curve corresponds to periods of economic recession, where investors expect yields of longer-maturity bonds to become even lower in the future.

Investors in corporate bonds assume not only interest rate risk but also credit risk, the chance that the corporate issuer will default on its debt obligations. Credit ratings published by agencies such as Moody’s, Standard & Poors, and Fitch are meant to capture and categorize credit risk.
The credit spread is the difference in yield between a corporate bond and a government bond at each point of maturity and reflects the extra compensation investors receive for bearing credit risk. In terms of business cycles, a slowing economy tends to widen credit spreads as companies are more likely to default, and an economy emerging from recession tends to narrow the spread.

Observation #7 – Market Anxiety

S&P 500 Price Index on a trailing 20-year time horizon versus the 200-day moving average of the index.

The ability for companies to navigate their way through the ebb and flow of business cycles is a key determinant in the stream of profits available to investors. Over the long-term, stocks love profits and will follow their path.
The price that investors are willing to pay to participate in the long-term stream of profits may be determined by an objective valuation process. But in the short-term, the price of stocks is frequently subject to the shifting investor sentiment between fear and greed.

Observation #8 – Destination AVG

Methods for valuing the stock market are plentiful, from using a simple Price/Earnings Ratio to employing a more complex model that contemplates future cash flows and discount rates. A wide variety of methods are used by investors everyday.
The P/E ratio is used by investors to determine the relative value of a market against its own historical record or to compare markets over time.

Category: Observation Deck