Tax Planning

In the Mood

A 2019 Gallup investor sentiment survey indicated that 52% of those surveyed said the performance of their investments affected their daily disposition, or mood. When broken down by demographics, an even greater number of retirees (63%) stated their moods were affected by the performance of their investments. Since this survey was conducted, we have experienced the Covid-induced market volatility of 2020 as well as the 2022 drawdowns in the stock and bond markets so it is likely if this survey was taken again today the results might be different, and not necessarily for the better.  From time-to-time analysts and the media will describe the stock market as having a mood, either positive or negative, which we have seen swing over the past couple of weeks. 

The first came on the heels of the credit downgrade by Fitch Ratings on debt issued by the United States from AAA to AA+ on August 1^st.  Markets moved lower the following day, with the Nasdaq having its worst day since February, but paling in comparison to the market rout that occurred in 2011 immediately following a similar (and even more surprising) move by Standard & Poor’s.  Fitch’s decision was based upon political dysfunction following contentious debt ceiling standoffs.  It remains extremely unlikely the U.S. will default on its debt and there is little doubt U.S. Treasuries will retain their status among the safest investments in the world.  However, this added layer of risk could push rates higher resulting in higher borrowing rates, such as mortgages and credit cards.  And now that two out of the three major credit ratings agencies no longer classify U.S. debt as AAA rated, perhaps it will get the attention of politicians to make some difficult (and politically unpopular) decisions towards better fiscal responsibility.  One of which very well could be in the form of higher taxes in the future. 

A week later the credit ratings downgrades of 10 regional banks, this time (ironically) from Moody’s Ratings, roiled the markets. They also placed the ratings of six banks under review and shifted the outlook of 11 banks from stable to negative.  In their report, the credit rating agency highlighted some of the issues that caused the banking crisis earlier this year have not disappeared, citing strains from a fast rise in interest rates eroding profitability.  Despite concerns about the stability of some of these institutions, deposits should remain safe from the regulatory backstops of FDIC insurance and the steps regulators took in the aftermath of bank collapses earlier this year. 

Mood Swings

Stock markets enjoyed a good month in July, with all major indices posting positive returns.  Value and growth performed in-line with each other, following through on a trend that began in June.  Prior to that point, growth stocks had largely outperformed value stocks in 2023, driven primarily by mega-cap tech stocks.  It seems the excitement and hype around A.I. is beginning to wear off as those stocks have become relatively expensive on a historical valuation basis.  The performance dispersion between sectors generally narrowed with almost all sectors performing well.  In a similar manner, small caps had an especially strong July, echoing decent performance in June after having a difficult first few months of the year. 

August is off to a more difficult start, especially in light of the aforementioned downgrades, with both the S&P 500 and Russell 1000 indices being lower by over 2%.  Value is generally outperforming growth as the technology sector has come under some pressure.  Investors have benefited from rather surprising positive returns so far this year so having the markets cool off a bit does not come as a surprise and is part of the normal market cycle. However, market sentiment is perhaps changing. Whether this becomes a longer-term structural change reflecting a slowing economy or is simply a short-term sector rotation remains to be seen.   

Even though the Fed is ostensibly winding down this cycle of interest rate hikes and inflation has become more benign, rates will remain higher for longer than previously anticipated, causing borrowing rates to remain at their highest levels in over two decades and continuing to put strain on consumers.  Employment remains strong, but the number of jobs created in July was less than expected so cracks may be appearing in the labor market.  And while one could argue about the validity of credit ratings downgrades, especially in light of the spotty track record of the ratings agencies during the 2007/2008 Great Financial Crisis, there is no reason to believe that the balance sheets of many institutions have improved, and we are not yet in the clear when it comes to the banking sector.  Oil prices have also moved higher, further putting a strain on budgets for families and companies. And even though the most recent inflation reports showed inflation continuing to slow this could reverse over the next couple of months if oil prices continue to move higher or remain where they are now. 

Looking Ahead

After raising rates a quarter point at their most recent meeting in late July, the Fed is now widely expected to pause for the foreseeable future.  Odds for an additional rate hike later this year slightly dropped after last week’s softer than expected inflation reports but this could change quickly if future data shows inflation remaining elevated or not continuing on its downward trajectory.  However, this most likely will not be a concern or affect markets over the next couple of months since it seems there is little that will impact the Fed’s rate decision at their next meeting in late September, absent an unanticipated event.

Speaking of the Fed, the annual Jackson Hole Economic Symposium will be held next week, August 24-26.  While this is not an official FOMC meeting and no action will come of it, Fed Chair Powell’s remarks last year did spook markets, sending them lower over the ensuing couple of months.  We would be very surprised to see a repeat this year, but the potential exists for comments from Fed officials to impact markets. 

Markets tend to be calm during the waning days of summer.    Earnings season is pretty much wrapped up, with the exception of reports from major retailers this week, and there are very few major economic releases prior to month-end so we do not have any reason to think this year will be different.  Often it is during the autumn months where we experience greater volatility in the markets.  This is a good opportunity to ensure your portfolio is positioned appropriately.  During retirement if you no longer can rely on a steady paycheck, investing money becomes an emotional commitment along with a financial one.  Be sure you have a solid income plan in place so you need not worry about what happens in the market;  do not let the performance of your portfolio alter your mood. 

Have a wonderful week!

Nathan Zeller, CFA, CFP®

Chief Investment Strategist
Secured Retirement
nzeller@securedretirements.com

Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.   

info@securedretirements.com
Office phone # 952-460-3260

Train Kept a Rollin’

The song “Train Kept A-Rollin,” which was first performed by jazz and blues artist Tiny Bradshaw in 1951 and further popularized by the rock group Aerosmith during the 1970s, is about a guy who is stunned by an attractive woman on a train but must act cool to not scare her away.  The stock market continues to keep rolling higher but can the participants remain cool, or will something happen to scare it?

Last week the S&P 500 posted its fourth weekly gain in the past five and the Dow Jones Industrial Average capped off its 10^th straight daily gain on Friday; its longest winning streak since August of 2017.  The small cap Russell 2000 outperformed the S&P 500 for the second straight week but the Nasdaq, whose improbable run may be cooling, was slightly lower as the shift from mega-cap tech stocks that began about a month ago continues with other sectors now showing strength.  Second quarter earnings kicked into full gear with strong results from the banking and financial sector.  Disappointing reports from Tesla and Netflix weighed on the sentiment of big tech, adding to scrutiny around valuations and higher expectations following outsized year-to-date gains.

Optimism remains in the market around the broadening of the rally and increased hopes of a soft landing.  Overall earnings reports have been generally positive and exceeded previously lowered expectations.  Signs of resilience in consumer spending and lower inflation have helped provide optimism to investors.  The headline CPI and PPI inflation reports from June showed inflation at the lowest levels in over two years, however it should be cautioned this was compared to June of a year ago when inflation reached its peak when CPI was over 9% on an annual basis.  With inflation moderating in the ensuing months of 2022, future inflation reports could become interesting since they will be compared to a year prior.  Core inflation, which does not include food and energy, remains elevated, hovering near 5% compare to a year ago.  Energy prices have been moving steadily higher this month and therefore are likely to put upward pressure on non-core, or “headline,” inflation readings over the next few months.    

Derailment?

What could derail the recent market rally or cause it to slow?  Likely culprits include higher interest rates and disappointing earnings.  Most market analysts and economists are predicting we are near the top of the current interest rate cycle.  If that is the case, then this might be an opportune time to lock in the highest interest rates we have seen since before the Great Financial Crisis over 15 years ago.  There is also a chance interest rates continue to move higher. We would suggest looking beyond some of the traditional fixed income strategies for ways to earn higher amounts of interest and protect against loss in stocks and bonds. Despite inflation falling, it remains elevated and continues to eat away at purchasing power, especially over longer time periods, making it especially important to ensure your savings are able to keep up.  This could prove more challenging in coming years as prospects of lower interest rates and more subdued stock market returns are seemingly rising.

With earnings season fully underway, the S&P 500 is reporting an earnings decline of 9% for the quarter compared to a year ago; the largest drop since the second quarter of 2020, in the midst of the COVID pandemic.  So far this has not been enough to throw the market rally off course since expectations going into earnings season were already lowered.  However, this remains an important lesson in the markets – performance is based upon expectations with future events often “baked in” to current prices. Major price movement, either negative or positive, tends to primarily be caused by surprises. 

Looking Ahead

The Fed is widely expected to raise interest rates by a quarter point at the conclusion of their meeting on Wednesday. Looking back, the trajectory of interest rates from Fed action this year has surprised to the upside but it has not been enough to thwart the stock market rally as investors have mostly shrugged it off and instead focused on the likelihood that the end of the rate hike cycle may be near.  Future Fed action will be become very dependent upon inflation data in following months so it is too early to make predictions, but current odds are the Fed will pause at the next meeting in September with about a 50/50 chance of another quarter point hike in early November. 

Earnings season continues in earnest with tech heavyweights Microsoft, Alphabet (Google) and Meta (Facebook) set to report.  Preliminary GDP from the second quarter will be reported on Thursday and is expected to show positive growth of around 2%, indicating a recession has thus far been averted but does not mean we are completely out of the woods. 

It has been hard to ignore the strong performance of the mega-cap tech stocks this year but with the broadening rally better opportunities may lie in other market segments such as small and mid-cap stocks, as well as other sectors which previously have lagged.  Given the surprising bull run, this would be a good time to review your investment strategy and rebalance your portfolio appropriately. When markets rally, many investors tend to get greedy and take on excess risk; the opposite of what should be done.  Be sure to protect yourself in the event of a market downturn, but not so much that you miss out on future opportunities.  We remain cautious in the short term but bullish in the long term.  You should remain focused on the long term and what can lead to your secure retirement and do not let it get derailed by short-term events. 

Have a wonderful week!

Nathan Zeller, CFA, CFP®

Chief Investment Strategist
Secured Retirement
nzeller@securedretirements.com

Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.   

info@securedretirements.com
Office phone # 952-460-3260

A.I. and the Magnificent Seven

As we pass the midway point of 2023, we would like to share our perspectives on what occurred in the markets in the first half of the year as well as share our outlook for the last half (and beyond).  The prospect of lower interest rates and continued economic growth, thanks to continued robust consumer spending, provided support to the markets. Also contributing to the strength was government backing of the beleaguered banking system, injecting further liquidity into the economy and helping prop up markets during a tumultuous time.  Equity markets rebounded strongly from the challenges experienced in 2022.  The Nasdaq had the best first half of a year in its history, climbing 39%, while the S&P 500 gained 16%.  Gains were primarily driven by a small handful of stocks (a.k.a. “The Magnificent Seven”) – Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla.  Much of the force behind the moves higher was based upon speculation on the prospects of Artificial Intelligence (“A.I.”).  The strong outperformance of these seven stocks propelled indices higher since collectively they now comprise well over one-quarter of the S&P 500 Index. It was not until June that the other sectors of the market began to play catch-up and also participate in the gains.  A stock portfolio not owning these particular names, especially in such large relative amounts, would have significantly underperformed the indices. This also led to many active strategies underperforming passive strategies.  It is for this very reason this reverse could occur in the second half of the year; if these stocks underperform the broader market, actively managed strategies will outperform. 

Many of this year’s best performers are now trading at high, but not necessarily absurd, valuations above historical averages.  From a fundamental analysis perspective, it would be difficult to justify purchasing certain stocks at these levels since these valuations seem stretched even if the most optimistic projections do come to fruition.  In some ways, the current environment is slightly reminiscent of the dot-com bubble of the late 1990s, in which former Fed Chairman Alan Greenspan referred to escalated asset values as being “irrational exuberance.”  When it comes to investing, timing can be everything.  Greenspan’s comments were eventually proven to be correct, however asset prices did not fall until more than three years later and in the meantime, gains in the stock market were plentiful.  Today, momentum continues to drive markets, especially the aforementioned stocks, and momentum, either positive or negative, is difficult to stop or reverse. 

 Inflation and the Fed

Inflation has been slowly decelerating but remains persistent and above the Fed’s stated comfort zone. After a series of 11 consecutive interest rate hikes the Federal Reserve decided to pause in June and keep rates steady, however they have indicated they anticipate raising rates at least two more times this year. Even though they are signaling future hikes, the Fed does appear to be nearing the end of the current rate hike cycle.  We could see a pattern of single quarter-point rate hikes followed by pauses to allow the Fed to assess monetary policy lag until they deem the job is finished and inflation is fully under control.  When the Fed does decide to fully stop, it seems likely interest rates will be held “higher for longer” and will take some time before being lowered.  One concern is that inflation, as measured by the government, could again accelerate, spurring further Fed action.  Data shows that inflation peaked in June of last year with subsequent months showing continuously lower levels of year-over-year price changes.  Now that the high readings of 2022 are more than a year in the past, future readings will be compared to 12 months prior when inflation was more subdued, increasing the probability of higher readings. Conversely, a worse than expected recession could spur the Fed to lower rates sooner than expected, but this is not an ideal scenario and would coincide with markets reacting unfavorably to economic data.  If a recession is avoided in the short term and employment remains robust, which it has thus far, the Fed will see no reason to stop the current campaign.  It should be noted that unemployment tends to trough, or reach its low point, at or near the beginning of a recession and then as the recession takes hold, jobs are cut, causing unemployment to spike.  Unemployment continues to sit near multi-decade lows, so any inference that we are not in a recession because of the strength of the labor market is a faulty argument. 

Soft Landing or Recession???

In addition to interest rates, corporate earnings are the other main factor driving the stock market over the long-term.  Earnings are expected to drop compared to a year ago as inflation continues to pressure margins.  We may already be in the midst of an earnings recession (not to be confused with an economic recession).  According to FactSet, the S&P 500 is expected to show a year-over-year earnings decline of 6.8% for the second quarter of 2023. Interestingly, earnings per share estimates declined during the quarter while the S&P 500 Index rose.  Increased probabilities of a soft landing coupled with the prospect of lower interest rates overcame lowered earnings expectations to push markets higher.  This may not be the case going forward; lowered earnings coupled with higher interest rates could become a major headwind for the markets and derail the recovery. 

Just about every Wall Street analyst has predicted a recession over the past year, but we have yet to see one. Are these analysts being too pessimistic or has the timing been off?  One school of economic thought is that the supply of money is a clear cause of inflation.  During the COVID pandemic we experienced the largest-ever expansion of the money supply through government stimulus programs and very loose monetary policy from the Fed. The stimulus payments have driven strong consumer spending, helping to prop up the economy over the past two years. When the stimulus money runs out, spending will return to normal levels and no longer provide as much support for economic growth.  More recently, higher interest rates and tighter bank lending standards have shown signs of reducing the money supply and historically contractions in money supply lead to a recession.  However, this seemingly has been the most anticipated and predicted recession of all-time so perhaps the bad news has already been priced into the stock market.

Looking Ahead

If you have been invested in the stock market you have most likely enjoyed rather robust gains this year, but you missed out if you are sitting on the sidelines.  We would recommend not trying to chase the current trends as it may be too late, but instead look at investing in a well-diversified portfolio.  We do not necessarily think a pullback is imminent, but rather see a slowdown with the “easy money” having already been made and gains being more difficult to achieve going forward. We expect returns to be more muted in the second half of the year. While we might sound pessimistic, we do not expect a major downturn but more of a levelling off in the market and do remain optimistic regarding certain sectors and strategies.  With the prospect of more muted gains, dividends could play a larger role in overall returns.  This is a good time to consider other investment alternatives and look beyond the traditional stock/bond portfolio.  Given the outlook for more modest market returns and further market volatility, it may be wise to consider protection strategies.  Many of these strategies provide potential for growth or income should the markets continue to rally but there is also downside protection should they fall. Risks certainly exist, as they always do, which have the potential to drive markets lower.  It is also a good time to remind ourselves that markets do not always behave logically and rationally. 

Despite what happens in the second half of the year and whether our outlook proves accurate or not, we would like to remind everyone that investing is a long-term proposition.  You should only invest money you do not plan on spending in the short term so you can ride out market fluctuations over longer periods of time.  Looking forward, we see challenges with returns possibly being less than we have experienced in recent memory while inflation remains persistent, chipping away at purchasing power. 

While both optimistic and pessimistic investors are due to be right often enough to boost an ego, at least in the short-term, we feel a better approach may be to focus less on the funds invested for long-term wealth accumulation, and more on a comprehensive plan built around a spend in confidence, pay taxes consciously approach, we feel you will be rewarded with a comfortable retirement.  We will continue to monitor the markets as we always do, making changes in portfolios when warranted, but we view our primary role for our clients being to ensure that the wealth accumulation from investment markets supports a well-designed retirement plan.  To discuss your individual situation or learn more about some of the strategies we are currently implement do not hesitate to contact us.  Our goal is to help guide you towards a Secured Retirement, regardless of what the next six months of 2023 provide in the financial markets. 

We hope you are having a great summer!

Nathan Zeller, CFA, CFP®

Chief Investment Strategist
Secured Retirement
nzeller@securedretirements.com

Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.   

info@securedretirements.com
Office phone # 952-460-3260

Summer Camp

In the summertime parents often send their children off to camp which generally is somewhere in a forest often near a body of water.  For parents it gives them a reprieve from having to keep their children occupied while not in school and for the children it is an opportunity to hang out with others their age as well as take part in outdoor activities.  While certainly not a restful vacation, camp tends to be a quiet time over the summer and a break from the normal routine.  The markets seem to be slowing down and taking a bit of a break, leaving us to wonder if this will continue for the remainder of the summer or if it will be short lived.

Last week the major indices finished lower with the S&P 500 breaking a five-week winning streak and the Nasdaq an eight-week streak.  There was not a main driver of the slight pullback with many analysts attributing it to the possibility the stocks which have recently enjoyed abnormally large gains perhaps are overextended or at least need to take a breather.  Otherwise, there were few changes to the broader themes that have been recently discussed.  During an appearance on Capitol Hill, Federal Reserve Chair Jerome Powell reiterated that two additional rate hikes are “a good guess” if the economy continues to perform as expected. This is in-line with comments made the prior week and the recently released Fed “dot-plot.”

The markets have been led higher this year by a small group of stocks with outsized gains, most of which have been associated with the artificial intelligence (A.I.) craze.  Reviewing valuation metrics of the stock market, the valuations of hyper growth stocks has fallen considerably from two years ago but remain elevated above long-term averages.  The recent market run-up has made them more expensive, especially on a relative basis compared to other sectors and higher quality stocks.  But as we’ve often seen in the past just because a stock or sector is cheaper does not necessarily guarantee it will perform better going forward.  We remain cautiously optimistic on the markets for the second half but think strength will come from different sectors and names than we saw in the first half.    

Campfire Songs

While at camp, once the sun goes down and it gets dark the children may gather around a campfire to sing songs and tell stories.  The songs tend to be of good nature and often elicit laughs while the stories may be of the scarier variety, often of a dreaded creature emerging from the darkness of the forest in which the campers are gathered.  What types of scary creatures could emerge from the darkness to derail your retirement?

There are always unanticipated threats such as war, natural disasters, pandemics, just to name a few, but we also try to think about the more common occurrences which could negatively impact the markets.  With the Fed seemingly winding down, the threat of higher interest rates seems to be abating but are we being lulled into a false sense of security?  Will inflation continue to abate and eventually fall to a level comfortable for the Fed as well as the general public where it does not inhibit economic growth?  It seems to be slowly headed this direction, but still has a long way to go. And while no longer near the multi-decade highs in inflation we were experiencing a year ago, increases in prices continue to lead to an erosion of purchasing power.  Even if inflation remains in the 4-5% range, this will erode purchasing power considerably faster than if inflation were around 1-2% so obviously should not be overlooked in your retirement planning. 

We also remain focused on corporate profits, which is the largest driver of stock market returns over the long term.  As of March, earnings expectations for the S&P 500 had been lowered by 12% from the prior year, leading to more positive earnings surprises from the first quarter than expected, providing a tailwind for the markets.  Since then, Wall Street analysts have increased their earnings estimates 2-3% for the next twelve months.  The change in sentiment, while not large but if proven accurate, does give stocks a firm foundation to climb.   On the other hand, with increased expectations comes increased risk they are not met, providing a headwind for the markets.  Historically, positive earnings surprises have averaged 4-5% of the companies in the S&P 500 in any quarter.  The first quarter of this year, nearly 7% of companies beat expectations, much better than the less than 1% that did in the fourth quarter of last year. 

Looking Ahead

This is the last week of this quarter and will end a positive first half of the year, exceeding most expectations and predictions.  The threat of a recession continues to loom large, especially as the yield curve remains inverted with the negative yield spread between 2-year and 10-year Treasury bonds around a full one percent, which is significant by historical standards.  In the past an inverted yield curve has been a strong recession predictor, with a lag of 12 – 18 months.  For reference, the 2-year/10-year inversion began in July of last year and if history is any indication, we very well could see a recession in the second half of the year.  But since a recession has been so widely anticipated for so long, it may not have much impact on the stock market since it may already be priced in.

We will continue to watch inflation and further action from the Federal Reserve.  A quarter-point hike at their next meeting in July is expected. The Personal Consumption Expenditures (PCE) inflation report this week will give ore clarity but since a major move is not anticipated it seems unlikely to derail the Fed.  Even though it is summer and market activity seems to be slowing, we continue to remain vigilant and watch the markets so you can spend time at camp, on vacation or at your cabin.  We are here to help you feel confident in your retirement, despite what might be lurking in the darkness. 

Have a wonderful week!

Nathan Zeller, CFA, CFP®

Chief Investment Strategist
Secured Retirement
nzeller@securedretirements.com

Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.   

info@securedretirements.com
Office phone # 952-460-3260