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Category: Insight

Inflation Conundrum: How to Protect Your Portfolio

Written by John Heneghan

Stock Market and Inflation Trends

Stock indexes have continued their bull run in July ahead of the much-anticipated June Consumer Price Index (CPI) report. On July 10th, the S&P 500 and the Nasdaq Composite both closed at record highs, marking their seventh consecutive session of gains in July. The Dow Jones Industrial Average ended just shy of its own record close. Through July 10th, the S&P 500 was up 3% for the month, while the tech-heavy Nasdaq surged 4.9%, and the Dow added 1.4%

The continuation of risk-on attitudes were encouraged by Fed Chairman Powell’s July 9th comments in Congressional testimony before the Senate Banking Committee.  Powell expressed caution about cutting interest rates, stating that the data does not yet support full confidence in the inflation path needed for a rate cut. He emphasized the need for more positive economic indicators to boost his confidence on the future path of inflation. Powell also warned that maintaining high interest rates for too long could negatively impact economic growth.  On the other hand, he commented that prematurely easing monetary policy or easing too much could harm the Fed’s progress in taming inflation.

The Federal Reserve remains focused on achieving its 2% inflation target and is closely monitoring labor market conditions, which have shown recent signs of cooling but remain relatively robust.  If you recall, May CPI came in much cooler than expected, which went a long way in restoring Wall Street’s faith that expected Federal Reserve rate cuts would happen in 2024.

The June Consumer Price Index (CPI) was reported on the morning of July 11th, and it did not disappoint. CPI for all items decreased by (0.1%) in June 2024, which was below expectations of a 0.1% increase. This is the first negative month-over-month inflation print since May 2020. Year-over-year headline inflation for June of 3.0% now sits at a 12-month low.  Core CPI, which removes more volatile energy and food prices, increased 3.3% from a year ago.

In response to the June CPI print, bond traders have increased the odds of a Fed rate cut by September 2024 to 83% from 67% odds before the deflationary June CPI inflation print.  Exactly one year ago, the Fed stopped raising interest rates.  Despite market and Fed expectations for at least one interest rate cut this year, U.S. inflation remains 100 basis points above the Fed’s 2% inflation mandate.

The next inflation update is the June PCE Prices Index on July 26, which is Fed’s favored inflation indicator. Additionally, there are two more CPI prints and one more PCE Price read due out before the Fed’s next meeting in September.

Bull vs. Bear

Bullish and bearish investors immediately began battling it out after the June CPI print as to whether inflation has been tamed by the Federal Reserve or not.  Mastering of inflation is generally considered bullish for both bond and stock markets.  Alternatively, the starting of a Fed easing cycle without putting a lid on inflation is considered bearish to both markets.  The worst-case economic scenario is stagflation where we experience slowing economic growth, but inflationary pressures remain.

Risk capital began making its bets on July 11th right away as capital made meaningful rotations by asset classes, equity market capitalization and sector, and geography.

Here is a heat map for the trading day for popular, domestic Exchange Traded Funds (ETFs):

Bond ETFs (AGG, +0.5%, LQD +0.5%, JNK +0.4%) as expected all responded positively to the deflationary CPI print. While the top-performing major equity benchmark was interest rate-sensitive small caps (IWM, +3.7%) on the day. Capital-hungry small caps have substantially lagged the S&P 500 (SPY, -0.9%) on a year-to-date basis by over 10%.    The technology-heavy NASDAQ (QQQ, -2.2%) was the worst performer on the day along with the S&P 500 Technology sector (XLK, -2.5%) as investors booked profits and/or took some chips off the Magnificent 7 table.  Interest rate-sensitive sectors within the S&P 500 had meaningful bounces with Real Estate (XLRE, +2.7%) and Utilities (XLU, +1.8%) the top performers.

It’s also worth noting that traditional inflation hedges like precious and industrial metals also did well with gold (GLD, +1.7%) and S&P Materials sector (XLB, +1.4%).  The U.S. Dollar Index (DX-Y.NYB, -0.6%) traded lower against a basket of the other global fiat currencies.   Fidelity Wise Origin Bitcoin Fund (FBTC, +0.1%) was flat, but China (FXI, 2.2%) was the top-performing international market on the day as the dollar weakness acts as a for sale sign on Chinese goods on international markets.

Relative to the S&P 500 decline on the day, noteworthy contributors to Servant Financial client models were Farmland Partners (FPI, +3.2%), gold miners (GDX, +2.8%), Sprott Physical Gold and Silver Trust (CEF, +2.0%), silver (SLV, 1.9%), high quality value-oriented large caps (DSTL +1.6%, BRK.B +1.2%, MOAT +1.1%) and uranium (URNM, 1.3%).

Protecting Your Portfolio

Inflation has remained stubbornly above 3% and well above the Federal Reserve’s official 2% policy target for more than three years.  Over this period, the traditional 60%/40% (equities/fixed income) portfolio has struggled and may no longer be an appropriate default investment approach going forward.

The risks of continued persistent inflation above the Fed’s target inflation of 2% are considerable.  The Federal Reserve is expected to begin an easing cycle at a time when the fiscal situation remains nothing short of precarious.  As witnessed in the recent Presidential debate and in the discourse that followed, there is a complete lack of fiscal restraint being expressed by political leaders on either side of the aisle.  The Congressional Budget Office recently estimated that the fiscal budget deficit was estimated at $1.9 trillion, or 7% of U.S. GDP, for the year ended June 30, 2024.  The last time the deficit was this high as a percentage of GDP was during World War II.

Just to cite one conundrum reflecting Washington’s inability to responsibly govern, the Federation for American Immigration Reform testified before the House Budget Committee that American taxpayers pay $151 billion annually due to illegal immigration.   The CBO estimated 2024 deficit of $1.9 trillion apparently does not fully account for the cost of illegal immigration at the state and local level or include discretionary costs and long-term entitlement costs associated with illegal immigration.

The prospects for a traditional 60/40 portfolio in a future resplendent with high and sustained inflation are worrying, particularly if inflation is like that experienced in the 1970s and early ‘80s stagflationary period. Servant Financial believes broadly diversified portfolios require a healthy allocation to inflation-protected assets like gold and precious metals, bitcoin (“digital gold”), real estate, high-quality large-cap equities, energy, and raw materials to weather any potential economic disturbances ahead.  Specifically, Servant Core portfolio allocations to Real Assets, Infrastructure (energy), and Digital Assets range from approximately 9% for the most conservative client risk profiles to 25% for the most aggressive risk profiles. We also run a bespoke “best ideas” portfolio that has substantially all its assets invested in Real Assets, Infrastructure, and Digital Assets.

We close this article with a wise quote from another period of war, irresponsible governance, and economic injustice for the working class and poor in our nation.

“In this unfolding conundrum of life and history, there is such a thing as being too late. Procrastination is still the thief of time. Life often leaves us standing bare, naked, and dejected with a lost opportunity.  The tide in the affairs of men does not remain at flood — it ebbs. We may cry out desperately for time to pause in her passage, but time is adamant to every plea and rushes on. Over the bleached bones and jumbled residues of numerous civilizations are written the pathetic words, “Too late.””

~ Martin Luther King, Jr., Beyond Vietnam — A Time to Break Silence

Delivered 4 April 1967, Riverside Church, New York City

Unplugged: Elon’s Untold Story

Written by John Heneghan

By John S. Heneghan and Grok

 

In the grand tapestry of human history, few figures have woven a hero’s journey as electrifying as Elon Reeve Musk. Born on June 28, 1971, in Pretoria, South Africa, Musk’s life has been a relentless pursuit of the extraordinary, a cosmic dance between ambition and innovation that has reshaped several industries and redefined the limits of human potential.

I’m listening to Walter Isaacson’s authorized biography, “Elon Musk.”  The book is a fascinating tour de force.  Musk’s life story through 2005 in the book has noticeable similarities with the “Pinky and The Brain” cartoon and the book “The Hitchhiker’s Guide to the Galaxy.” Elon has been applying the Brain’s mission to “take over the world” in each cartoon episode on an industry-by-industry basis. Unlike the Brain, Elon has successfully executed his business strategies to dominate one innovation-starved industry after another.  After world domination, Elon’s galactic aspirations may end up being his final chapter as he dreams of humanity’s future inhabitation of Mars.

Elon’s accomplishments in his first 53 years are a testament to the power of human ingenuity and the limitless potential of the human spirit. Here are five electrifying facts about Elon Musk (through 2005 in the book) that might just make you see him in a whole new light.

1. Musk the Gamer: Elon was a tech whiz from the get-go. At the tender age of 12, he developed a video game called “Blastar.” Blastar was a simple space shooter game reminiscent of classics like “Space Invaders” and “Asteroids.” The game’s objective is to pilot a spaceship and destroy alien freighters carrying deadly hydrogen bombs and “status beam machines.” Elon sold Blastar to a computer magazine for a whopping $500 but talk about an entrepreneur starting at a young age!

2. Musk the Survivor: During his childhood in South Africa, Elon had a very tough time. He was socially awkward and was often bullied and beaten up as a smaller child in his youth. Elon’s father Errol sent him and his brother Kimbal to a wilderness survival camp known as a “veldskool” when Elon was 12. In the camp, the children were given small portions of food and water and were encouraged by camp counselors to fight over their meager provisions. The bigger and older kids took advantage of the Musks. Elon was once thrown down a flight of stairs by a gang of classmates and kicked into a bloody mess.  Elon proceeded to train in judo, karate, taekwondo, and Brazilian jiu-jitsu, briefly, to be able to better protect himself and Kimbal.  The bullying stopped at around age 15.

3. Musk the Space Enthusiast; SpaceX: “Launching rockets and dreams, one Falcon at a time.”: Elon’s fascination with space isn’t just a recent thing as you might have discerned from his development of Blastar. Musk’s love for science fiction as a teenager extended beyond “The Hitchhiker’s Guide to the Galaxy.” He read the Foundation Series by Isaac Asimov. This series explores the fall and rise of a galactic empire, showcasing the cyclical nature of civilizations.  Dune by Frank Herbert, the epic tale of political intrigue, religion, and ecology on a desert planet, is also a favorite of Musk’s. The novel’s themes of human survival and adaptation resonate with Musk’s business ventures.  The Lord of the Rings by J.R.R. Tolkien is another Elon favorite. Although not strictly science fiction, the themes of heroism, friendship, and the struggle against overwhelming odds resonate with the challenges he’s faced “taking over the world.”

In his early days, Elon was so obsessed with space exploration that he even tried to buy a rocket from Russian sources before founding Space X. In fact, Elon and his team traveled to Russia to purchase and repurpose ICBMs. As Musk tells the story, the Russians agreed to sell him two missiles for $16 million.  After Elon agreed to the Russian’s terms, they quickly upped their asking price to $21 million for each rocket.  This lesson left a mark as Elon vowed to make his own rockets with Space X and would further pursue a vertical integration strategy for Space X and other subsequent ventures.

4. Tesla “Where the S, 3, X, and Y come together to electrify the world”:

In 2008, Tesla was on the brink of bankruptcy. Elon stepped in and invested $40 million of his own money to save the company. He then took over as CEO and turned Tesla into the electric car giant it is today. Elon Musk’s business strategy at Tesla is a fascinating mix of innovation, risk-taking, and maniacal focus on products.

They’ve spent very little money on advertising at Tesla. Instead, they focus on making the best possible products. Tesla has vertically integrated virtually all aspects of its business, including battery production, software development, and even the construction and development of its own charging network and Artificial Intelligence supercomputer, called DOJO, for autonomous driving. Vertical integration allows Tesla to control the entire customer experience and maintain its high level of quality. Musk also has a clear vision for the future of Tesla and the role it will play in the global transition to sustainable energy sources.

Elon is not content with simply making electric cars; he wants to create a sustainable energy future for the world through renewable energy applications.  Tesla’s growing energy generation and storage segment represents 10% of total revenues and is the company’s highest-margin business. In fact, Elon wrote a paper in college about the importance of the world embracing solar energy. The paper discussed the idea of using solar-powered satellites to capture solar rays and convert the energy into microwaves to beam to Earth as an energy source.

5. Musk the Rebel: Elon’s relationship with his father, Errol Musk, was far from rosy. In reality, it was downright offensive. According to Walter Isaacson’s biography, Errol was verbally abusive and often told Elon he was “dumb” and “would never amount to anything.” Can you ever imagine telling your son or daughter that, let alone the boy who would become the richest man on the planet?

As we close this hero’s rousing tale, we are reminded that the future belongs to those who dare to dream, to those who are unafraid to challenge the status quo, and to those who never stop reaching for the stars.  You can continue to follow future attempts by Elon to “take over the world” on X/Twitter.

“One small step for man, one giant leap for Elon’s ego.”

Three-Legged Stools

Written by Ailie Carlene Elmore

Whether it’s a beachfront condo in Florida, time spent playfully spoiling the grandkids, or hours carefully tending an award-winning garden, everyone has their own vision of retirement. If you’re like me then you never plan on retiring but at least want to build a large enough retirement nest egg to make that choice. As a personal finance professor, I encourage my students to start saving for retirement immediately after landing their first job. I can’t say that every young student follows this advice. According to the Federal Reserve, only 49.6% of people under age 35 have any retirement savings account with an average account balance of $18,880. By age 65-74, 51% of Americans have a retirement savings account with an average account balance of $115,000. I imagine most Americans who retire at age 65+ likely couldn’t retire for long with only $115,000. That size of a retirement fund certainly wouldn’t buy you an oceanfront property in Florida and those grandkids may have to make do with rice and beans at grandma’s and grandpa’s inland Florida shack.

Retirement planning is often referred to as a three-legged stool with the legs referring to 1) social security, 2) pension plans, and 3) personal retirement savings accounts commonly known as 401(k)s or IRA(s). Ideally, each leg is sturdy and collectively can support you comfortably throughout retirement. However, if one peg comes up a bit short, you may find yourself taking a tumble off of your retirement stool. Unfortunately, a quick fix like putting a piece of paper under the inadequate leg like you would in a restaurant likely won’t be an easy option when stabilizing your retirement savings.

Personal Retirement Plans

Defined Contribution plans such as 401(k)s, IRAs, 403(b)s, and employee stock ownership plans (ESOPs) have become increasingly common as companies move away from offering defined benefit plans, such as pensions, under which the company bears all the investment risk. Defined contribution plans shift the investment risk to the individual by offering the individual control over the selection of their investment allocation. Giving individual plan participants control over investment decisions could be to the detriment or benefit of the person depending on the performance of their investment choices. According to the U.S. Census Bureau, 401(k)s, 403(b)s, 503(b)s, and Thrift Savings plans are among the most common retirement account types. Unsurprisingly, these accounts have higher participation among employers who must make regulatorily defined contributions to these plans. Roughly 92% of employers offer 401(k)s through which the companies make defined contributions to the accounts of employees. On average, of those companies with 401(k) plans, individuals contribute 7.4% of their annual salary to their 401(k) account while employers contribute 4.5% of employee salaries.

The Census Bureau table above presents ownership rates by type of retirement account.  These ownership trends are not consistent across age, gender, or race. The Baby Boomer generation shows the highest level of participation, with 58% owning at least one type of retirement account. Ownership rates progressively decline in the younger generation, with the lowest participation seen in Generation Z, which is understandable since many in this group may still be in high school, college, or early in their careers.

One concern highlighted by this census data is the significant inequality in participation rates among races. White Americans have the highest participation levels, while individuals identifying as Asian, Black, or Hispanic lag behind. This discrepancy stems from systemic issues in the United States, as these minority groups have historically had lower access to higher education, which can lead to jobs with better retirement programs and greater financial literacy.

Not only are participation levels divergent across age and race for retirement planning but the type of investment mix within existing accounts is also worth considering. Investment allocation differs based on individual goals, risk profiles, and knowledge of financial markets. While overall financial literacy levels have grown significantly with the rise of the internet, access to information, and professionals advocating in the space, the financial literacy leg of the retirement stool varies across populations, especially in the minority groups mentioned above.

Nowadays many people hit the easy button for selecting their retirement investment allocations. No, I am not talking about the big red button at Staples, but I am referring to target date funds.  These are the “set it and forget it” asset allocation options for retirement savings. Fidelity reported that 94.3% of its plan participants default to target date funds (date of planned retirement). Target date funds can be a great option for those who do not want to manage their accounts actively, but it comes at a cost. Target-date funds require frequent adjustments to the investment mix for risk allocation as the fund approaches the specified retirement date. This active management may result in higher fees compared to self-managed index funds. According to Vanguard, the average yearly return for retirement accounts is 4.9%, which may not be sufficient for most individuals as inflation continues to erode returns.

Pensions

Defined benefit plans, better known as pensions, have declined in popularity as companies look to shift investment risk onto their employees. Only 15% of the U.S. workforce have access to a pension whereas in the 1960s around half of all private sector workers were covered by a defined benefit plan. Various factors have contributed to this shift, but one of the main reasons is that people are living longer due to better access to nutrition, healthcare, and overall healthier lifestyles. Longer lifespans mean a longer investment horizon and the need to pay retirement income for 25 to 30 years instead of 15 to 20 years which may have been the pension assumption in the 1960’s. This increased capital commitment led employers to phase out pensions and introduce defined contribution options to their employees. The creation of the 401(k) plan by the U.S. Congress in 1978 as part of the Revenue Act facilitated this transition.

While pensions are increasingly rare in the private sector, people working in government, military, infrastructure, public schools, public safety, and unions are still largely covered by pensions. The often dangerous and more strenuous nature of work in these positions and often lower pay make pensions a powerful selling point for some employees. Pension commitments are one of the largest outstanding long-term obligations for many states alongside retiree health care benefits and outstanding municipal debt. Unfortunately, many states face large unfunded obligations with a total of $1.25 trillion of outstanding unfunded pension obligations among all states as of 2019. The Pew Charitable Trusts report that this debt is equal to 6.8% of all the states’ income and that percentage has been on the rise since before the Great Recession.

Many states deferred their pension contributions during the Great Recession, and the gap in unfunded pension obligations grew further. Some states have felt the burn more than others with New Jersey’s unfunded pension liability accounting for 20% of their total state revenues. The state of Illinois follows closely behind with its unfunded pension liability amounting to 19.4% of state revenue. Illinois in particular is known to have a relatively young retirement age with 63% of workers retiring before age 60. The average pension for a person in Illinois retiring before age 60 with at least 30 years of service is $63,424. This information suggests Illinois’ pensions may be unsustainable unless there are policy changes to alter retirement ages.

Social Security

It is impossible to talk about retirement without opening the door to a discussion about Social Security. Currently, 70 million Americans are receiving Social Security benefits which provides retirement benefits to Americans who have paid into the system during their working years. For every dollar that an individual contributes to Social Security, 85 cents goes toward the Social Security Trust Fund, while the remaining 15 cents is used to assist people with disabilities. For 4 in every 10 retirees, social security provided at least 50% of their total retirement income suggesting that for many retirees social security is crucial to ensuring a secure retirement.

The funds collected from the current year’s FICA (Federal Insurance Contribution Act) taxes are used to pay out benefits in the current year. In theory, the system seems sound but recent reports from the Social Security Administration suggest that the Social Security will run out of money to pay full benefits by 2035. Unless congressional action is taken, the Social Security fund will only be able to pay out 83% of retirees’ full benefits. According to the Social Security Administration, it has been 11 years since Social Security collected enough FICA taxes to meet its current year’s obligations and SSA has been steadily eating away at cumulative surplus FICA contributions. To cover the shortfall, the Administration has issued Trust Fund bonds totaling $24 billion.

The reason behind the funding gap is similar to why many companies are phasing out defined benefit plans. People are living longer, which means benefits must be paid out for more years than actuarially assumed, and there aren’t as many people paying into Social Security relative to the number of Social Security recipients as before. Until 2020, the Baby Boomer generation was the largest. As this generation began to retire, there weren’t enough workers to fill their positions as Social Security contributors, leading to a decline in Social Security reserves. Fortunately, subsequent generations, particularly Millennials and Gen Z, have started to enter the workforce, which will help alleviate the funding burden. However, many people are calling for policy reform to either raise the FICA tax level or lower the benefits paid out. It is unlikely that Social Security will go bankrupt, as it is a key issue for policymakers’ constituents.

Another concern surrounding Social Security is the long-term decline in U.S. birth rates since 2008. This decline isn’t just a worry for Social Security but also for the economy, as our supply chain, workforce, and infrastructure rely on a sufficient population size to fill roles. While artificial intelligence may offer some relief, it’s unlikely that the U.S. government will start requiring AI to pay income taxes, including Social Security.

The Wobbly Three-Legged Stool

Based on the current inflationary environment and improving lifespans, it is likely that the three-legged retirement stool may become a bit uneven and require some long-range planning. As private sector pensions continue to disappear and the structural integrity of social security becomes increasingly untenable, individuals must become more self-reliant by balancing the personal savings part of the stool. Thankfully, financial literacy programs abound and sophisticated financial advisors can employ innovative technology and a broad, diversified investment opportunity to reinforce the personal savings leg of your retirement stool. Servant Financial is dedicated to understanding your retirement goals and building a purpose-built retirement savings plan for your golden years. Optimally, you will find yourself sitting at ease throughout retirement resting on the personal savings leg entirely while the other two legs serve as a footstool for your beach flip-flops or as seats for your grandkids.

Mind the Gap In U.S. Infrastructure Investment

Written by Ailie Carlene Elmore , John Heneghan

In its 2021 report card “Failure to Act: Economic Impacts of Status Quo Investment Across Infrastructure Systems”, the American Society of Civil Engineers (ASCE) gave the United State’s infrastructure a “C-,” up from a “D+” in 2017—the highest grade in twenty years. Still, ASCE estimated an “infrastructure investment gap” of nearly $2.6 trillion this decade that, if unaddressed, could cost the United States $10 trillion in lost gross domestic product (GDP), 3 million jobs, and $2.3 trillion in exports by 2039.

The chart below summarizes ASCE estimated spending gaps to be mindful of in the 2021 infrastructure report card:

By far the largest spending gap in nominal dollars at $1.2 trillion is in surface transportation which includes highways (ASCE – D grade), bridges (ASCE – C grade), and other transit systems (ASCE – D- grade).   These vulnerabilities in U.S. infrastructure were punctuated recently by the mishap at the port of Baltimore.

Baltimore Bridge Collapse

While the nursery rhyme whimsically suggests that the London Bridge may be crafted of silver and gold, recent events have starkly toppled this notion. On March 26th, 2024, tragedy struck as a cargo ship departing from the Port of Baltimore en route to Sri Lanka experienced engine failure. This untimely malfunction while the ship was leaving the port led to a collision with the Francis Key Scott Bridge, one of America’s busiest roadway bridges. Prompt action by transportation authorities upon receipt of the ship’s “mayday” call enabled them to halt traffic just in time, yet the collapse claimed the lives of six construction workers performing repair and maintenance work on the bridge. The news of this disaster shocked the nation, sparking concerns about potential disruptions to U.S. supply chains and highlighting ASCE’s earlier warnings about underinvestment in the country’s strategic infrastructure. Cleanup of the bridge wreckage is ongoing with the U.S. Army Corps of Engineers anticipating the port’s reopening by the end of May.

The Port of Baltimore ranks as the 15th largest container port in the United States with its major exports including automobiles, coal, natural gas, and agricultural equipment. India is the largest trading partner with the Port of Baltimore with coal being the primary product being exported to India. Even though the port is expected to re-open by the end of May, the bridge collapse has caused an estimated $28 billion worth of goods to be diverted to other ports leading to additional transportation and fuel costs and delays for suppliers. However, analysts do not expect there to be a considerable impact on consumer prices globally. Locally, the bridge collapse has negatively impacted 15,300 port jobs and is estimated to have cost the State of Mayland $28 million in potential lost tax revenue.

Analysis of U.S. Infrastructure

The Baltimore Bridge collapse is unlikely to have a meaningful impact on global markets, however, this incident warrants more diligent oversight of the U.S. Port system given its importance to U.S. international export markets. The U.S. exports 2.3 billion tons of freight from its seaports annually and currently has 208 commercial ports across America’s coastlines. The largest U.S. port is located in Houston, Texas with more than 265 million tons of freight flowing from the port annually. U.S. ports handle 43% of all U.S. international exports totaling almost $2.3 trillion worth of goods making them crucial to the U.S. Economy. Keeping these ports running smoothly is crucial to the United States’ $27.4 trillion economy as highlighted by the 2021 ASCE infrastructure report.

Experts suggest that the independent ASCE report contributed in part to the bi-partisan infrastructure bill passed in March of 2022 called the Infrastructure Investment and Jobs Act (“Infrastructure Act”).  The Infrastructure Act provides $550 billion from 2022 to 2026 to improve roads, bridges, mass transportation systems, and water infrastructure. The main goal of the legislation was to improve supply chain resiliency through improved security, inventory management, and emergency stockpiles after the disruptions that occurred during the COVID-19 pandemic.

Gaps for Investment

The 2021 ASCE report card and recent events make it clear that one of America’s investment priorities should be its strategic transportation, telecommunication, and energy infrastructure. During the spring and summer seasons, it is nearly impossible to travel on of the 164,000 miles of the United States interstate highway system and not encounter road construction or bridge repairs. From an investing perspective, investing in local and national infrastructure, whether it’s transportation, telecommunications, energy, medical, or water management systems, has never been more critical. According to Marsh McLennan, infrastructure emerged as an investment class in the mid-1990s as the .com revolution revealed opportunities in the telecommunications and internet industries. Currently, $100 billion of capital is raised annually for infrastructure expenditures through a variety of investment vehicles, with the most common being private equity and real estate funds. More recently, other forms of tax-advantaged opportunities for infrastructure investing have emerged. Under the 2017 Tax Cuts and Jobs Act, the federal government introduced the opportunity zone program.   Opportunity Zones (OZs) are economically distressed communities, designated by the IRS, in which investments in real assets and infrastructure, with requisite improvements thereto, may be eligible for tax-exempt appreciation and other tax benefits. Opportunity zone investments support local economies by building workforce housing, medical or industrial facilities, or renewable energy, data, telecommunication, or agricultural infrastructure. If you are interested in learning more about farmland OZ infrastructure investment in rural America, we encourage you to visit the website for Promised Land Opportunity Zone Fund.

Artificial Intelligence Infrastructure

One of the more topical areas within infrastructure investing these days is in the semiconductor space to meet the growing demand for microchips used in artificial intelligence (AI). AI has been around for several years but recent deployments and advancements of Chat GPT and other AI software are poised to potentially revolutionize the way many businesses are run. The United States has traditionally been dependent on China for microchips and the supply chain backlogs from the COVID-19 pandemic highlighted the risk of continued dependence on Chinese production for this crucial integrated operating component in everything from cars to agricultural equipment. As a result, the White House recently announced a $5 billion investment through the CHIPS and Science Act which will be used for research and development in the semiconductor industry. The goal is to boost domestic chip manufacturing while bolstering a qualified workforce to ensure strategic production capacity remains in the U.S.

The other consideration with artificial intelligence is the immense amount of electrical power necessary to fuel the massive AI computational capacity of the future. As our country works to create a more carbon-neutral society, AI companies are publicly promoting and sponsoring investments in nuclear power as a reliable, renewable baseload power source. Alex De Vries from the Vrije Universiteit Amsterdam School of Business and Economics researched the necessary electric power for the expected AI infrastructure buildout and estimatedthat a 50% increase in the amount of electricity would be required to power the growing demand for AI-driven data collection and analysis.  Alex’s analysis bodes well for all renewable and traditional sources of electrical generation generally.   Further, many experts believe AI-driven demand for electricity may result in a nuclear power renaissance.

Servant Financial expanded its allocation to real assets and infrastructure by adding the Sprott Uranium Miners ETF (Ticker: URNM) and Recurrent MLP & Infrastructure Class I mutual fund (RMLPX) to client portfolios in mid-February.  Each fund received an initial position size ranging from 0.7% to 1.7% depending on investor risk profiles.   URNM invests in uranium mines and the infrastructure necessary to procure and process uranium. The ETF invests in 20-40 globally diversified stocks with its top holdings consisting of Cameco which is a Uranium producer located in Saskatoon, Canada. URNM’s total return year-to-date through April 26, 2024, was 5.7%.

RMLPX invests in energy infrastructure master limited partnerships (MLPs) and C‐corporations, which primarily hold midstream pipeline assets. RMLPX’s total return year-to-date through April 26, 2024, was 17.0% and its current yield is 5.7%.  Servant Financial will continue to closely monitor URNM’s and RMPLX’s performance along with its other real asset allocation as the economy moves through a transitionary period that has the potential to reignite inflation.  The nascent nuclear renaissance to support the artificial intelligence capacity buildout will also be a keen area of interest.

The recent Baltimore Bridge collapse serves as a blunt reminder of the vulnerabilities within our transportation networks and the potential ripple effects on domestic supply chains. As we continue to assess its aftermath, it is clear from the ASCE 2021 report card that investments in infrastructure are not just prudent but imperative for sustaining economic growth and prosperity for communities nationwide. Fortunately, investment opportunities abound, spanning from traditional sectors like transportation and energy to emerging fields such as data centers and artificial intelligence infrastructure. Whether it’s investing in local roads and bridges or speeding along the information superhighway of the future with artificial intelligence, infrastructure investing is poised to remain a cornerstone in investment portfolios for years to come.

While bridges aren’t made of silver and gold, silver and gold are common materials used in computer chip design, including artificial intelligence chips. Gold is often used for its excellent conductivity and resistance to corrosion, while silver is valued for its high thermal and electrical conductivity. Both metals play crucial roles in ensuring the efficiency and reliability of computer chips used in AI applications.  By minding the gap in U.S. infrastructure investment, your investment portfolios may shine brighter.

IPOs Ready for Liftoff

Written by John Heneghan

Risk markets have been generally buoyant since the Federal Reserve paused its interest rate hiking cycle in 2023 and with the Fed continuing to signal a “pivot” to lower interest rates later this year.  Year-to-date through March 15, 2024, bitcoin is leading risk assets with a total return of 38.7%, followed by midstream energy at 11.4%, and the S&P 500 at 7.6%.

Optimism is rising that the U.S. initial public offering (IPO) market is “ready for liftoff” after a couple of years of significant declines in volumes and valuations.  According to Ernst & Young, there were 128 U.S. initial public offerings in 2023, with a listing value of $22.6 billion.  2023 was a nice uptick compared to 2022, yet well below the capital raised in the 2019 to 2021 period.

Ernst & Young experts believe the 2024 IPO market could return to historically “normal” levels.  Favorable indicators for their optimism are the significant backlog of IPO hopefuls and more favorable market conditions characterized by rising valuations, moderating volatility and inflationary pressures, and expectations of Federal Reserve interest rate cuts in the not-too-distant future.

The 11 spot bitcoin ETFs approved by the Securities and Exchange Commission (SEC) on January 11th were the first new securities offerings off the 2024 IPO launch pad.  And what an amazing blastoff it has been.  Bitcoin held by these vehicles has grown some 226k to 836k bitcoin in the two months since launch.  The total assets in the 11 spot Bitcoin ETFs have crossed above $60 billion, over $3 billion higher than the assets under management (AUM) in the largest Gold ETF (GLD) with $56.9 billion. Bitcoin is sometimes referred to as digital gold.

Further as the chart depicts below, BlackRock iShares Bitcoin Trust (IBIT) AUM at $25.3 billion and Fidelity’s Bitcoin Fund (FBTC) garnering $9.7 billion have been the fastest growing entrants in the bitcoin fund space.  The spot bitcoin ETF’s IPOs have been more widely successful than even the most optimistic expectations by garnering AUM expected over a full year in just two months.  Consider this, IBIT and FBTC rank 3rd and 4th in year-to-date inflows among all ETFs, standing tall on the podium against some of the biggest, more established ETFs in the world.

Source: https://heyapollo.com/bitcoin-etf

 

In the 2024 IPO staging area is Reddit (RDDT), set to go public on March 21st.  RDDT and is one of the most highly anticipated IPOs of 2024. The social media company is seeking a $6.5 billion valuation and is aiming to raise up to $748 million through the sale of 22 million shares at an expected price of $32.50 per share.  Reuters commented on St. Patrick’s Day that Reddit’s IPO is currently between four and five times oversubscribed.

Reddit has been around since 2005 and is best known for hosting text-based discussions with expert influencers gaining popularity for their opinions and answers to audience questions. The Reddit business model is based on ad sales, as well as sponsored posts and promoted content, and premium features through subscriptions.  The Reddit platform hosts vast discussion forums called “subreddits,” focused on topics ranging from technology, music, food, etc.  Users are called “Redditors.” In fact, it is expected that approximately 1.8 million shares of newly issued stock in the IPO will be allocated for purchase to Redditors.

More recently Reddit has entered into licensing agreements with various Artificial Intelligence (AI) software providers to further monetize its proprietary content and data.  AI companies use databases, like Reddit’s, to train their models.  In its IPO registration statement with the SEC, Reddit disclosed, “In January 2024, we entered into certain data licensing arrangements with an aggregate contract value of $203.0 million and terms ranging from two to three years. We expect a minimum of $66.4 million of revenue to be recognized during the year ending December 31, 2024, and the remaining thereafter.”  The licensees were not disclosed, but there is broad speculation that one or both of Google and OpenAI could be customers.

According to Axios, Reddit received a letter of inquiry on Thursday, March 14th, from the Federal Trade Commission (FTC).  Reddit said publicly that the FTC is “conducting a non-public inquiry focused on our sale, licensing, or sharing of user-generated content with third parties to train AI models.”  Of note, Reddit is not the only company receiving these so-called “hold letters,” according to a former FTC official who spoke with Axios.

We’re looking forward to seeing how the Reddit IPO launch performs later this week.  This could ignite the IPO market for 2024.

Ready for blastoff is Starlink, a subsidiary of Space X, Elon Musk’s sponsored aerospace company. Starlink provides satellite-based internet service around the globe. Space X uses spaceships with rocket grade kerosene and liquid oxygen in its recoverable and reusable Merlin engine system to place Starlink satellites into orbit.  The scale of Starlink’s satellite system is absolutely out of this world!  On March 15, 2024, Space X announced that it placed its 6,000th Starlink satellite into Earth orbit.  In addition, Starlink has “bravely gone where no internet service has gone before.”  Last year, Starlink introduced its broadband internet service to two of the most remote areas of the globe – Pitcairn Island and Easter Island – both thousands of miles from the nearest continent.

AG Dillon & Co managing director Aaron Dillon estimated Starlink’s possible valuation at $1.6 trillion based on the following key metrics:

  • Starlink has satellite internet monopoly,
  • 6 billion people (33% of global population) have no access to internet,
  • Starlink charges a monthly subscription fee of $50 to $110 per month,
  • And with an assumed 10% Starlink capture rate of internet-less humans, or 260 million subscribers, at $50/month is $156b in annual recurring revenue,
  • Aaron uses an aggressive 10x revenue multiple to derive his $1.6 trillion valuation.

With the Reddit IPO in the staging area, Elon could be possibly waiting in the wings to see how this IPO performs before proceeding with Starlink.  There is little dispute about Starlink’s success in launching satellites, nor Elon’s success in launching IPOs. Talk about a match made in heaven.

So long as markets remain receptive to risk-taking, we believe it’s not a question of if, but when the Starlink IPO will come to market in 2024.  In that light, we’re preparing for an Apollo 11-type countdown:

“Twenty seconds and counting. T minus 15 seconds, guidance is internal. Twelve, 11, 10, 9, ignition sequence starts… 8, 7, 6, 5, 4… 3… 2… 1, zero, all engine running… LIFT-OFF! We have a lift-off, 32 minutes past the hour. Lift-off on Apollo 11.”

 

 

 

 

Leaping Out of Credit Card Debt

Written by Ailie Carlene Elmore , John Heneghan

Every four years, Americans are given the rare gift of time. February 29th only appears on the calendars every 1,460 days marking the well-known holiday of Leap Day. This extra day brings about traditions across the world such as women proposing to men and is commonly called “Bachelor’s Day” or “Ladies Privilege.” In other countries, Leap Year is known as an unlucky year for agriculture and particularly sheep. There is an old rhyme that says, “Leap Year was never a good sheep year.”  So don’t be a sheep this Leap Year, do your own thinking, particularly on important matters.

What does Leap Year mean for Americans? For credit card holders, it means an additional day to tackle the mounting $1.129 trillion debt Americans currently owe. Americans now have more credit card debt than ever before, and the COVID-19 pandemic only accelerated its “leap” higher. Credit card holders with unpaid balances hold an average of $6,864 with the highest average debt levels being owed by East Coast residents. The debt balances on these credit cards aren’t getting cheaper to carry either given rising interest rates. The average Annual Percentage Rate (APR) on credit cards is 21.47% making it even more difficult for consumers who have found themselves in the debt hole to “leap” their way out of it.

Source: Lending Tree

 

How did the average Americans find themselves in this dilemma? Higher prices at the gas pump and grocery store together with the increasing costs of housing have significantly contributed to the current crisis. Borrowers between the ages of 30 to 39 are particularly feeling the pain of rising interest rates as this age bracket often is also dealing with student loan debt repayments. Even though the U.S. economy continues its expansion, debtholders may be reaching a breaking point and be forced to scale back consumption.  Consumer expenditures represent approximately 70% of U.S. economic activity. The post-pandemic inflation levels were believed to be largely attributable to temporary supply chain shocks that would resolve themselves over time and prompted a slow response by the Federal Reserve. Credit card holders felt acute pain when a tardy Federal Reserve instituted an aggressive rate-hiking campaign to tame inflation. Some claim that debtholders are at fault for overspending and while that may be true, they are just taking a profligate spending lesson out of the Federal Government’s budget playbook. The current National Debt is hovering around $34 Trillion which comes out to an average of $102,279 per each American. Interestingly enough, the slope of the National Debt graph shows a very similar shape to the above graph featuring individuals’ credit card debt.

Source: U.S. Department of the Treasury

 

Even though credit card debt levels continue to rise, delinquency rates remain relatively low with only 3.1% of Americans with a balance that is more than 30 days delinquent. What do high debt levels and low delinquency levels mean? Huge profits for credit card companies. Currently, there are four major credit card networks in the United States: Visa, Mastercard, American Express, and Discover. Visa, Mastercard, and American Express have experienced rising earnings over the past several years as people swipe cards quicker and pay later. Not only are these companies leaping into financial success from higher individual card debt but also higher transaction fees. In 2022, credit card companies charged consumers an all-time high in interest and transaction fees of $130 billion.

These oligopolies are only projected to get stronger and more concentrated as Capital One announced this month their plans to buy Discover Financial Services for a whopping $35 billion.  Discover shareholders would receive 1.0192 Capital One shares for each Discover share under the terms of the proposed deal.  Capital One desires Discovers’ independent card network to go with its Capital One Visa operating on the shared Visa credit card network.  As more consumers swipe plastic cards rather than pay with cash, financial services are taking notice of the “leap” in prospects for the credit card sector. Some worry the rising credit card debt is signaling a weakening economy, JPMorgan CFO, Jeremy Barnum, reported during their earnings call that consumers are adjusting to the end of government stimulus checks and government-mandated pause on student loan repayments. Other bank executives point to a strong labor market signaling that consumers can afford the high credit card balances.

Servant Client Portfolio Positioning

Here is our Leap Year summary of Servant client portfolio composition compared to traditional benchmarks.  A traditional 60/40 portfolio would hold 60% equities and 40% fixed-income securities and cash for a client with moderate risk tolerance.

1. Underweight equities

2. Overweight non-U.S. equities vs. U.S. equities

3. Overweight precious metals, gold miners, and digital assets/bitcoin

4. Underweight fixed income duration

U.S. equity valuations are near extremes.  For example, Hussman Fund’s February 26, 2024 newsletter “Speculative Euphoria and the Fear of Missing Out” states that “the valuation measure we find best-correlated with 10-12 year S&P 500 returns in market cycles across history is the ratio of nonfinancial capitalization to corporate gross value-added, including estimated foreign revenues (MarketCap/GVA).  Presently, this measure is higher than at any point before June 2021, with the exception of three weeks surrounding the 1929 peak.”

Likewise, market breadth is very, very narrow with the performance of the so-called “Magnificent 7” (U.S. tech behemoths Apple (AAPL), Amazon (AMZN), Alphabet (GGOGL), Facebook/Meta (META), Microsoft (MSFT), Nvidia (NVDA) and Tesla (TSLA)) diverging with NVDA soaring and TSLA tanking.

In our opinion, the aggregate stock market is priced for perfection and assumes inflation will sheepishly return to Fed’s targeted rate of 2% and a soft economic landing where a broad recession is avoided.  We see the potential for volatility in future economic data.  If such volatility were to occur, it could quickly “leap” into the stock market  For example, market projections for core PCE (Personal Consumption Expenditures), the Federal Reserve’s preferred inflation measure, remain closer to 4% than the Fed’s targeted 2%.  Further, recent economic data (employment and layoff announcements and retail sales) are consistent with a slowing economy.

We think the recent move in Bitcoin may be an economic tell.  Bitcoin has leaped from below $52k at the beginning of this week to breach $61k on the day of this writing on February 28th.  You may recall that Servant Financial initiated small allocations to client portfolios in 2020 of generally 1% to 2% based on the deep research that we conducted which showed that adding a small bitcoin allocation would historically benefit globally diversified portfolios by lowering risk while providing the potential for higher returns.  Market history has been rhyming lately.

John Heneghan recently received his Certificate in Blockchain and Digital Assets –  Financial Advisor Track from the Digital Assets Council of Financial Professionals so Servant Financial is prepared to serve your financial planning and investment needs regarding digital assets and bitcoin.

For more bitcoin-curious readers, we have been beta-testing a couple of more concentrated and volatile portfolios on the bitcoin, anti-fiat themes.  The first portfolio is focused on active best ideas in both the real asset and bitcoin/digital asset space.  This portfolio holds about 15 positions and has almost a 3-year track record.  The second and newer portfolio (10-month history) is much more speculative and holds only 6 positions – Fidelity Bitcoin Trust ETF (FBTC) and five other bitcoin-related businesses.  Please reach out if you are interested in learning more.

Leap Day is known to be a lucky day – good luck for some and bad luck for others. As Ray Charles sang, “If it wasn’t for bad luck, I wouldn’t have not luck at all.” One thing is sure, consumers cannot rely solely on good luck to leap them out of their debt holes because bad economic luck may be lurking around the corner. If you have found yourself struggling with high levels of credit card debt, we encourage you to check out the National Foundation for Credit Counseling for strategies and tips for your unique situation. Leap Day should not be just another date on the calendar; instead, view it as an opportunity to leap closer to financial freedom from credit card debt.

 

 

 

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