Leadership Perspectives | 11.02.21
For Booming Advisory Industry, Troubling Macro Conditions Can’t Be Ignored
From thorny compliance headaches to recruiting and marketing challenges, there’s never any shortage of things for heads of advisory practices to tackle. That’s the case even in the best of times, which, by some measures (e.g. stock market valuations of publicly traded advisory firms), we seem to be in – right now – seemingly.
Against this perhaps fleeting rose-colored backdrop, a lead macro factor has risen to the fore, center stage, under a fluorescent spotlight: inflation.
Some economists fear rising prices could be on the cusp of going from "transitory" to something more akin to an out-of-control spiraling. Worst-case scenario contingency plans should be at the ready.
Some inflation, as a sign of growth, is not all bad and can even bode well for banks and advisory firms, as securities markets keep reaching record highs and with heaping pools of cash sloshing about after years of loose money supply.
But what if inflation does rise more steeply, more quickly, than anyone at central command ever bargained for?
Suffice to say, it wouldn’t be great for the financial sector.
If inflation continues to rise, and at a faster-than-anticipated clip, the U.S. Federal Reserve monetary policy would likely get much more hawkish.
Banks borrow at short-term rates; they lend at longer-term rates. Industry leaders can do the math.
"When the Fed raises short-term rates aggressively," as Charles Schwab's David Kastner explained, "it typically leads to expectations for slower economic growth that can drive long-term rates lower, resulting in lower net interest margins and potentially weaker relative performance for financials."
So, what could mitigate such headwinds?
“Historically strong balance sheets,” said Kastner, Schwab's senior-most investment strategist.
A Truly Banner Year
A closely followed financial sector bellwether company is Raymond James. It recently closed the books on a remarkable fiscal year (ending Sept. 30), one in which its advisory business reached a pinnacle, Paul Reilly, chairman and CEO, told analysts on a call late last month.
The firm just turned in exceptional results. Raymond James at the end of October reported record quarterly net revenues of $2.7 billion and record quarterly net income of $429 million.
“The increase in quarterly net revenues was largely driven by record investment banking revenues and record assets under management and related administrative fees, primarily due to higher private client group assets and fee-based accounts,” according to Reilly.
"We've proven once again that focusing on providing outstanding service to our advisors and their clients will guide us through uncertain economic and global conditions," he continued.
And one more note of optimism from Reilly, featured in a late October CNBC segment titled "Financials on Fire.") He thinks inflation is transitory.
But what if it's not?
Worst Case What If
Stocks are at record highs. Valuation levels are reminiscent of October 1929. Year-over-year inflation, as of the end of September (reported in late October), rose at its fastest pace in more than three decades, according to the Commerce Department.
“Such persistently high inflation across world economies, manifest throughout the fall, has prompted a shakeout in bond markets,” the Wall Street Journal reported in early November.
Investors expect central banks to quickly tighten monetary policy. All eyes are now on the Fed.
Based on recently released minutes from a September policymaking meeting, some Fed officials have said inflation could last longer than they had previously assumed.
As 2021 comes to a close, the central bank is likely to begin winding down its $120-billion-a-month asset-buying program with an eye toward ending those purchases in mid-2022.
Additionally, the labor force has changed in a structural way, complicating the tightening game plan, and there is the real risk that the Fed ends up raising rates too soon.
Supply chain bottlenecks, spurring inflation, may loosen; if, at the same time, the Fed were to raise rates in the weeks ahead, that could weaken the economy.
“We could easily find that demand is damping just as supply is increasing,” Randal Quarles, a member of the Fed’s Board of Governors, said in a recent speech. “In the worst case, we could depress the incentives for supply to return, leading to an extended period of sluggish activity.”
Stagflation Fears Also On Rise
It’s not just inflation causing indigestion. It’s also stagflation, a boogeyman of a macroeconomic condition, one marked by high inflation and high unemployment and prone to flummox policymakers largely handcuffed in a double-edged, choose your own peril environment.
As of early November, there were manifestations of stagflation in China, as prices continue to rise while the latest manufacturing data showed production slowing, economists said.
Stagflation remains at the top of the list in terms of the walls of worry reported by some Registered Investment Advisors (RIAs), who were surveyed by CNBC.
Most investors typically do not have stagflation on their radar. But they are measurably worried about inflation.
Nearly three-fourths of retirement age investors said they believe rising inflation will negatively affect their retirement savings, according to a recent survey from Global Atlantic Financial Group.
Despite the looming specter of worsening inflation, the advisory industry itself is healthier than ever, particularly as measured by the stock market, cash balances and mergers and acquisitions, numerous Schwab executives said during the firm’s Impact Conference held last month.
A majority of RIA firms are looking for M&A opportunities to get bigger and grow their capacity, according to Schwab Advisor Services. But the window on doing deals seems to be closing fast. Thanks to the macro headwinds that, it would appear, can no longer be dismissed as merely transitory.