Tax Planning

Catching Lightning in a Bottle

The idiom catch lightning in a bottle means to accomplish a nearly impossible task, to trap something elusive or fleeting. The origins of the phrase have not been verified but it is often credited to Benjamin Franklin’s experiment where he flew a kite during a thunderstorm in hopes of lightning striking the kite, traveling down the string and being collected in a Leyden bottle. (Fortunately the experiment was a failure, otherwise one of our country’s Founding Fathers could have been electrocuted.)  The Federal Reserve is faced with a nearly impossible task right now, engineering a “soft landing” for the economy. 

We are dealing with historically high levels of inflation now due to supply chain constraints and higher demand for goods and services resulting from stimulus payments and easy monetary policy.  While the latter two were most likely necessary to keep our economy from ruin during the early days of the pandemic, looking back it can be argued that we, or more precisely our government officials, went too far.  In hindsight, there is little argument that the Federal Reserve was too loose with monetary policy and should have began tightening much sooner instead of insisting that inflation was “transitory.”  Now the Fed is faced with difficult decisions, the implications of which might be the largest in a generation, if not longer.  If they do not tighten the money supply enough, through interest rate hikes and bond buying, a.k.a. quantitative tightening (“QT”), inflation is likely to get worse and we will be faced with even larger problems.  If they tighten too much, especially by raising interest rates too quickly, the risk is it will slow growth considerably and cause irreparable harm to the economy.  Hence, the goal of doing enough but too much so there is a “soft landing,” such as what one hopes for when flying in an airplane.  With the size of the economy being about $25 trillion dollars, this certainly is no easy task. 

As expected, the Fed did raise interest rates by one-half of one percent, often quoted as 50 basis points, last week. This was the largest increase since the year 2000.  After the meeting, Fed Chairman Jerome Powell stated that a three-quarter point, or 75 basis point, hike was not likely at the next meeting, but it remains widely anticipated we will see half-point increases for at least the next two Fed meetings.  The Fed Funds rate is now at 1% while inflation remains near 8%.  There is no magical formula that says the Fed Funds needs to match the inflation rate, however conventional knowledge says that interest rates have a lot of room to move higher before they have the desired impact on bringing down inflation.  Interest rate hikes generally take months to work through the system and have a noticeable effect, so the Fed also must be concerned about not “overshooting” and raising rates too much or too fast. 

Lightning Strike

As an 80-1 longshot, Rich Strike won the Kentucky Derby over the weekend.  Given the odds, the name seems fitting and might even conjure up an image of a lightning strike.  There were some storm clouds over the stock market last week, where we experienced wild swings, especially on Wednesday after the Fed meeting with the market being significantly higher, and then again on Thursday where the markets suffered their worst losses in over two years. Despite the day-to-day roller-coaster ride including some signs of panic, the S&P 500 and Dow “only” lost 0.2% for the week while the tech sell-off continued with the Nasdaq dropping 1.5% for the week.  It may seem incredulous, and is certainly unprecedented, but bond yields continue to move higher, causing continued pain in the bond market.  This is the worst year-to-date start for the Bloomberg Barclays US Bond Aggregate Index since its inception in 1977.  Even in 1994 when the Fed raised rates six times for a total of 2.5%, the index only lost 3% compared to the 10% losses experienced so far this year. 

Last week the monthly employment report showed continued growth in the labor market and unemployment remaining steady at 3.5%, a relatively low number.  The reported increase in hourly earnings was slightly less than expected, leading to some postulation that labor costs are perhaps slowing which could ease some of the inflationary pressure since this is a major expense for most businesses.  Job openings remain at historically high levels, but the labor force participation rate decreased signifying there are fewer people in the workforce. Overall the labor market remains strong and is not showing signs of cracking, despite reports of a slowdown in economic growth.  In the eyes of the Fed this is good news because they have the dual mandate of price stability and maximum employment so they can maintain their focus on the former for the time being, but this also indicates they can continue to raise rates for the foreseeable future since the labor market does not yet seem to be affected.

Looking Ahead

The monthly Consumer Price Index (CPI) and Producer Price Index (PPI) reports will be released this coming week.  As inflation remains a central theme, not only in the markets but also in everyday life, there will be a lot of attention on both. Projections are these reports will show that inflation has slowed from last month but they are both fully expected to reflect a continuation of rising prices. Even if inflation does start to slow it is likely to take many months, if not years, to return to long-term “normal” levels and the large price increases already experienced will not be reversed. 

The continued volatility in the market is a good reminder of the importance of having a solid plan in place and maintaining a long-term outlook.  When it comes to buying stocks, it should not be short-term speculation, but rather investing in companies that will provide shareholder value over the next several years.  It is nearly impossible to catch lightning in a bottle;  don’t leave your retirement up to a long-odds chance, let us help you craft a solid plan to weather all storms. 

Have a great 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

Truth or Consequences

A popular game show on TV during the 50s and 60s was Truth or Consequences where contestants were asked wacky questions and if they were unable to answer correctly, they then had to face the “consequences,” which generally was an embarrassing stunt.  There are times in real life where we have to deal with the truth, or a hard reality, and then deal with the consequences of whatever decision was made.  For example, you might decide to attend a party and stay out late (which the author considers to be anytime after 9:30) but the next day you will have to deal with the consequences.  We are now facing the truth of past action from policymakers and have to deal with the consequences in the markets. 

The consequences of many years of low interest rates and a burgeoning money supply, in the form of stimulus, are now being felt via high levels of inflation, which has only been exacerbated by the pandemic and geopolitical events. Last week’s stock market weakness was attributed to comments from Federal Reserve officials emphasizing that more aggressive action will need to be taken to combat inflation.  Expectations now are for half point interest rate hikes at each of the next two Fed meetings, and quite possibly the two after that.  The Fed is also expected to use another tool in their arsenal to combat inflation – reduce their balance sheet by selling bonds, which would reduce the money supply.  Did we mention there is even some chatter about the potential for the Fed to raise rates by as much as 75 basis points (three-quarters of one percent) at one of their upcoming meetings? We do not think this is likely, but it is certainly possible, and something to consider since inflation seemingly continues to accelerate. 

The S&P 500 and Nasdaq suffered their third consecutive week of losses, with Friday being the largest losing day since the onset of the pandemic in March, 2020.  Earnings season kicked off in earnest and positive momentum in the market showed promise mid-week but unfortunately this quickly faded. Many of the earnings reported were worse than the already lowered expectations or the companies provided underwhelming forward guidance.  Most notably was Netflix, which showed a loss of subscribers for the first time in history.

There is no place investors are dealing more with truth and consequences of their past decisions than with the “profitless” tech stocks, many of which are down as much as 70 to 80 percent from their highs.  These stocks are speculative since they are bought with a hope that at some point the company will turn a profit.  However, stock prices are affected by the present value of future earnings, which are dependent upon interest rates.  With interest rates rising, the present value of earnings becomes less, putting pressure on share prices.  This niche of the market, which is primarily in the tech sector, strikes an eerie similarity to the tech crash of the early 2000s. 

Flight to Safety???

We have touched on this in the past but it is worth revisiting given what has happened over the past few weeks.  Conventional wisdom when it comes to asset allocation is to buy a mix of stocks and bonds with the thought being that bonds will perform well when stocks fall as there will be a “flight to safety.”  Going further, the thought is that even if bonds do not increase in value when stocks fall, their volatility should be less, and any potential losses will be relatively small especially in comparison to stocks.  Over the past few decades this has worked rather well since inflation has been fairly benign and interest rates have remained mostly steady.  Now that inflation is stubbornly high and interest rates are quickly rising, this strategy is not proving to be as successful.

Year-to-date the most widely followed bond index, the Bloomberg Barclays Aggregate Bond Index has lost nearly 10%.  This does not sound like something providing protection against market downturns.  Longer duration bonds have performed even worse with the iShares 20+ Year Treasury Bond ETF (Ticker: TLT) losing almost 19% year-to-date.  Both investments did very well during the financial crisis of 2008-2009 since investors dumped stocks and moved into the relative safety of bonds.  At that time, we were dealing with a deflationary environment and interest rates were falling. Now we have high levels of inflation and interest rates are rising so the inverse relationship between stocks and bonds, especially longer duration Treasury bonds, is no longer holding and bonds are not providing the protection they once did.  As can be seen, bonds have lost more value than stocks in the short-term, a pattern which very well could continue as interest rates continue to rise.  We would advise looking elsewhere for protection and diversification.    

Looking Ahead

It is difficult to sugar coat the stock market action on Friday since 489 out of 504 stocks in the S&P 500 lost value. This coming week major tech bellwethers Apple, Amazon, Microsoft, and Alphabet (Google) report earnings which is bound to impact how the markets perform.  The S&P 500 is trading near the lows reached in March so we think we might see a short-term bounce, especially since the prospect of larger interest rate hikes from the Fed have been baked into the market. That being said, we remain long-term investors and maintain our focus on what the markets will do over the next several years versus the next few weeks.  Short-term predictions are mostly for fun and not what should be used to make investment decisions.  More “experts” are now predicting a recession sometime in 2023 which seems probable but often times the stock market, which is a leading indicator, reflects months in advance.  And it is worth mentioning there often is a dichotomy between the stock market and economy, so a market downturn does not always coincide with a recession.  If you are concerned about market volatility and would like to discuss ways to protect your assets please give us a call to discuss your individual situation further.    

Have a great 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

Up, Up and Away

For those of you who were around in the late 1960’s you might remember the song “Up, Up and Away,” which was themed around riding on a hot air balloon.  The song has a light, airy feeling and is an example of “sunshine pop” which was popular at the time.  A large hot air balloon conjures images of something leaving the ground and floating high into the air.  Sound familiar?  As everyone is aware, this is what is going on with prices of just about everything right now – they are moving higher and seem to be headed into the stratosphere. 

Not surprisingly, the inflation data released last week showed a continuing momentum higher and marked the largest year over year change we have seen in 40 years.  Even the “core” inflation numbers, where food and energy are removed, were relatively high implying that costs of just about everything are rising, not just energy which has recently received the most attention. With energy prices pulling back over the past few weeks some economists are thinking we have now reached “peak” inflation and the pace of inflation will begin to subside.  Even if this is the case, inflation will remain elevated and near the highest levels seen in decades. We are not convinced this is what will happen since the Producer Price Index (PPI), which measures wholesale prices, rose by a whopping 11.2% compared to a year ago and notably higher than expectations.  These price increases are passed along to consumers, therefore we expect consumer price increases to continue, and possibly further accelerate, for at least the next few months.    

From a consumer perspective inflation is bad if income does not keep pace since purchasing power is eroded, but from a borrower’s perspective inflation can be good since the money that is being paid back is worth less than the money borrowed.  If the interest being charged on the borrowed money is equal to the rate of inflation it is basically a break-even proposition for both sides, but if the interest rate charged is less than the rate of inflation then the borrower is coming out ahead.  What is an example of a very large borrower who is paying a relatively small amount of interest and therefore is benefitting from high inflation?  The heavily indebted U.S. government may be the first one that comes to mind.  (If you want to learn more about the current state of government debt, you will want to hear David Walker speak. More about that later.)

“Sticky” Inflation

Hot air balloons eventually return back to the ground.  Prices generally do not return to where they were, unless there is deflation and the odds of that occurring anytime soon seem miniscule.  If prices move higher but inflation eventually subsides, prices tend to remain elevated from where they were previously and therefore “stick.”  Some price inflation is good since it reflects economic growth but when price increases are higher than wages and consumers’ incomes are unable to keep up with the cost of goods and services they purchase, then we could see slowing, if not stagnant, economic growth. 

The labor market remains robust and unemployment remains low, but data released from the Bureau of Labor Statistics indicates that wages are not keeping up with inflation. With wages adjusted for inflation, or “real” wages, falling and prices increasing, discretionary spending is likely to pullback also.  Consumer sentiment data released last week was higher than expected, showing that consumers are remaining resilient.  However, it should be noted there have been reports of an increase in consumer credit, meaning more people are using credit cards to make purchases and not immediately paying them off, presumably because they are unable to.

Consumer spending makes up nearly two-thirds of GDP, so a slowdown in spending would likely lead to a slowdown in economic growth, which in turn could lead to smaller or even stagnant wage growth and we enter a downward spiral.  On the other hand, some of the supply chain constraints are being caused by a lack of labor so if job openings are filled, the supply constraints could lessen, and we could potentially see an increase in economic growth.  As of now, it seems the former, not the latter, is more likely. 

Looking Ahead

Earnings season began last week and gets going in earnest this coming week. Expectations have been lowered slightly but earnings are still expected to show growth compared to last quarter and a year ago. Since earnings growth tends to drive the stock market there is hope for some market strength, but with lowered expectations it seems unlikely we will see a large move upwards.  Often times, companies report strong earnings but give lowered outlooks, causing stock prices to drop.  Expectations have already been lowered and the market has pulled back, so perhaps this has been priced into the market and positive surprises will provide a tailwind for stocks.  There remain many dark clouds hanging over the market so we are not as optimistic as we were a few months ago.  Hopefully we are wrong in our assessment and the next big move in the markets is to the upside. 

With relatively benign inflation over the past 20 years most investors have become complacent and now higher inflation is making many wonder how to combat it.  The recent stock market pullback does not help and we are likely to experience continued challenges in the markets during the months and years to come.  This is why we emphasize the importance of having a solid income plan in place during retirement which can weather all storms and keep up with inflation.  If you have not reviewed your income plan recently or do not have a steady plan in place, please contact us to discuss further before the inflation balloon floats away and out of reach. 

Have a great 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

Choose Your Own Adventure

When I was growing up, “Choose Your Own Adventure” books became popular.  In these books the reader becomes the protagonist and makes choices which determine the final outcome.  What I especially enjoyed is that after reaching one ending, I would return to a decision point, make a different choice and the story would have a different conclusion, providing various stories within the same book.  Savers and investors also make decisions which ultimately affect their outcome but unfortunately in real life, you do not have the ability to go back and make a different decision in hopes of realizing a different result. What makes investors’ decisions complicated is that nobody knows for certain what the markets are going to bring in the future, so choices can only be made using the best information available. 

Many investors tend to review past decisions and evaluate what they could have been done differently. Spending a reasonable, not excessive, amount of time doing so can be helpful for making future decisions since history tends to repeat itself and we can learn from our mistakes.  History does repeat itself, but it is very rarely exactly the same.  Right now, the major market headlines include inflation and rising interest rates with comparisons to conditions of the late 1970s and early 1980s.  There are similarities between then and now, but there are also differences. For example, we have a stronger labor market today which is fueling higher wages and contributing to inflation.  When not accompanied by high inflation, higher wages provide workers with the ability to increase their spending since they are receiving more pay.  The concern is that “real” wage growth, which is the growth in wages adjusted for inflation, is currently negative so consumer spending will slow, leading to slower economic growth. 

Speaking of the markets, April has come in like a lamb.  This does not mean it has been quiet or lacked volatility, but rather it has not roared to new highs as if it were a lion.  Last week the stock market retreated as more Federal Reserve officials indicated they expect interest rates to increase at a faster rate than previously expected due to inflationary pressures remaining elevated and possibility accelerating.  Not surprisingly, these comments also caused bond yields, especially longer term, to move higher.  In the past, interest rate increases have been a headwind to equity returns, which is what we have experienced so far this year; so in the short-term history does appear to be repeating itself. 

Multiple Outcomes

There is always some uncertainty in the markets and economy, but there seems to be an abnormally higher amount now.  The yield curve, which was inverted a week ago, has for the most part “uninverted” but remains flat.  Recent movement in the yield curve has led some economists to predict a recession, but not until late this year or sometime in 2023.  Higher costs and lower inflation-adjusted wages are likely to lead to less spending which would slow growth but will it pullback enough to cause negative growth, a.k.a. a recession?

There could also be a case made for deflation in the future, as spending slows and energy markets normalize.  As a side note, another differentiator between now and 40 years ago is that the energy markets are substantially different but that is another topic unto itself.  Only time will tell if we end up with higher inflation or deflation over the next year, but either way the outcome could be similar – a recession.  There is a chance the Federal Reserve engineers a “soft landing” with inflation and interest rates where the market does continue on a strong bull run but that probability seems to be diminishing and lower than other possible outcomes. 

The real question for investors is how this affects the markets and what choices need to be made.  As for the bond market, higher interest rates, most likely much higher, seemingly continue to be on the horizon so bonds are probably not going to be a great place to be invested, at least for the next several months.  As we discussed last week, most of the time the stock market retreats well in advance of a recession.  And recessions are not always accompanied by bear markets.  But current conditions seem to be pointing towards higher probabilities of a market decline than we have seen in many years. 

As an investor you have the choice of taking your money out of the market, potentially missing out on opportunity with a rebound.  On the other hand, if you remain fully invested and the market drops you will lose some of your hard-earned savings.  Another option would be to reduce holdings and hold some cash.  In gambler’s parlance, this is referred to as “taking some money off the table.”  By remaining mostly invested you would be able to capture market gains should the market move upward but if it were to drop you would have cash available for a buying opportunity. Over the longer term, the stock market continues to hold a lot of potential especially for sectors such as healthcare and technology, which will continue to innovate and impact our lives.  Much of the investing decisions made today should be dependent upon your individual tolerance for risk and shorter-term liquidity needs. 

Looking Ahead

The upcoming week will bring numerous events with market-moving potential, especially the kick-off to Quarter 1 earnings season and the release of Consumer Price Index (CPI) numbers for March.  According to FactSet, the expectations for year-over-year increases in earnings for the S&P 500 has been lowered but remains positive compared to a year ago.  With energy prices recently pulling back, the March CPI report has the possibility of reflecting “peak” inflation but even if that is the case the highest levels of inflation in 40 years have already caused damage to the economy, by way of largely affecting consumer spending, and reduced purchasing power.  And even if this is the highest point inflation reading, price increases are likely to remain persistent with elevated inflation for at least the next several months. 

Despite what happens with the markets and economy, we can expect volatility to continue. This is a critical juncture to make decisions which will affect the outcome of your long-term financial plan.  We are here to help you make the best choices to be successful.  Do not try to be your own guide in this adventure, leverage the expertise and knowledge of professionals so you can choose wisely. 

Have a great 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