5-Minute Huddle: Wall of (no)Worry

December 16, 2019

By Justin Pawl, CFA, CAIA

In this week’s edition:

  • Last Week Today. Answers to many questions weighing on the market.
  • Holiday PSA. Scams via gift cards are on the rise.
  • Fed 4.0. The Fed will formally review its approach to monetary policy next year, and the implications are significant.
  • Philanthropy.  I don’t expand on this below, but I want to recognize my colleagues for their significant efforts in our communities. Last week, Covenant was one of twenty firms selected for the Invest in Others Charitable Foundation’s 2019 Charitable Champions List. If you want to learn more about the award, click here. Well done team!

Last Week Today. A week of answers:

  • Will the House approve the USMCA trade deal with Mexico and Canada (aka NAFTA 2.0)? Yes, confirmed Tuesday.
  • Will the Fed keep interest rates low? Yes, confirmed Wednesday.
  • Will the European Central Bank maintain an easy monetary policy? Yes, confirmed Thursday.
  • Will the U.S. and China agree to a Phase I trade deal? Yes, confirmed Friday.
  • Will the House impeach President Trump? Yes, confirmed Friday.
  • Will the UK leave the European Union? Yes, confirmed Friday.

As answers to critical questions came into focus last week, the S&P 500 and Nasdaq indices hit record highs giving credence to the Wall Street axiom that markets hate uncertainty. Less uncertainty = higher asset prices. Another popular Wall Street saying is that markets like to climb a wall of worry. With lifting uncertainty last week, one could ask what is there left to worry about?

The age-old debate on valuation is certainly one remaining worry. The S&P 500’s YTD gain of 26% this year is not the result of strong earnings growth. Instead, approximately 90% of the rise is attributable to the expansion of the Price/Earnings (“P/E”) multiple. The Forward P/E multiple on the S&P 500 is close to 18x (vs. the 25-year average of 16.24x), and the cyclically adjusted Shiller P/E multiple is 30.0 (vs. the 25-year average of 27.1). As the founder of Universa investments, Mark Spitznagel, remarked last week, “The market has become untethered from the economic fundamentals.” In these types of situations, it’s as if the law of gravity governing market valuations is temporarily suspended. “This doesn’t mean the market will crash in the short term… momentum could just as easily cause it to rise even higher.” Historically low global interest rates certainly support above-average valuation multiples. But, meaningful additional gains in the market will require better earnings growth than we saw in 2019.

For more detail on weekly, MTD, and YTD financial market performance, click on the table below.



Holiday PSA. “Hi, this is Justin. Can you help me? I’m in Vegas, and I’ve been in a car accident! Please don’t tell Michelle, but I’ve been arrested, and I need money to pay bail.” This is a true story, except it wasn’t me on the phone, it was someone impersonating me (who also said “I” had broken my nose in the accident, to cover for a different sounding voice). The call was to my wife’s parents in California. This type of scam is increasingly common and, sadly, highly effective. Typically, the scammers will request that the person on the other end of the line purchase gift cards from a store such as Walmart or Target. Once the gift cards are purchased, the scammers ask for the numeric code on the back, which they use to make purchases immediately and anonymously.


Source: Federal Trade Commission

Thankfully, my in-laws didn’t fall for the scam. They eventually reached me at work in San Antonio, and the thieves were thwarted, but that’s not the case for many, many victims. As the chart above highlights, these types of scams are occurring more frequently. Indeed, the amount of money lost in scams through the third quarter of this year is nearly equal to the total amount lost in all of 2018. In 2015, theft via gift card was only about 7% of reported scams, but that number has more than quadrupled to 33% this year.

Moreover, it’s not just family relationships who are targeted; these types of scams also occur in the workplace. The scammers research a company and then send an email from “the boss” to someone at the firm requesting they purchase retail gift cards for clients. Credit on retail gift cards can not only be spent anonymously but recovering the lost funds is nearly impossible.

If there’s any good news from this rising trend, it’s that the popularity of the scam is bringing increasing awareness. And when it comes to not being taken by the scammers, a few basic rules of thumb can save you and your loved ones a lot of money:

  • Confirm the caller. If someone calls claiming to be a relative or friend and in need of money, hang up and call that person directly. NEVER fall for the “don’t tell so-and-so” bit. If you can’t reach the person that called, try a close friend or relative to verify the situation. Patience is key, so wait to hear back from a known phone number.
  • Fishy calls. There’s not a legitimate business, tech-support service, government, or law enforcement agency that will accept payment in the form of gift cards. If you receive a call requesting payment over the phone, your suspicions should be high, and if they require payment via gift card, just hang up.
  • Verify the email. Like the fishy phone calls, emails requesting you purchase gift cards should be viewed skeptically. If you receive one, check the email address carefully to ensure it is coming from who purportedly sent the message. Preferably check it from a computer, as email addresses are often truncated on smartphones making it more challenging to identify who is sending the message. It’s worth spending a little extra time to call the person and verify the request as scammers are very good at ‘spoofing,’ masking a fake email address with one that looks legitimate.

Fed 4.0. Next year the Federal Reserve will undertake a formal monetary policy review in an attempt to understand the impact of monetary policy on the economy better. As FHN Financial points out, we are likely entering the fourth era of Fed monetary policy:

  • 1946 to 1978.  Fed pursues maximum employment  inflation and interest rates rise.
  • 1978 to 2012.  Fed pursues lower inflation  inflation and interest rates fall.
  • 2012 to 2019.  Fed pursues 2%, stable inflation using outdated models inflation and interest rates are stable but too low.
  • 2020 to ?.  Fed adjusts policy to target inflation averaging 2% instead of 1.50-1.75% → inflation and interest rates should be stable, but the range should be 0.25% – 0.50% higher.


Why now? Up until recently, economists at the Fed have blamed demographics, slowing productivity growth, and globalization for the steady decline in the equilibrium interest rate. Known as “r-star,” the equilibrium interest rate is the interest rate at which the economy can maintain both full employment and stable inflation. However, research by the Fed’s staff suggests the Fed’s approach to monetary policy is outdated and may be responsible for inflation levels consistently falling short of the 2% inflation target.

Keep in mind that the equilibrium interest rate cannot be precisely measured, only estimated. The staff’s theory is that the Fed’s reliance on traditional economic models, in a period of declining r-star, has consistently pushed the Fed to raise rates higher than necessary (the December 2018 interest rate hike is a recent and striking example). As a result, inflation has remained below the 2% target since the Financial Crisis.

We’ve written about this before, but transitioning monetary policy from the recent era of treating 2% inflation as a ceiling to using 2% as an average target is a big deal. If the Fed adopts this “symmetrical inflation goal” approach, they will be less reactive to inflation approaching or even exceeding 2% for a time when inflation has been below 2% (like it has been for the last ten years). What this means is that the Fed will be reticent to raise interest rates unless there is a clear and present danger of inflation rising significantly above 2%. Thus, interest rates will remain low for even longer, which is essentially what the Fed reiterated at their meeting last week.

Be well,